CO-OP Financial Services Blog: Insight Vault

CO-OP Financial Services has launched a new site dedicated to helping credit unions grow their institutions with access to the cutting-edge, thought-provoking information needed to break through and become more profitable, meaningful and dynamic. The site was inspired by our conversations with credit union leaders, who have been challenged by the economic and regulatory environment of the past few years. Knowledge has never been more important to the credit union movement.

How do we know? Among the most emailed stories on the New York Times site last week was this piece about how banks are dealing with stalled revenue growth by cutting jobs. Big banks are having a hard time figuring out how to make money these days.

Credit unions are having their struggles, too. But unlike big banks, credit unions have agility – and, we think, the will to grow.

Certainly, here at CO-OP, growth (that is, your growth) has become a near obsession. This isn’t entirely new. CO-OP has a long history of working with credit unions to develop products and services that enable growth and profitability. But since the latest financial crisis hit, helping our members bring in more money, improve profitability and deepen member relationships has been our absolute priority.

When you grow, of course, we grow. But over the past few years, it’s become evident that simply offering great products and services isn’t going to make us a great partner. We’ve been listening to what members are concerned about, beating the bushes for the best strategies and innovations, and looking for new ways to deliver news that members can use. What tools will make a difference to your credit union right now? How do they apply to your organization?

On the CO-OP Growth Initiative site, look for fresh approaches to member engagement and smart ideas to boost bottom line growth. You’ll find out how to use CO-OP Member Center to drive new loans, leverage remote services like CO-OP My Deposit to keep members happy, and manage vendor relationships to maximize profits. Through white papers, webinars, case studies and a growing wealth of compelling content, you’ll find food for thought – and action.

In all the discussion we’ve had here at CO-OP about growth – internally, with our members and throughout the industry – one thing has become clear. The financial services industry has changed so substantially that the only way forward is to grow.  That isn’t bad news. With change comes opportunity. Armed with the right information and inspiration, growth is not only possible: It’s exciting.

We believe the credit union movement received good news on June 29 when the Federal Reserve Board announced its rules covering debit card interchange fees, and routing and exclusivity restrictions.

For credit unions with under $10 billion in assets, your interchange rates are likely to show little or no decline for the remainder of 2011. For these institutions, we believe all networks will implement a two-tier system maintaining interchange at rates near the current $0.44 per transaction average. All members of the Fed expressed concern over their inability to enforce the exemption and were clearly exerting influence on the networks. In addition, a consensus item was adopted to report data regarding the exemption over the next 18 months.

For non-exempt institutions, the Fed set the interchange fee cap at $0.21 per transaction, with an ad valorem component of five basis points of the value of a transaction to reflect a portion of fraud losses. Additionally, a fraud-prevention adjustment of $0.01 is available to issuers that implement effective fraud prevention policies and procedures.

The higher cap is clearly an improvement on the proposed $0.12 cap. The Fed obviously heard our concerns expressed in the historic grassroots campaign conducted by credit unions, leagues and industry associations. We can all take pride in this and related changes found in the rules.

It was also good news that the more manageable version of the exclusivity provision was adopted, meaning that issuers will need to belong to two independent networks, such as one PIN and one signature network, as long as they are unaffiliated.

If your credit union is currently VISA-exclusive (VISA for signature and Interlink for PIN) or MasterCard-exclusive (MasterCard for signature and Maestro for PIN), you will need to add an unaffiliated PIN network (such as STAR, Pulse or NYCE). You do not need to add a second signature network to be compliant.

Thankfully, the less manageable exclusivity provision requiring two unaffiliated networks for each type of authorization (PIN and signature) was not included in the final rule.

The effective date for interchange fee caps is October 1, 2011, while the deadline for compliance with the exclusivity provision is April 1, 2012.

CO-OP is confident that our industry associations will continue to work with the Fed to improve the rule further to ensure small issuers are protected from the impact of the debit interchange limits, as Congress said they would. We will also continue to keep you informed of these developments.

Thank you.

