2011 Debit Issuer Study

Executive Summary

Contents
1. Overview Key findings Outlook 2. 3. 4. 5. 6. 7. 8. 9. Research Metrics Drivers of Debit Performance Debit performance Consumer Debit performance Business Debit P&L The Durbin Amendment Regulation E Rewards 2 2 4 5 6 7 11 12 13 15 17 18 19 20 21 21 21 22

10. Fraud 11. ATMs 12. Prepaid cards 13. Alternative payments Contactless cards Mobile financial services Alternative payments companies

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1. Overview
The 2011 Debit Issuer Study presents an objective fact base on debit card issuer performance and perspectives across the spectrum of electronic payments. The Study, the sixth annual report commissioned by PULSE, is based on primary research with 50 financial institutions (FIs) that collectively represent more than 50 million debit cards. The sample is nationally representative, with FIs distributed by size, geography and debit network affiliation.

Key findings The presence of ongoing and impending regulatory changes Regulation E and the Durbin Amendment, respectively greatly influenced participating FIs metrics and perspectives in the 2011 Debit Issuer Study. A full 96% of FIs listed the Durbin Amendment and other regulatory pressures as a key challenge for 2011.
As a result of changes to Regulation E, overdraft revenue declined by 45% among surveyed FIs. In response to the Federal Reserve Boards Proposed Regulation to implement the Durbin Amendment, issuers expect to lose as much as 79% of their current debit interchange revenue. The total annual revenue per active consumer debit card (combining interchange revenue and debit card overdraft fees) was down to $107 in 2010 (from $118 in 2009) and will likely go down even further post-Durbin. Anticipation of the Durbin Amendment also influenced FIs plans and outlook in several categories. Performance metrics: Traditional FI performance measures penetration, activation and usage (PAU) are being revisited in light of debits anticipated new economic structure. For regulated issuers1, most debit transactions will be unprofitable if interchange is regulated at $0.12 hence, FIs will need to rethink to what extent they should drive debit usage. The signature/PIN debit transaction mix also is likely to change (in favor of PIN). Instant issuance and branch incentives: 2010 saw a significant decline in issuers interest in instant issuance. Several FIs also are rethinking incentives for their branch personnel for issuing debit cards. Rewards: Many FIs are considering eliminating or reducing rewards on debit cards, given lower interchange revenue. Of standard programs, only airlines miles-based programs are likely to survive, albeit with reduced benefits. As a result, there will likely be increased interest in merchant-funded rewards and relationship-based programs. Prepaid Cards: The Durbin exemption for general purpose reloadable (GPR) prepaid cards has increased FI interest in the product, though it is unclear how FIs will bring it into their product suite alongside traditional offerings. Alternative Payments: The Durbin Amendment will make it significantly harder for alternative payments to gain merchant acceptance, since they now need to price under the new debit ceiling which will be uneconomical or provide a superior value proposition which is untested. It also gives a shot in the arm to PIN debit on the Internet, notably improving its prospects for FI adoption. Despite these headwinds, from a consumer preference and usage perspective, growth in the debit market remains robust. PIN transactions grew 8% in 2010, while signature transactions increased 10%. The average active consumer debit card now performs 16.3 point-of-sale purchases per month, 68% signature-based and 32% PIN-based. With average gross interchange rates of $0.49 per consumer signature debit transaction and $0.31 per PIN debit transaction, the average active consumer debit card currently generates $87 of interchange revenue per year for FIs. There is wide variation between best-in-class FIs and the overall average in terms of the key performance metrics.

Regulated issuers are financial institutions with at least $10 billion in assets and are hence subject to the interchange cap of the Durbin Amendment. Exempt FIs are not subject to the cap, but are subject to other provisions. 2011 Debit Issuer Study Executive Summary

