Preparing for the new normal for card transactions

The research has not been exhaustive, but there is a 99.99 percent certainty that the predictions published in our industry for 2020, as well for the next decade, did not include the COVID-19 pandemic.

Though most financial institutions have a pandemic crisis plan – proposed by the regulators since 2007 – few expected to break the seal on that document during their careers. Yet here we are in the middle of the unimaginable, realizing that our near-term road maps are now outdated. Gatherings have been cancelled and social distancing is in place worldwide, but in many areas of business, the show must go on.

A significant number of card agreements, for example, will be up for renewal for many financial institutions, something that happens at regular intervals. These Tier-1 contracts with major card EFT networks, EFT processors, core processors and digital banking providers often affect the largest expenditures and non-interest revenue streams for most banks.

Banks must also consider that many of these expiring agreements were executed during the aftermath of the financial crisis, when the impact of the Durbin Amendment was unclear, so today’s payments landscape was already notably different even before the recent impacts from COVID-19. 

Conducting a successful card brand or processing renegotiation is an extended exercise – a best practice is to allow for 12 to 18 months of lead time and significant internal effort. Millions of dollars may be at stake, so it’s paramount that banks give this project the time and attention needed for the best possible outcome.  

In the face of protracted economic uncertainty, banks can expect customers to start moving credit transactions to debit, as seen during the recession of the late 2000s. To brace for this impact, banks need to rigorously evaluate not only their debit and credit card programs, but all of their card network agreements and relationships, even against new challenges such as working remote.

What’s more, each bank’s situation is unique. For example, if your bank owns its credit card program (rather than using an affiliate agency), optimizing your credit portfolio is usually first priority because of higher revenue per transaction than debit. With the economy we’re forecasting now, though, debit will have an appreciably higher volume. Even with the debit interchange reductions mandated by the Durbin Amendment, debit is still a valuable source of revenue for banks. In fact, the 86.4 billion U.S. debit tranactions in 2018 were nearly double the number of credit transactions. Credit accounted for a higher transaction value, but debit is now poised to tip those scales as well.

Banks also have to consider other consumer impacts of COVID-19 – these include a rising use of digital payment methods and contactless cards. Given these conditions, banks must be strategic and willing to shift focuses in the changing business landscape. For example, they should be promoting the use of their debit cards for e-commerce purchases since many account holders are shopping online these days. Federal Reserve data shows that debit transaction volumes rose more than 50% between 2012 and 2018, but the average transaction value barely changed.

In addition to these changes to transaction volumes, banks should also account for new developments in the payments landscape occurring over the past several years. These include the introduction of EMV, the mainstreaming of e-commerce and the advanced adoption of U.S. mobile payments. All of these changes have impacted the offerings banks provide to customers and will influence their current and future card renegotiation projects.

Evaluating card portfolios and planning for negotiation

Banks that take seriously the optimization of their card programs and processor structures will make gains and form stronger relationships with customers regardless of the economic climate.

Specifically, these institutions will use tools for card program optimization, such as the PAU principle (Penetration, Activation, Utilization). Measuring the target market penetration, activation rates and card utilization of a portfolio are crucial steps in evaluating revenue performance, helping banks better understand their positions before the negotiations on expiring contracts begins. 

These banks will consider the multiplicative effects of the cost structures in processing agreements. Although using the PAU principle in a card portfolio will increase the quantity and quality of transactions, if the processor agreement’s cost structure is not in-market, your bank can incur greater fees as compared its peers.

When prepping for their next card brand or processing negotiation, institutions should be proactive and not delay beginning their due diligence and deliberation. Doing so will only cause more pain points, including a material loss in leverage for negotiating with providers. Be aware also that these service providers have various types of proposal structures at their disposal, both to spur the closing of a deal and to drive win/win results in the long run. Before choosing a provider, the bank should also consider the provider’s potential M&A activity and determine if its goals align with their own.

Banks will continue to move toward deadlines that are made even more important given the context they must operate in now and in the near term. Because card brand and processing agreements last for several years, banks must do everything possible to strike equitable deal – negotiating at-market rates and avoiding mismatched terms or missed revenue opportunities are vital to achieving that goal. While these have always been important, today they are perhaps critical to emerging from the COVID-19 crisis viable and competitive.

Bob Koehler is executive vice president at Strategic Resource Management.

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