Some Gain Revenue By Switching Networks

In the year since the Wal-Mart settlement that threatened debit card profitability, banks have learned that the revenue potential of their debit cards can depend on the electronic funds transfer network they belong to as much as on the form of debit card consumers use.

According to a recent study by Boston-based Dove Consulting, the revenue that banks receive on transactions secured with a personal identification number (PIN) rose from an industry average of 9 cents per transaction in 1999 to 19 cents a transaction in 2003. By comparison, interchange rates on transactions secured with a signature were lowered by about 30% last year as the result of the settlement between the payment card associations and a group of retailers led by Wal-Mart Stores Inc. Visa later revised those rates so that its interchange rates vary by merchant size, but banks say the per-transaction revenue they receive is still about 20% lower.

While banks generally still make more revenue from signature-based transactions than PIN debit, the gap is narrowing.

With signature-based debit, customers can generally use their cards at any retail location that accepts Visa and MasterCard. The transaction is handled much like a credit transaction and secured with a signature. The only difference is that funds are debited from a checking account rather than charged to a credit account. Transactions are routed through Visa and MasterCard, which set the interchange fees.

PIN debit transactions, by contrast, occur only at retail locations where the owner has installed a PIN pad that customers use to enter the same personal identification number they enter at an ATM. The payment is routed through an EFT network much like an ATM transaction.

Because the EFT networks set their own PIN interchange rates, the fees can vary widely. Recently, a number of big banks realized that they can gain greater revenue by switching or limiting their membership to those networks that have the highest point-of-sale (POS) interchange rates.

Three large banks — Wells Fargo & Co., Wachovia Corp. and Bank of America Corp. — have entered into exclusive memberships with Interlink, owned by Visa. The switches position the banks to earn higher interchange rates.

"Banks previously decided what networks to join based on the benefits those networks offered them related to ATM use," says John Gould, director of consumer credit for TowerGroup Inc., a Needham, Mass.-based consulting firm. "But now that POS transactions are surpassing ATM transactions, banks are realigning their strategies based on what networks offer the highest POS interchange."

But others say there is more to choosing a POS network than going with the one with the highest fee rate. While Jeanine Tabaczynski, senior vice president of access services for Charlotte-based Wachovia, acknowledges that interchange revenue was a factor in her bank's decision to join Interlink, she emphasizes that it was not Wachovia's only criteria. She says Wachovia re-examined its EFT memberships following the merger with the former First Union Corp. "We wanted to manage our debit business in a centralized way and not have distinct signature and PIN-based debit programs," she says. Because Interlink was owned by Visa, it was easier to integrate the management of the Interlink PIN and Visa signature programs and view debit "as a holistic product," she says.

"It's important to look at the role debit will play in the long term. As consumers migrate to electronic payments and look at such products as payroll cards, commercial incentives and other emerging payment technologies, banks need to look at which networks can offer them the best overall debit products," she says.

Long-term, the issue of PIN vs. signature debit may become moot. Not only is the gap between the pricing structures of the two payments instruments narrowing, there are fewer differences today between how the two types of transactions are handled. Several years ago, banks needed up to five days to settle a signature-based transaction while PIN was authorized in real-time. Today, many banks do real-time signature authorizations with next-day funds.

"In a few years, the pricing will become even closer and banks will want to merge these two programs. Many banks that had been trying to push one type of transaction over the other today are just trying to get customers to use their cards," says Gwen Bezard, senior analyst for Celent Communications, Boston.

— Lauri Giesen