On a pre-Durbin basis, business debit offers better economics than consumer debit, despite having lower activation and penetration rates than consumer debit: on a per-transaction basis, business debit delivers revenue that is four times greater than that of consumer debit cards. Roughly one-quarter of surveyed FIs identified business debit as one of their top three opportunities to grow in 2011, though it remains to be seen if this will hold true post-Durbin. The Feds Proposed Rule (released on December 16, 2010) to regulate the debit card market, as required by the Durbin Amendment, will significantly alter the dynamics within the debit card market. For FIs with at least $10 billion in assets, the Proposed Rule sets interchange to either (a) between $0.07 and $0.12 per transaction based upon each issuers costs or (b) up to $0.12 for all issuers. Additionally, all FIs regardless of asset size will be required to participate in at least two unaffiliated payment networks (and possibly two per payment method). Issuers are strongly critical of the proposed interchange cap, arguing that the proposed rate is too low (the definition of allowable costs is too narrow, the price is below issuers costs and the definition of reasonable and proportional is anything but reasonable) and a cap is inconsistent with free market principles (and the statute). On average, regulated FIs expect an 80% decline in interchange revenues; even FIs that are exempt2 from the interchange cap are expecting a 73% decline. Moreover, issuers believe that network exclusivity provisions are unnecessary given the interchange cap. Since debit is a key component of the demand deposit account (DDA), many FIs are already working to reposition its value proposition and to retool their existing product set, including introducing additional fees, reducing or eliminating rewards programs and offering more profitable alternatives to consumers, such as charge cards and prepaid cards. Changes to Reg E, governing opt-in requirements for continued debit-initiated overdraft coverage, went into effect last summer. Following concerted campaigns, on average, 24% of all cardholders have opted in to overdraft services, notably lower than issuers earlier projections. However, of customers that incur more than five overdrafts per year (these customers comprise 14% of accounts, but 93% of overdraft revenue3), the opt-in rate was almost twice as high, at 45%. As a result of these changes, overdraft revenue declined by 45%, from $0.36 per transaction to $0.20. Debit rewards programs are expected to be adversely impacted by the Durbin Amendment. While 56% percent of FIs currently offer some type of rewards program, 54% of those FIs are considering terminating or restructuring their programs. Many FIs are moving away from points-based programs and are looking toward merchant-funded or relationship-based programs. Similar to past years, while the majority of FIs are satisfied with their current rewards programs, few are able to quantify the programs benefits. Post-Durbin, being able to understand the true value-add of a rewards program will become increasingly important as FIs evaluate the return on investment. Actively managing fraud losses also will be critical in the post-Durbin market. In 2010, the PIN debit net fraud loss rate increased by 27% to 1.26 basis points (bps); the signature debit fraud loss rate remained notably higher at 7.50 bps. Forty-nine percent of FIs implemented one or more new fraud detection tools in 2010, and 34% of FIs cite processor tools as being one of their most effective ways of managing fraud. Tackling fraud is a never-ending journey, requiring FIs to constantly invest and remain vigilant, as fraudsters become ever more sophisticated. Some of debits growth is from displacing cash transactions, as illustrated by a continued decline in ATM cash withdrawals. On average, active cardholders performed 2.6 ATM transactions per month in 2010; down from 2.7 in 2009 and 3.0 in 2008. The number of FIs selling prepaid gift cards, the most popular type of prepaid card, increased from 67% in 2009 to 73% in 2010. However, many FIs expressed dissatisfaction with their gift card programs, which tend to be non-strategic and low-revenue producing. In fact, of the FIs that sell gift cards through their branches, 47% sell less than 100 cards per branch per year. Moreover, the gift card provisions of the CARD Act are prompting many FIs, especially those already disenchanted with gift cards, to reconsider their commitment to gift card programs.

2 3

Issuers with less than $10 billion in assets are exempt from the Durbin Amendment interchange cap

Source: 2008 FDIC Study of Bank Overdraft Programs 3

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While some FIs are considering exiting or outsourcing their gift card programs, others are looking into different segments of the prepaid market, such as general purpose reloadable (GPR) cards. In part due to their exemption from Durbin, GPR prepaid cards have become relatively more attractive, providing more and larger revenue streams than gift cards and offering a potential lower-cost substitute for debit cards/checking accounts for low-balance customers. As a result, 14% of FIs currently are offering GPR prepaid cards, up from 9% in 2009. Interest in contactless debit cards continues to erode: only 9% of cardholders with a contactless-enabled card actually use the contactless feature and, overall, contactless represents just 0.03% of total debit transactions. As a result, some current issuers plan to backtrack and remove this capability from their cards. Conversely, mobile financial services are growing, with 62% of FIs supporting mobile banking and 26% of FIs exploring mobile payments, up from 46% and 21%, respectively, in 2009.

