Credit card portfolios, for many credit unions, are the second most important revenue source, behind auto loans. And a significant line item, specifically, is interchange. Many credit cards come with a reward program to influence members to use credit for purchases, rather than use lower interchange debit cards. But there are global and local factors starting to take shape that are putting pressure to lower credit interchange rates.
The Durbin Amendment forever changed the dynamics of debit interchange, forcing most financial institutions to rethink offering rewards on debit card usage. That amendment lowered interchange on debit to 21 cents, plus 0.05 percent of the transaction, plus 1 cent for fraud prevention. Merchants are looking to have that one cent removed now that chip cards are expected to eliminate counterfeit cards at the in-store POS terminal. There are more chinks in the armor – at least one major grocery chain is refusing to accept signature debit, forcing debit transactions to a lower interchange PIN network. And a lawsuit filed by Walmart is trying to enable the same at the world’s largest retailer. While these examples are both aimed squarely at debit transactions, once merchants get some wins on the debit side, they will certainly turn their attention to the much higher interchange associated with credit cards.
Just recently, the European Union Parliament imposed an EU-wide cap on credit card interchange, representing a drastic reduction in most countries for MasterCard and Visa transactions, down to 30 basis points for credit and 20 for debit. Prior to the Interchange Fee Regulation (IFR) at the end of 2015, rates widely varied across the continent, with Austria starting from 1.00%, Germany starting from 1.58%, and the U.K. starting from 0.87%. While it’s not a given that any regulation will be put in place in the U.S., never mind such drastic rate cuts as was seen across the pond, credit unions should still perform risk planning and be prepared to answer the question: “What if interchange gets cut in half?”
Interchange rates have become a very complex topic in the U.S. market. Visa’s most recent publicly published rates show hundreds of combinations, ranging from 1.15% + $0.05 for supermarkets with high volumes, all the way up to 2.95% for the highest business card rates. MasterCard’s published rates are fairly similar.
Issuers derive revenue from their credit card portfolios from several line items. For most issuers the biggest source is interest income, on average 31% of portfolio revenue. Second to interest is interchange, at around 23% of revenue. Fees and foreign exchange comprise the remainder. So imagine if the 23% of credit card revenue from interchange was cut in half? Or more? Regulators around the globe talk to each other. What if the Durbin Amendment was extended to cap credit interchange rates, with a cap for non-exempt issuers at 60 basis points? This would be double what the regulators in the EU allowed, but roughly half of the lowest rate in the Visa and MasterCard networks.
First, credit unions would need to scrutinize their card portfolios product-by-product, and determine if some card programs are not profitable at the new regulated rates. Fee-free cards would probably be on the chopping block, along with generous reward programs (anything more than 1 cent reward per dollar spend may no longer make sense). An increase in fees may seem attractive, but could easily become a competitive disadvantage if members feel they are getting “nickeled and dimed”. So that leaves revenue from interest. Credit unions have a responsibility to charge their members a fair interest rate, but there are lots of levers to use to encourage more cardholders to carry balances. Low introductory rates, balance transfer specials, no monthly payment “holidays”, and lower minimum monthly charges have all been deployed with varying degrees of success at encouraging cardholders to carry a balance. And none of those steps need to wait until regulators step in and impose caps on credit interchange, should that ever happen. Credit unions can, and should be doing all those things now to tilt the revenue pie toward interest income, and away from reliance on interchange.