CO-OP Financial Services

We would like to thank you for the action you took to write or call your U.S. Senator regarding the June 8 vote on the Tester-Corker amendment. Unfortunately, the U.S. Senate fell six votes short of the 60 votes required to pass this measure to stop and further study the regulation of debit card interchange fees. While this is profoundly disappointing, our trade organizations did a great job representing our industry and the high level of grass roots activity was encouraging as well.

The impact of the Durbin interchange amendment to the majority of credit unions depends on how the $10 billion exemption is handled within the Fed rules, and the requirements for network implementation. The task now falls back on the Fed to finish the rule-writing process.

Fortunately, there is some clarity to the path forward. We expect final rules from the Fed within the next two weeks. That will provide a very short time frame in which to implement by July 21; in fact, the time frame may be too short to adequately perform end-to-end testing within the payments system. Regardless, the Fed will have to deal with this.

We believe all networks will implement a two-tier system maintaining interchange at rates near the current $0.44 per transaction average for financial institutions under $10 billion in assets. Although this pricing is probably not sustainable long term, there is likely to be little or no decline for the remainder of 2011. Your interchange revenue will not fall off a cliff the day after July 21.

All of the large banks have either re-priced their checking accounts or will shortly. There will be a window of competitive advantage for credit unions under $10 billion to move market share.

In addition, it is now clear that the network exclusivity provision will become effective October 21.  Credit unions for which this is a consideration will need to move forward quickly. The TCF lawsuit will have standing effective July 21 and it will begin to move through the courts. We doubt there will be an injunction or stay.

CO-OP Financial Services is committed to helping you prepare for the changed regulatory environment, whatever form it may take. We urge you to continue to call upon us as a strategic resource in your planning for the Fed rules.

Over the last two weeks, credit unions have maintained a steady stream of contacts with U.S. House and Senate members, urging them to support bills moving through both chambers that would delay implementation of the Fed’s proposed rules on debit interchange. Credit unions have generated more than 50,000 contacts with Congress in just that short amount of time.

CO-OP Financial Services joins CUNA President/CEO Bill Cheney in urging all credit unions to take the next step – engage your members and encourage them to “Call on Congress.”

This grassroots campaign is designed to help you educate your members on the importance of the interchange issue to them as credit union members and consumers; promote the campaign to your members, and equipment them with the means to “Call on Congress.”

By clicking here, you can access the following helpful materials:

• Poster for your branches with a toll-free number.
• Copy of script credit union members will hear when they call the toll-free number.
• “Save Our Free Checking” cards for members.
• Suggested plan of action for your credit union in this campaign.
• Sample letter to tellers explaining the campaign.
• Talking points to help tellers speak to members about this issue.
• Key points for a credit union member letter to their Senators and Representative.

There is no time to lose! Again, please click here to getting your members calling on Congress!

February 22, 2011

Ms. Jennifer Johnson
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551

Re:         Docket No. R-1404 and RIN No. 7100 AD 63

Dear Ms. Johnson:

CO-OP Financial Services (CO-OP) is the largest debit processor Credit Union Service Organization.  CO-OP serves 3,400 credit unions for Debit Issuer Processing, Credit Issuer Processing, ATM Processing, ATM Network, Shared Branch, and Call Center services.  In 2010 we processed over 2 billion transactions.  We have followed Dodd-Frank closely with special interest in the Durbin Interchange Amendment and its potential impact on our credit union participants.

Thank you for the opportunity to comment on the draft rules.  We opposed the Durbin amendment because we believe it will lead to increased costs to consumers with the beneficiary being large retailers.  The Board asked for our comments on the proposed rules, not the merits of the amendment, and we will focus accordingly.

Interchange Fee Standards

The proposed rules and commentary suggest two alternatives.  We believe Alternative 2, the $.12 cap, is the most practical to implement operationally and administratively, especially given the time frame.   We believe the safe harbor and range would present many systems, reporting, and record keeping issues that would be prohibitively time consuming and costly to implement.