Outlook
FIs forecast an overall increase in consumer PIN transactions of 7% and in consumer signature transactions of 7.3% in 2011 (see Figure 1).
Figure 1: Projected 2011 PIN and signature growth rates4

30% PIN txn growth (%)

20%

10%

10%

20% Signature txn growth (%)

30%

Large Banks

Credit Unions

Comunity Banks

The two biggest challenges that FIs anticipate in 2011 are regulatory pressures and fraud. Ninety-six percent of FIs cited the Durbin Amendment/regulatory pressures as a key challenge for 2011. Beyond Durbin, FIs continue to be concerned with the impact of Reg E and how they will make up lost overdraft revenue. With regard to fraud, 51% of FIs expect signature debit fraud rates to increase over the next two years, while 43% expect PIN debit fraud rates to further increase. For 2011, FIs exempt from the interchange provision of Durbin are focusing on improving their overall debit portfolio performance. FIs also believe there is untapped opportunity in business debit, particularly in capturing small business DDAs. Lastly, many FIs cited product design (in light of post-Durbin debit economics) as an opportunity for 2011. In sum, 2011 brings greater challenges than in past years, reflected in the impending Durbin Amendment regulatory changes and continued consumer preference for debit as a payment vehicle. Going forward, FIs will need to fully understand the role of debit within the broader context of the DDA to strike a balance between fulfilling customer needs and profitable growth.
4

Weighted by 2010 transaction volume 2011 Debit Issuer Study Executive Summary

2. Research Metrics
Research was conducted in February and March 2011 and the data provided by FIs is for 2010, unless otherwise noted. Debit card issuers performance metrics were gathered and analyzed in 10 specific areas, as listed in Table 1.
Table 1: Debit performance metrics categorization 1. Debit performance Consumer Penetration and active rates Instant issuance Incentives Transactions per active card Signature/PIN ratio Transaction growth Average ticket sizes and distribution Spend by merchant category

2. Debit performance Business 3. Debit P&L

% of FIs offering business debit Penetration and active rates Transactions per active card Signature and PIN interchange rates (consumer and business) Interchange revenue per card Cardholder pricing FIs opinions on draft rules Expected decline in interchange revenue Potential changes to debit due to Durbin Regulatory changes Overdraft programs pre- and post-Reg E revisions Communication of regulatory changes Rewards program offerings Types of rewards programs and program providers Value to the cardholder from rewards programs Signature and PIN debit losses Card reissuance criteria Data breaches and compromised cards ATM transactions per card ATM density On-us vs. off-us transactions Ratio of ATM to debit POS usage Prepaid card programs Gift card sales revenue per branch Gift card fees Gift card sales projections

Transaction growth Signature/PIN ratio Average ticket size Processor fees Network fees and net revenue Cost of rewards and fraud FIs preferences for interchange and network alternatives outlined in draft rules Opt-in rates Declined transaction rates Impact of Reg E changes on overdraft revenue Consumer participation levels Rewards program results and FI satisfaction Outlook for rewards programs Effective fraud tools Expectations of future fraud rates ATM fees Surcharge-free network participation Surcharge reimbursements Impact of the CARD Act GPR card features and offerings Prepaid card processors FIs perceptions of threats by alternative payments providers

4. The Durbin Amendment

5. Reg E

6. Rewards

7. Fraud

8. ATMs

9. Prepaid cards

10. Alternative payments

Contactless cards Mobile banking Mobile payments

In addition to these quantitative performance metrics, FIs commented on the key opportunities and challenges that they expect in 2011, including the impact of the Durbin Amendment.
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3. Drivers of Debit Performance

The debit business begins with DDAs. Debit card managers need to penetrate these accounts with cards, encourage cardholders to actively use their cards (% of cards that are active) and promote greater debit card usage (usage). Ignoring potential implications arising from the Durbin Amendment for a moment, these three drivers penetration, activation, usage (PAU) are the key performance indicators that determine the success of a debit card portfolio.
Figure 2: Drivers of debit performance5

Penetration rate 73%

DDAs 1005 Debit Cards 73 Active cards 39 Annual usage 7,628 txns per yr $307,281 Card performance Performance drivers under in uence of FI External drivers FI drivers

