By Kerri Shannon
The U.S. Federal Reserve dealt a blow to credit card providers and banks on Thursday with a proposal to cut debit card transaction processing fees as much as 90%.
Congress directed the Federal Reserve as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act to review the debit card swipe fees - or "interchange fees" - charged by banks and card networks to determine if they were "reasonable and proportional" to the transaction processing cost. Analysts had expected the result would be a reduction in fees of up to 50%.
The proposal went beyond estimates, aiming to cap the interchange fees at 7 cents to 12 cents per transaction, or about 0.3% of the face value of the average purchase. This would be about an 84% drop from the current 1.3% average, or 44 cents, per transaction. "Nobody expected it to be this draconian," said David Robertson, publisher of the credit-card industry newsletter the Nilson Report.
The news triggered a 12% plunge Thursday in Visa Inc. (NYSE: V) and MasterCard Inc. (NYSE: MA) stock. Investors feared that banks would reduce their payments to card networks in an effort to offset billions in revenue losses from the fee cuts. Debit card companies would also lose control over pricing since merchants would have more freedom to choose rival networks for payment processing.
"It's bad for the issuers and the networks," Rod Bourgeois, a payments analyst at Sanford C. Bernstein and Co. Inc., told The New York Times. Final rules are set to be completed by April 21 and implemented in July.
Banks will likely make up for revenue lost on lowered fees by increasing monthly charges on deposit accounts, raising minimum account balance requirements or steering customers away from debit card programs. JPMorgan Chase & Co. (NYSE: JPM) already announced it would no longer offer debit card programs with reward points, which charge more fees than regular debit cards to operate the rewards program.
The banks that will be most affected by the rules change are Bank of America Corp. (NYSE: BAC) and Wells Fargo & Co. (NYSE: WFC). Revenue from debit interchange fees constitutes 2.5% of both banks' total revenue. Bank of America in the third quarter already predicted a $2.3 billion annual decline due to decreasing value in its cards business.
Bankers are challenging the fairness of the proposal, saying that it will "essentially relieve retailers of paying their fair share for a card payments system that offers them tremendous benefits," Ed Yingling, president and chief executive of the American Bankers Association, said in a statement.
The proposal is a victory for merchants who have for years protested against high interchange fees on debit card transactions. The businesses claim that debit cards are no different than cash and checks, but stores take a revenue hit on card purchases because of banks' fees. The proposed rules limit merchants' payments to no more than 12 cents per transaction.
"The proposed rules that the Federal Reserve issued today are a positive step in addressing the anticompetitive behavior of banks and credit card companies," Henry O. Armour, chief executive of the National Association of Convenience Stores, said in a conference call.
Visa and MasterCard argued that the Fed had not considered the full range of costs involved in operating debit card programs. MasterCard warned that the policy allowed merchants to shift their costs to consumers. "This type of price control is misguided and anticompetitive and in the end is harmful to consumers," Noah J. Hanft, MasterCard's general counsel, wrote in a statement.
Credit card companies have been getting slammed by proposed rules stemming from financial reform. The Dodd-Frank Act increased card company competition by requiring all debit cards run on two different companies' networks, meaning a merchant could process a Visa debit card on a network other than Visa's.
The Justice Department in October settled an antitrust case against Visa and MasterCard, ending in the card companies agreeing to let merchants direct customers to the payment network the merchant preferred. This gave merchants more leeway to negotiate lower processing fees from networks by promising to route more payments to one network in exchange for better rates.
"Banks have long enjoyed some immensely profitable businesses," said Gilani. "They push credit cards with high interest rates (relative to the historic, low-interest-rate environment in which they operate), high fees - and high penalty payments. They slap merchants with 'interchange fees' when customers pay a bill by swiping debit cards to extract money from their checking accounts. All these banking practices - and others - were attacked for being just what they are - consumer rip-offs."
Contributing Editor Shah Gilani knew there would be trouble ahead for credit card providers as financial reform attacks unfair banking practices. Gilani said that while the Dodd-Frank Act "cleaned up a lot of the credit-card tyranny," banks have had to adjust to a dwindling stream of revenue from credit card business as fees are trimmed and U.S. consumers cut down on debt after a paralyzing recession. The financial reform has become a tailwind pushing banks toward accepting the industry's shift from credit cards to mobile banking and mobile-payment services, where smartphones will become consumers' most important banking tool.
Facing declining revenue from typical plastic transactions, credit card companies are also adjusting to the mobile takeover.
Visa has its own "payWave" contactless payment system that it's testing with Bank of America, JPMorgan and U.S. Bancorp (NYSE: USB). Meanwhile, MasterCard says it's planning on first-quarter 2011 trials with its own system offered through an as-yet-unnamed large U.S. bank.
While credit card providers work on mobile-payment programs, there is a clear early leader ready to profit from the trend. This company should snag investors' attention away from banks and card companies that are scrambling to prepare for the mobile banking era.
"[R]ight now, for my money, the light in the tunnel is VeriFone Systems Inc. (NYSE: PAY)," said Gilani. "VeriFone is the world's premiere maker of transactions terminals. Whether you swipe, tap, wave or bump your mobile device to connect with a terminal reader, it's likely to be one of VeriFone's receivers that you're communicating with.
"If there's going to be a starry future for anyone in the overcrowded mobile-payments kitchen, I've got my money on VeriFone delivering up whomever survives on their gilded plates," said Gilani.
Investors need to avoid the troubled path of banks and credit card providers and not get caught in the financial sector squeeze. By embracing the future of the industry, focused on consumer protection and technologically enhanced features like mobile banking, investors can find profits in a company like VeriFone Systems Inc.: the only way to profit from the credit-card sector meltdown.
VeriFone is ahead of the game because it's the world's premiere maker of transactions terminals. And it's making deals to expand its business into Europe and other foreign markets. Investors shouldn't miss VeriFone's stock price surge as the fast growing mobile-banking business readies for rapid growth.
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