Network Exclusivity and Routing

CO-OP believes Alternative 1, one signature brand and one unaffiliated PIN brand, is the only workable approach.  Alternative 2 requiring two signature and two PIN brands is not practical.  The network rules, system routing, adjustment processing, marketing, brand equity, and consumer confusion issues presented by Alternative 2 would be insurmountable.  Even implementation of Alternative 1 will cause a compression of projects in June and July of 2011.  It would be prudent for the Board to establish a temporary delay/waiver process that would allow institutions sufficient time to minimize risk in executing associated projects.

Fraud Prevention

CO-OP strongly supports the Board’s effort in gathering additional information on fraud and fraud prevention costs.  This is a major area of debit program cost and one that needs to be better understood by all parties.  Specific to the questions raised in the draft rules and staff commentary:

• Technology-Specific vs. Non-prescriptive Standards – We believe the Board should engage in defining non-prescriptive standards appropriate to be included in the examination process.  CO-OP and CUNA Mutual Insurance Services worked jointly to establish fraud best practices that could be incorporated in the insurance/bond underwriting process.  Building upon this exercise for guidelines within the examination process seems prudent recognizing that these guidelines and standards will evolve over time.  Having the Board set technology-specific standards appears problematic.  In our opinion the board would be better served leaving technology mandates and vendor decisions to market forces between the various issuers, acquirers, networks and processors.  We also must recognize that we are part of a growing global payments system and interoperability must be maintained.
• Setting Non-prescriptive Standards – A great deal of payments industry infrastructure exists in the form of committees and standards boards.  Any such standards need to be set with the full input of all payments industry participants.  Where appropriate, the work product of existing standards boards and committees should be considered. 
• Fraud Protection Efficiency – The Board should commission studies from time to time to evaluate fraud protection efficiency recognizing that this will very quickly evolve.  Fraudsters are nimble with great technological prowess. 
• Fraud Protection Re-imbursement Not Specific to Debit Cards – Specific to fraud, and the problem it creates for all parties in payments system, it seems the broadest array of fraud prevention services should be reimbursable.  This is a fundamental matter of insuring consumer confidence in the debit payments system.
• Fraud Protection and Data Security Reimbursements – There are industry standards and best practices relating to fraud prevention.  Clearly any activity to fulfill these standards and best practices should be reimbursable.  The differences between signature and PIN are narrowing, however there is sufficient difference that a different reimbursement amount for each may be appropriate.
• PIN Fraud Reimbursement Only – Approximately1/3 of merchant locations are PIN capable.  Restricting fraud reimbursement to PIN only is very limiting.
• Fraud Adjustment Only for Activities That Lessen Chargebacks to Merchants – Consumer confidence in debit payments is the core issue.  Large data breaches within the merchant community have been devastating.  We would encourage the Board to take the broadest view of fraud prevention activities as being reimbursable as a matter of consumer protection.
• Would Issuers Scale Back Fraud Prevention If Costs Are Not Reimbursable – Possibly, but the more likely scenario as with all other elements of the amendment, is that issuers will raise fees to consumers in order to cover the costs and a reasonable return on investment.   

ATM’s

The amendment does not reference ATM transactions or fees therefore they should not be in the scope of the rules. 

Emerging Payments

Emerging payments systems are exactly that, emerging.  Any extension of the definition of payment card network would undoubtedly retard innovation and growth in an emerging environment.  The amendment did not reference emerging payments therefore they should not be within the scope of the rules. 

Prepaid Cards

The proposed rules contain a strong theme of preventing circumvention.  Reloadable prepaid cards have many functional similarities to debit cards.  We do not understand why a prepaid card issued or distributed by a large merchant would not be subject to the same rules as a debit card issued by a non-exempt financial institution.  Why should a prepaid debit card distributed by WalMart be treated differently under the rules than a debit card issued by Bank of America? 

General Comments

Similarity of Debit to Checks – The premise of the amendment is that a debit transaction is functionally equivalent to a check.  A debit transaction is the functional equivalent of a guaranteed check since debit transactions are authorized and subject to good funds settlement.  Merchants pay anywhere from 2% to 5% of face value to have a check guaranteed versus 1% to 3% for Debit.  Furthermore many merchants have stopped accepting checks due to payment risk.