Active rate6

Usage7 16.3 transactions per active card per year Signature/PIN ratio 68%/32%

Sig. transactions 5,187 txns per yr

PIN transactions 2,441 txns per yr

Avg. sig. ticket $36 Sig. interchange 140 bps

Annual sig. interchange revenue $2,619

Annual PIN interchange revenue $768

Avg. PIN ticket $42 PIN interchange 74 bps

Interchange: annual revenue of $3,387 equates to $34 per DDA or $87 per active card

% txns charged overdraft: 0.3% Overdraft fee $29

Annual overdraft fee revenue $772

Overdrafts: annual revenue of $772 equates to $8 per DDA or $20 per active card

Total revenue: annual revenue of $4,159 equates to $42 per DDA or $107 per active card

DDAs exclude any revenue from per-card fees, per-transaction fees or rewards program fees. All revenue totals index to 100 DDAs. Active rate uses the most common definition among FIs of card activation, defined as any signature transaction within the last 30 days. Usage is measured by average transactions per month for 2010 (past survey participants only). 2011 Debit Issuer Study Executive Summary

As illustrated in Figure 2, the number of DDAs is the top of the funnel, and FIs need to work to minimize leakage at every step along the activity chain. On average, FIs have penetration rates of 73%, active rates of 53%, usage rates of 16.3 transactions per active card per month, a 68%/32% signature/PIN transaction mix, and an average ticket of $36 per signature purchase and $42 per PIN purchase. With these averages, consumer debit generates $107 per active card per year, equating to $42 per year for a typical DDA. The following sections discuss the key drivers of FI debit performance in more detail.

4. Debit performance Consumer

Penetration is the first step in any debit card program getting cards into account holders hands. The industry average penetration rate has remained flat at 73% since 2007 (meaning that 73% of DDAs can be accessed by some type of debit card). Penetration rates vary notably by account tenure, as new customers tend to have higher penetration rates than legacy customers. Once cards are issued, the second step is ensuring that the cards are active, or regularly used for purchases and/or ATM transactions. FIs continue to define active cards in a variety of ways, varying both the timeframe of usage and type of transaction that qualifies a card as active. Table 2 lists the percentage of FIs that employs each definition.
Table 2: Active definitions (by percent of FIs) Type of transaction Signature txns only Time frame 30 days 90 days 6-12 months Ever 30% 0% 0% 2% Any POS txn 15% 2% 0% 0% Any txn 24% 13% 7% 7%

The two most common definitions continue to be Any signature transaction in the past 30 days, for which the average active rate is 53%, and Any transaction in the past 30 days, for which the average active rate is 60%. However, some FIs are shifting from a signature-active to a purchase-active definition (meaning that the card is considered active if used for either a signature or a PIN POS purchase). Additionally, 7% of debit cards are used only at ATMs and never at the POS. Usage of and interest in instant issuance has decreased from 2009 to 2010. With instant issuance, cardholders receive a debit card at the branch as part of the account opening process. Without instant issuance, consumers open their checking accounts in a branch and receive their debit cards in the mail some time later, with a separate PIN mailer. Historically, instant issuance has had a positive impact on card activation and usage rates. However, FIs are unclear about whether instant issuance fits into their debit strategy in light of the Durbin Amendment. Currently, 26% of FIs offer instant issuance in either all or some of their branches while an additional 20% of FIs are actively considering its adoption (down from 36% in 2009).

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To increase PAU, FIs can provide incentives to their branch personnel for the distribution of debit cards. These incentives can be in the form of a direct dollar incentive (e.g. $X paid for each debit card issued), or in the form of an indirect contributor to a broader compensation framework. Thirty-eight percent of FIs offered such incentives in 2010; of these FIs that provided incentives, roughly half of them provided a direct dollar incentive (see Figure 3).
Figure 3: FIs that incentivize debit card issuance and type of incentive awarded

38% 62%

53%

47%

Do not o er incentive O er incentive

Direct dollar incentive Indirect contributor to total compensation

Of FIs that offer incentives, one-third are currently looking to adjust or even eliminate their incentive programs. For most of these FIs, the catalyst for change is the upcoming regulatory reform. Others want to more closely align the incentives with value created by their debit businesses. In 2010, the average active debit card performed 16.3 point-of-sale purchases per month. Figure 4 illustrates the average number of monthly transactions per active consumer card per month for each segment of FIs.
Figure 4: Monthly transactions per active consumer card (past survey participants)8 16.4 14.0 11.7 14.0 12.3 16.4 13.7 16.3

5.2

6.2

5.5

5.3

Large Banks

Credit Unions

Community Banks

Overall

PIN

Signature

Total

Best-in-class consumer debit card issuers achieve an average of 9.6 PIN and 20.5 signature transactions per active card per month as shown in Figure 5. Historically, best-in-class consumer card issuers were defined as those having high PAU.

