Debit Issuers Respond to Post-Regulation II "New Normal"
2013 Debit Issuer Study finds large and small issuers taking actions in response to economic impact of debit industry regulations
HOUSTON, July 10, 2013 — Financial institutions participating in the 2013 Debit Issuer Study, commissioned by PULSE, experienced continued growth in their debit businesses despite downward pressure on interchange revenue as a result of Regulation II. Additionally, the study details financial institutions' opinions and plans with respect to prepaid, EMV and mobile payments.
"The post-Regulation II era represents an important time for the debit industry, and the latest Debit Issuer Study provides a comprehensive look at what changes issuers are making in response to this environment," said Steve Sievert, executive vice president of marketing and communications for PULSE. "Even in the face of significant regulatory challenges, issuers managed to grow their debit volumes in 2012 and expect further growth this year."
Post-Reg II "new normal" for debit continues to take shape
Reg II's cap on interchange rates has reduced debit interchange revenue for issuers with at least $10 billion in assets ("regulated issuers"). Average interchange rates for regulated issuers have declined by 59 percent for signature debit transactions (from $0.52 to $0.23, on average) and by 32 percent for PIN debit transactions(from $0.32 to $0.23, on average) compared with pre-Reg II levels.
The study also found downward pressure on interchange rates for issuers with less than $10 billion in assets ("exempt issuers"). While not subject to the regulatory interchange cap, exempt issuers cited competitive dynamics as the cause of a decrease of $0.02 in their average interchange rates for both signature and PIN debit transactions. One in three exempt issuers anticipates further declines in debit interchange.
In response to this reduction in interchange revenue, both regulated and exempt issuers are making fundamental changes to their debit businesses. The most common actions are:
- Reducing debit operating costs to better align costs with debit's new revenue proposition;
- Reducing fraud to support the cost-containment goal and to qualify for the fraud prevention payment outlined in Reg II;
- Adjusting their overall demand deposit account (DDA) product structures to either grow the financial institution's share of wallet with a particular type of account holder or direct account holders to accounts that generate more revenue or have lower service costs; and
- Restructuring or eliminating traditional issuer-funded debit rewards programs (40 percent of regulated issuers terminated or restructured their programs in 2012).
This changing environment defines the "new normal" for the industry. Despite these changes, issuers experienced continued growth in their debit businesses in 2012. Overall, there was a 14 percent increase in PIN transactions and a 6 percent jump in signature transactions. When asked about their outlook for 2013, issuers were more cautious. Survey respondents project smaller growth levels this year, with PIN volume forecast to increase by 8 percent and signature transactions by 4 percent.
"Issuers are more tepid in their outlook for debit. They still expect the industry to grow, just not as rapidly as in the past. In fact, this is the lowest growth projection for signature debit we've seen since the study began," said Tony Hayes, a partner at Oliver Wyman who co-led the study.
For 2012, issuers reported strong performance in key debit metrics: penetration, active rates and usage (transactions per card). Penetration and active rates both improved year-over-year. Penetration increased to 77 percent from 76 percent in 2011, and active rates were 68 percent, compared to 66 percent in 2011. The average active cardholder performed 19.4 debit transactions per month in 2012, up from 18.3 in 2011. As a result, the total annual spend per active consumer debit card reached $8,753 in 2012 vs. $8,326 in 2011.
As in past years, the 2013 Debit Issuer Study examined financial institutions' debit card fraud. Issuers reported a decline of approximately 30 percent in their net fraud loss rates for both signature and PIN debit. Signature fraud losses fell from an average of $0.031 per transaction in 2011 to $0.020 per transaction in 2012. PIN debit remains eight times more secure than signature debit, with fraud loss rates dropping from $0.004 per transaction to $0.003 per transaction.
New developments in "adjacent areas"
Beyond the core debit business, issuers reported mixed outlooks on a range of topics spanning prepaid cards, EMV and mobile payments.
A record number of financial institutions (84 percent) now offer some type of prepaid card. The most commonly offered prepaid product is gift cards, which are sold by 73 percent of issuers, but due to low sales, issuers tend to be indifferent toward the product. By contrast, a growing number of financial institutions are entering the general purpose reloadable (GPR) prepaid space, with the percentage of GPR issuers almost doubling between 2011 and 2012 from 19 percent to 36 percent.
Some issuers are positioning GPR cards as supplemental accounts designed for their existing accountholders; others are launching GPR prepaid products to serve consumers outside of the banking mainstream. Financial institutions project 55 percent year-over-year growth for their GPR card sales in 2013 (compared to a projected 2 percent decline in prepaid gift card sales).
With respect to EMV, the chip-based payments standard, 95 percent of issuers are aware of networks' plans to shift the liability for disputed transactions in 2015. In anticipation of the liability shift, 38 percent of financial institutions plan to issue chip-based debit cards in 2014, with another 8 percent planning to issue the cards in 2015. However, many institutions remain unsure of how to support EMV, while also adhering to their merchant routing choice obligations within Reg II. In this environment, more than half of issuers reported that their plan is to wait to see if the industry converges around a common solution.
In the area of mobile payments, issuers are increasingly interested in testing mobile solutions. Thirteen percent of financial institutions are currently participating in a mobile payments pilot, up from 9 percent in 2012. Large banks are the most active pilot participants, with 26 percent testing a solution, an increase from 15 percent last year.
Many issuers view the shift from card to mobile payments as inevitable, with the primary question being when, not if, consumers will adopt mobile payments. Ninety-three percent of issuers expect more than 5 percent of debit transactions to migrate to mobile in the next five years. However, issuers also cite the need for a compelling solution that goes well beyond the novelty factor of paying with a phone to drive meaningful uptake.
About the study
The 2013 Debit Issuer Study, commissioned by PULSE, is the eighth installment in the study series. The study provides an objective fact base on debit card issuer performance and financial institutions' outlook for the debit card business. Sixty four financial institutions – including large banks, credit unions and community banks – participated in the study, conducted by Oliver Wyman; of these, 26 have at least $10 billion in assets and are therefore subject to Reg II's interchange cap. Collectively, the participants issue 140 million debit cards and operate 78,000 ATMs; these cards performed 21 billion annual transactions, representing approximately 45 percent of total U.S. debit transactions. The sample is representative of the U.S. debit market in terms of institution type, location and debit network participation.
PULSE, a Discover Financial Services (NYSE: DFS) company, is a leading debit/ATM network, serving approximately 6,100 financial institutions across the United States. This includes 4,100 issuers with which PULSE has direct relationships and 2,000 additional issuers through agreements PULSE has with other debit networks. PULSE links cardholders with ATMs and POS terminals at retail locations nationwide. Through its global ATM network, PULSE provides worldwide cash access for Diners Club and Discover cardholders through more than 1.3 million ATM locations. The company also is a source of electronic payments research and is committed to providing its participants with education on emerging products, services and trends in the payments industry. For more information, visit www.pulsenetwork.com.