Cost – The overall approach to cost is flawed.  While we understand the process the Board followed in gathering cost information as well as the wording of the amendment, it seems that a more inclusive interpretation of cost could be made.  Forcing a producer to sell a product below their average cost with no profit or allowance for recovery of investment is fundamentally wrong.  We recommend the board seek cost information from exempt parties in addition to the information already gained from non-exempt.   

Exemption Threshold – One of our credit unions is non-exempt and one is on the cusp of becoming non-exempt.  Why should a few additional dollars in assets cause a 73% decline in interchange income for an institution crossing the exempt/non-exempt threshold?  This matter of equity and fairness needs to be addressed.

Exemptions – Unfortunately the amendment did not specifically define exempt.  It is clear from the amendment’s author that his intent was that current interchange income would be maintained for exempted issuers.  Commentary from staff suggested that pricing for exempted parties would be determined by the various networks.  Market economy principles would suggest that disequilibrium exists if 80% of homogenous volume receives a price 73% less than the remaining 20% of volume.  Over time market equilibrium will be restored.  To protect current interchange income to issuers below $10 billion, we believe the board will need to interpret exempt as was intended by the author and further provide some means of enforcement within the rules. 

We are participants in and supporters of the Credit Union National Association (CUNA) and the Electronic Funds Transfer Association (EFTA).  We have contributed to and are fully supportive of their comments as well.  We hope through all of these channels to engage in additional dialog on behalf of our 3400 participating credit unions. 

Sincerely,

Stanley C. Hollen

President and CEO
CO-OP Financial Services

As retail banking channels converge and innovations continue, an engagement strategy is beginning to emerge that will not only position your credit union to better attract Gen Y but will set you on a course for greater general consumer engagement regardless of demographic.

Though the population at large might not define themselves by their technology preferences, Gen Y is the canary in the coal mine when it comes to understanding where all demographics are headed.

Though you might see marketing to Millennials as a mysterious puzzle, the communications and product strategies you develop to reach Gen Y will lay the groundwork for the rest of your market while positioning your credit union as a progressive, channel-rich financial institution.

So, how do we leverage technology to engage credit union members?

According to Bank 2.0 author Brett King, we are an increasingly tech-focused society seeking instant gratification. He argues consumers gravitate toward rich and personal online experiences, a mobile wallet, robust social media, “branches of the future,” touch-screen ATMs and personalized digital marketing. The channels and tools members use to manage their financial lives, improving efficiency and convenience often at the expense of member intimacy, now have the power to engage members like never before. Consumers choose all of these channels at different times when they provide the most expedient means to achieve their goals.

King said that those financial institutions that classify the Internet, ATM and mobile phones as “alternative” channels will be playing catch-up for the next decade while pop-up intermediaries will progressively capture niche service opportunities. We will all come to expect personally relevant interactions in any retail experience and therein lies our opportunity.

Rule No. 1: It’s All about Engagement. Offer services that allow expression and collaboration, invite dialogue and engage members of all ages in conversation. This can be done through message boards and blogs and social network sites. Blur the lines between your products and your marketing – make them seamless. Find ways to better interact and engage members through every payment channel: branches, ATMs, call centers, mail, online bill pay and more.

Rule No. 2: Be On-Demand as Well as Online. Establish ways members can interact with your credit union via online and mobile banking. This goes to the heart of access and convenience that all potential members demand and is a key component to compelling a greater cross section of your membership to regard your credit union as their primary financial institution.

Though online and mobile banking are essential services, do not neglect your branch. Consumers today don’t visit a branch to get better service unless they feel that human interaction is a critical element of a specific solution.

Rule No. 3: Show the Credit Union Spirit of Social Responsibility. Gen Y and upwardly mobile women segments use corporate responsibility values to screen companies. Showing civic-mindedness is easy for credit unions. Promote your next Credit Unions for Kids fundraiser throughout your community. This is one of the best ways potential members can naturally discover your credit union.

Rule No. 4: Be Authentic. Gen Yers are extremely savvy, so don’t give in to hype when you are marketing to them or any of your members for that matter. They will sniff out insincerity faster than you can deliver it. Give them the tools to make their own decisions by ensuring that data is easily available via your website or other channels. Allow the flow of information to go both ways. Invite feedback and engage them in dialogue, which does not have to be done exclusively online.

