Recalibrating the Debit Equation: Settlement of the Merchant Lawsuit Will Affect Short-Term Pricing and Profits. Long-Term Growth Will Be Up to All Players

Sorry bankers, but the debit card business just got a whole lot tougher. Last April, Visa U.S.A. and MasterCard International settled a major class action lawsuit that had been filed against the two associations and their member banks by a group of national merchants led by Wal-Mart. That action did not necessarily bring the long running feud between merchants and the banking industry over debit card usage to a conclusion, but merely shifted the battle to a new venue--the marketplace. Under the settlement, the interchange rate for highly profitable signature transactions will be established by forces starting Jan. 1, 2004--meaning that banks will make less income on their debit card programs, at least in the short-term. banker asked me what [the settlement] means, and I said it means you can't stand out in the rain and collect money any more, says Denise Saylor, a senior vice-president for EFT services at Norcross, Ga.-based InterCept Inc., a bank technology and transaction processing firm. Banks and credit unions are going to have work a lot harder to make back that income. But the future for the debit card business isn't necessarily as bleak as Saylor's sobering but honest assessment might imply. Most experts, Saylor among them, expect the debit card market to continue its impressive growth despite the settlement's unsettling effects--although the agreement will probably alter the market's evolutionary path in certain important ways. It's also inevitable that some level of tension will continue to exist between merchants on the one hand and the card associations and their member banks on the other because--initially at least--one side's gain comes at the other side's expense. But it's important that merchants and the banking industry find common ground because ultimately both sides will benefit when consumers move away from cash and checks. Honor all cards? Not anymore MasterCard and Visa settled the six-and a-half year-old suit just as it was scheduled to go to trial in late April. The associations agreed to pay $3 billion over a 10-year-period of time--$1 billion from MasterCard and $2 billion from Visa--and to make significant changes in how they do business. A central issue in the case was the card associations' honor all rule, which required participating merchants to accept both credit and debit cards, including signature- and PIN-based debit cards. The merchants charged that this was an unlawful trying together of two products--i.e. credit and debit cards--by a competitor with market power. Under the old system, PIN-based cards--whose transactions are processed online through one of the regional ATM networks--were much cheaper than signature transactions, which are processed offline through separate propriety networks maintained by Visa and MasterCard. Although merchants could request that consumers use their PIN when paying for a purchase with a debit card, the honor-all-cards rule required that they accept both kinds of debit transactions--including signature with its higher transaction charge. The settlement does away with the honor-all-cards policy and allows merchants to select whatever method of payment they prefer--including, if they so choose, PIN-based debit cards but not signature cards. The associations also agreed to lower the interchange rate for offline debit by approximately one-third, beginning August 1, 2003. This rate may then be reset as of Jan. 1, 2004 to whatever level the market will bear. Debit cards must also be reissued with the word debit or similar terminology clearly labeled on the front, and they also must be identifiable on electronic terminals. Slashing the offline interchange rate by one third will have an immediate--and quite negative--impact on the bottom line of many large banks. Bank of America projects this will cost it about $60 million in lost revenue this year--and $200 million in 2004. …