By Ray Birch
SCOTTSDALE, Ariz.—A move made by the Federal Reserve in late 2022 means it’s time many credit unions redesign their checking accounts to keep interchange revenue flowing at current levels, according to one analyst, who says the issue is especially acute for smaller institutions.
Cornerstone Advisors director Glenn Grossman told CUToday.info there is a looming threat to financial institution checking accounts as the Fed is now extending its debit routing requirements, established under the Durbin rules, to card not present (CNP) transactions as well as point of sale.
Grossman reminded that early in October of 2022, the Federal Reserve finalized a rule, known as Regulation II (Debit Card Interchange Fees and Routing), that requires every debit card transaction to have access to two unaffiliated payment card networks. The rule extends the existing regulation from PIN debit transactions to card-not-preset (CNP) transactions and enables merchants and acquirers to choose from competing networks, with the intent to lower their debit card processing costs.
The final rule will be effective July 1, 2023.
“With this new rule, a large proportion of CNP transactions, including ecommerce purchases and recurring payments, could—and likely will—end up on networks other than Visa or Mastercard, where interchange fees are lower,” Grossman said.
Grossman explained the Fed waited until last year to make the move because technology has finally advanced to properly support CNP with multiple networks.
“While there is no modification to requirements related to interchange fees, this change will negatively impact banks’ and credit unions’ payments revenue and, likely, increase their fraud-related costs,” Grossman said.
With the COVID pandemic only serving to accelerate an already quickening transition to digital activity, CNP transaction volume has soared. Historic data show that 50% of CNP transactions are on signature debit rails. With the rule change, a percentage of financial institutions’ revenue from related debit/CNP transactions will be cut in half, Grossman predicted.
‘Caught Off Guard’
“This has just caught people off guard,” Grossman said. “It's not very sensitive to financial institutions. If you think about the demographic change that came out of COVID, we got a lot more card not present transactions. This will trickle down to the income statement.”
Every institution will be affected in varying degrees, explained Grossman, but it’s the smaller FIs that will feel the pinch the most.
For the very largest credit unions, like Navy Federal, this will be a “rounding error,” Grossman stated. “It’s just easier for the big institutions to absorb this. For the small credit unions this is a big deal.”
Recommendations Offered
Glenn Grossman
With about six months left before the rule becomes effective, Grossman said there is work for FIs to do, and he offered the following recommendations:
- Analyze current transaction volume. “Banks and credit unions need to analyze their current transaction volume distribution and forecast the financial impact of a portion of CNP debit card transactions on the networks they have agreements with today. The Federal Reserve reported that 23% of debit card transactions were CNP in 2019. According to the debit card network Pulse, a one in three debit purchases were CNP and represented, on average, 7.5 purchases per month for a debit card user in 2020,” Grossman said.
- Analyze transaction volume by network. “Financial institutions that currently use multiple unaffiliated networks should cut back to no more than two by July 1, 2023, to help mitigate the potential revenue shortfalls,” Grossman said. “The timing of this change comes as some institutions have already made budget decisions based on existing debit card revenue trends for 2023. It is possible these financial revisions will have a downstream effect on 2023 projects as revenue expectations are adjusted.”
- Assess the fraud implications of the amended regulation. “CNP transactions carry a greater inherent risk of fraud, and the volume of single message transactions will likely increase. Debit card issuers should check the CNP fraud resolution rights afforded by their networks to verify how they’re covered,” Grossman said.
Innovate and Redesign
Grossman insisted that small- and mid-size institutions must innovate and redesign their checking accounts to increase the value to account holders.
To do that, Grossman said, requires three strategies:
- Value-added services. “Cornerstone Advisors research indicates that more than half of consumers between the ages of 21 and 55 are interested in getting value-added services from a financial institution. Banks and credit unions should study their customers and members and identify services that compliment them and the institution’s brand,” he said. “However, just offering debit card rewards in the current environment will prove to be extremely cost punitive, so FIs should consider migrating to relationship-based rewards versus spend-based rewards.”
- Relationship value. “Seasoned bankers know the checking account can be the foundation to a profitable relationship. Today, it is common for consumers to hold multiple checking accounts, making loyalty challenging and even demoting FIs to ‘paycheck motels.’ Effective designs will provide value for profitable behavior, such as bonus interest on deposit balances or savings on a mortgage loan origination,” Grossman said.
- Financial security. “Banks and credit unions are positioned to help customers be financially resilient. Initiatives that gracefully integrate data with targeted banking solutions provide institutions with an opportunity to own more of the customer’s share of wallet. No ‘boil the ocean’ or financial management programs here. Consider a targeted program such as bonus interest or a cash reward when a savings goal is achieved and tied to a loan down payment,” Grossman explained.