Don’t be afraid of technology. Dive in, integrate your efforts and share experiences. By putting these strategies to work, you increase the chance of not only engaging Gen Y but also demonstrating the credit union difference to all audiences, ensuring your credit union is relevant today and in the future.

 CO-OP Financial Services would like to thank the nearly 500 viewers who joined us for our Jan. 28 webinar on the Fed’s Draft Rules on interchange.

We urge all credit unions to make their voices heard by the Feb. 22 deadline to comment on the draft rules. For advice on where and what to write, please click here. For further background, we invite you to view a replay of the webinar here.

The Durbin amendment and the associated Fed Draft Rules are bad for credit unions. At minimum they restrict credit union choices and at worst they will lead to increased fees for members. CO-OP has financially supported the credit union trade associations, the Electronic Payments Coalition and the Electronic Funds Transfer Association in both fighting and shaping the legislation. We’ve also worked closely with these groups and provided direct input to the Fed as they have developed the draft rules.

We are now reviewing and testing systems to insure we will be ready for a two tier interchange rate and modified routing environment. We have made these and future expenditures to support you, our credit union clients. Our greatest concern is that a combination of fees, merchant steering and member confusion will retard the growth of or even reduce debit transactions.    

For these reasons and many more, please make your voices heard by the Feb. 22 deadline!

Editor’s Note: The statement below represents an update to CO-OP Financial Services’ assessment of the Federal Reserve’s published draft rules relating to interchange. If you would like to learn more, join us on Fri., Jan. 28 at 11:30 a.m. Pacific time for an informational webinar. You can register to attend here.

CO-OP Financial Services has been following the interchange issue for many years and has taken an active role on behalf of credit unions through our support of CUNA, the Electronic Payments Coalition (EPC), and the Electronic Funds Transfer Association (EFTA). Despite our best efforts, the Merchant Payments Coalition and Senator Richard Durbin were successful in adding an interchange amendment to the Wall Street Reform Act.  

On Dec. 16, the Federal Reserve Board approved release of draft rules for comment pertaining to the Durbin Interchange Amendment. Comments are due by Feb. 22, with final rules to be published by April 21 and taking effect July 21, 2011. As with most draft rules, they create as many questions as they provide answers.

The first question is: What does this mean to credit unions?

• The current national average interchange for signature debit and PIN debit transactions is $0.44. The new rules propose a cap of $0.12 interchange per transaction and a “safe harbor” floor of $0.07. Many analysts believe even the $0.12 cap is below cost for most financial institutions. The statute was extremely restrictive on what costs could be considered.

• The $0.12 interchange cap represents a 73% decline in current interchange revenues. Using data from the 2009 Callahan and Associates survey, credit union debit interchange income is estimated at $2.2 billion. A 73% decline represents a potential $1.6 billion in revenue and income for credit unions at risk. To put this in perspective, Callahan reports total credit union net income after assessments in 2009 as $1.54 billion and estimates 2010 at $4 billion.

• The Durbin Amendment does exempt all financial institutions below $10 billion in assets as well as government card payment programs and reloadable prepaid cards. The Federal Reserve in comments during the Dec. 16 meeting indicated the networks (Visa, MasterCard, Star, NYCE, Pulse, etc.) will need to determine if they will offer interchange pricing tiered by asset size or card purpose. The lawmakers clearly intended that “exempt” mean current interchange income be sustained for exempted parties, but unfortunately that was not clearly defined in the law. Visa recently announced they will implement a two tier interchange structure with the exempt tier at least initially being very close to existing interchange rates.

• Fraud costs are not part of the $0.07 to $0.12 proposal. The Fed was dissatisfied with the fraud cost information gathered and was going to do additional surveys. Another consideration is whether the Fed will mandate new fraud technologies and how costs for those technologies will be recovered. Fraud costs are not likely to be part of the rule published April 21.

• The Fed proposed two routing rule alternatives. The first, that each issuer have one signature debit network and a second non-affiliated PIN network. The second alternative was that each issuer has two signature debit networks and two PIN networks. This second alternative would impact all credit unions and we believe would be unworkable from both a technical and market perspective. The first alternative will impact some credit unions, but would be the most practical and least disruptive. 

The headline in all of this is that $1.6 billion in annual interchange income is potentially at risk for credit unions. This brings us to the second question: What can credit unions do?

• First and foremost, all credit unions need to support our movement’s trade associations in their activities.

• Write a comment letter to the Fed. CUNA and your league are drafting samples, but if you want your letter to have full impact, personalize it from your credit union:
  • The lawmakers intended that credit unions under $10 billion in assets be exempted.  Encourage the Fed to enforce this exemption and see that current interchange levels are maintained for credit unions under $10 billion in assets.
  • If the exemption is not enforced, what will the impact be to your credit union? How much net income will your credit union lose? The calculation is simple, 73% of current debit interchange revenue. What would you need to do with pricing and how would that impact your members?
  • Even though credit unions should be exempted, we think it is important you comment on interchange rates. Two alternatives were proposed, a $0.07 to $0.12 range dependent upon individual institution costs or a $0.12 cap. We believe the only operationally workable solution is their second alternative, a cap.
  • The Fed also asked for comments on routing. We think the only practical solution is their first alternative: one signature debit network and one unaffiliated PIN network per card issuer.
  • Fraud remains a huge concern. Please comment on the cost of fraud prevention and the cost of fraud to your credit union. 

• Talk with your network representatives and encourage them to comply with the intent of the law and maintain current interchange levels for credit unions under $10 billion in assets.  Visa has announced their intent to implement a two tier structure, but even they left the door open for change in response to market conditions. We expect MasterCard and other networks to follow suit. CO-OP asks all credit unions to encourage the two tier structure and sustaining current interchange levels.       

The House Banking Committee is likely to hold hearings to review the interchange provisions. We need to support this process even though the likelihood of any new legislation is low. Interchange is a critical issue to credit unions and the payments industry. We encourage all credit unions to make their voices heard on this issue.  

(Editor’s Note: The statement below represents CO-OP Financial Services’ assessment of the Federal Reserve’s published draft rules relating to network interchange and exclusivity).

The Federal Reserve has published draft rules relating to network interchange and exclusivity. The Fed has asked for comment in all areas and posed specific questions relating to costs and routing.

WHAT WE KNOW

Interchange – The Fed has proposed a $0.12 cap per transaction on interchange with a $0.07 “safe harbor” floor. This translates to a 73 to 84 percent reduction in debit interchange. This is a far deeper reduction than the financial industry expected. It is prudent that you reflect this reduction in your budgets beginning July 2011.

How specific rates will be established will be up to the networks and the financial institutions. Fraud avoidance costs continue to be studied and will be incorporated, but possibly after implementation in July 2011.

Routing Exclusivity – The Fed suggested two models. The first calls for each card to have a signature brand and a nonaffiliated PIN brand; the second stipulates that each card have two nonaffiliated signature and two nonaffiliated PIN brands. The Fed asked for comments on these alternatives. We believe the latter – the second model – is impractical and detrimental to interchange income.

Timing – Final rules will be published in April for July implementation, with the caveat that some issues may not be fully defined.

WHAT WE DON’T KNOW

A member of the Fed’s Board of Governors specifically asked about exemptions of which all but three credit unions would be exempt. Fed staff responded that exemption pricing would be up to the respective networks. The staff member also noted the possibility of merchant discrimination against exempted cards despite both the law and network rules.

As expected, the draft rules have created as many questions as they have provided answers. The key issue for most credit unions remains the exemption. The Federal Reserve left it up to payments networks to implement the exemption. At this time we do not anticipate that the exemption will result in the exclusion of institutions below $10 billion in assets.

As we wrote in our white paper, “2010 Debit Payment Challenges: An Update on Regulatory Reform,” CO-OP Financial Services suggests the following course of action:

• Debit Strategies. The growth rates for both signature and PIN debit have remained strong. The impact of the Durbin Amendment should drive credit unions to re-think strategies about debit products and their positioning and pricing to members.
• Pricing Strategies. Various pricing strategies can be used to modify member behavior to increase volume and drive members to the revenue generating access vehicles. Continue to help members make the transition to card-based and electronic payment.
• Reduce Expenses. In addition to new pricing strategies, credit unions can mitigate the impact from lower revenues by paying close attention to the expense side of the business. Areas to look at in particular are fraud, card activation and card issuance.
• Scenario Planning. Plan, but don’t overreact until we know if the exemptions will work. We recommend using revenue and cost data to plan through various best and worst case scenarios, including debit impact, debit strategies, and account and relationship strategies.

You can read the complete white paper, downloading it for free, by completing the brief registration form here.

CO-OP Financial Services will continue to provide information and we suggest you comment directly to the Fed and through your trade associations, and please be prepared to assist in any lobbying efforts they may pursue.

Thank you.

(Editor’s Note: The article below is excerpted from the white paper “2010 Debit Payments Challenges,” provided by CO-OP Financial Services. If you would like to read all the insights provided in the complete paper, you can order it for free by clicking here.)

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) was signed into law by President Obama with great fanfare on July 21, 2010. The event marked the start of the nine-month timetable placed before the Federal Reserve Bank for the writing of new rules governing pricing of debit transactions. This daunting task has been placed at the Fed’s doorstep by the Durbin Amendment to Dodd-Frank. Among other things, the Durbin Amendment:

• Challenges the Fed to create rules that address debit pricing at the marginal and transaction-specific level in an effort aimed at creating a “reasonable and proportional” pricing model.
• Bans practices that actually or virtually create exclusive relationships between debit card issuers and payments networks.
• Enables merchants to set minimum and maximum transaction amounts on credit card purchases.
• Prohibits merchants from discriminating against specific issuers or networks in card acceptance.
• Exempts most government benefit transfer and branded reloadable prepaid card programs.
• Exempts issuers with assets fewer than $10 billion.

At first glance, it would appear that the letter of the law relating to Durbin grants the vast majority of U.S. credit unions an exemption and the amendment will not impinge on their ability to earn debit interchange at historical levels. However, industry practices may contort Durbin’s spirit and cause major harm.

Due to its recent enactment, it is easy to overly focus on the Durbin Amendment to the Dodd-Frank Act as being the only wolf at the door. Yet, the Fed’s final rules on overdraft opt-in and the CARD Act play considerable roles in the overall non-interest income fracas.

To better prepare for the consequences of these three sets of regulations, we suggest the following:

First, it is essential that all credit unions gain awareness of what the market place is doing in response to financial reform. That is, how are payments networks, small and large commercial banks, processors and retailers posturing to either take advantage of change or to stem it? Frequent contact with industry trade associations, network partners and trusted advisors should keep awareness high.

Second, internal assessments of the combined revenue and net income impacts stemming from overdraft, CARD and Durbin ought to be updated frequently to measure the short and long term implications of these regulations. In conjunction with internal modeling on the revenue side, credit union executives should be watching for opportunities to strip non-essential processing and delivery costs from account and debit card programs – card re-issue cycles, paper statements and postage are areas worthy of review.

Third, plan for the full range of potential outcomes connected with the Fed’s rule-making activities and/or adverse actions taken by marketplace players. For instance, should the $10 billion carve-out stand up, most credit unions will foresee at least a temporary market advantage enabling them to offer better deposit account programs and debit rewards schemes. In short, prepare and launch an aggressive membership growth plan. There should also be a plan on the shelf for if/when networks capitulate to pressure and unify debit pricing into a single system. We have estimated that a 25 percent decrease might be possible, suggesting that credit unions will need to develop modest repricing strategies and encourage members to increase deposit balances to make up the shortfall.

Finally, credit union executives are reminded that debit transactions are a key part of an overarching relationship with members and that relationship has several moving parts. The endgame strategy for awaiting the outcome of overdraft opt-in, CARD and Durbin needs to encompass all components of that relationship – account pricing, customer service, all deposit account access channels and the value of affiliation.