PIN transactions per card and signature transactions per card do not sum to total transactions per card due to the presence of dual-function cards, which are both PIN- and signature-capable. Past participants are FIs that participated in both the 2010 and 2011 studies and that reported the same active rate definition for both years. 2011 Debit Issuer Study Executive Summary

Figure 5: Best-in-class issuers9

PIN Monthly transactions per active consumer card

Average = 6.2 10 8 Transactions/card 6 3.6 4 2 0 4th 3rd 2nd Quartile 1st 5.5 7.4 Best-in-class 9.6

Signature Monthly transactions per active consumer card

Average = 13.2 25 20 15 9.8 10 5 0 4th 3rd 2nd Quartile 1st 10.6 13.9 Best-in-class 20.5

Unlike prior years, signature growth outpaced PIN growth in 2010. Signature transactions grew 10% over the prior year and PIN transactions grew 8% (see Figure 6). As a result, signature transactions represented a higher proportion of the overall transaction mix than the prior year (68% in 2010 versus 65% in 2009). The ratio of signature to PIN transactions is highly influenced by fees for PIN usage, rewards programs, marketing promotions, merchant steering and cardholder preferences.
Figure 6: Debit transaction growth10

2010 PIN growth projected and actual

Transaction growth

2010 signature growth projected and actual

Transaction growth

17% 12% 9% 8%

16% 12% 12% 9% 10% 8% 8%

17%

10% 8% 8%

7%

Large Banks

Credit Unions

Community Banks

Overall

Large Banks Actual 20092010

Credit Unions

Community Banks

Overall

Expected 20092010

For 2011, FIs project 7% growth for both PIN and signature transactions. These projections are slightly down from 2010 levels, largely due to uncertainty around regulation and its impact on debit card usage.

9 10

All quartile averages are weighted Weighted by 2010 transaction volume 9

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The average ticket size is $42 for PIN purchases and $36 for signature, slightly higher than the prior years average ticket sizes of $41 and $35 for PIN and signature, respectively. Gross dollar volume (GDV) growth for 2010 was 8% for PIN debit and 11% for signature debit. Cardholder use of PIN versus signature debit varies considerably by merchant category (see Figure 7). Many PIN transactions take place in supermarkets (40%), which account for only 10% of signature transaction activity. Conversely, restaurants (standard and quick service) generate 30% of signature debit activity but only 1% of PIN POS transactions. Differential card usage is driven by cardholder preference, merchant PIN pad deployment, PIN prompting, use of cash-back and choice within the channel (PIN is not typically supported for card-notpresent transactions nor for many bill payment transactions).
Figure 7: Usage by merchant category

PIN transactions

Signature transactions

40% 28% 22% 0% 1% 0% 9%

Supermarket Retailer Gas Restaurant Quick Service Restaurant Travel & Entertainment Other

10% 21% 15% 16% 14% 3% 21%

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2011 Debit Issuer Study Executive Summary

5. Debit performance Business

A large majority of surveyed FIs (82%) issue business debit cards; these cards represent 6% of the total debit card base. Business debit cards have lower penetration rates than consumer debit cards (46% versus 73%). For accounts opened in 2010, 56% of business accounts are linked to a debit card, versus 83% for consumer accounts. Business debit cards also have lower active rates than consumer debit cards (40% versus 53%). Beyond penetration and activation, usage also is lower for business cards, at 13.2 transactions per active business card per month versus 16.3 transactions per active consumer card. While PAU rates are lower for business debit, the average ticket size is notably higher than consumer at $64 for business PIN and $92 for business signature, versus $42 for consumer PIN and $36 for consumer signature. The transaction mix tends to skew more toward signature purchases (79% of all business debit transactions are signaturebased versus 68% of all consumer transactions.) Lastly, business debit cards have much higher interchange rates than consumer cards, earning 2.35 bps (equating to an average of $2.10 per business signature transaction). Overall, as shown in Figure 8, the average interchange revenue per active business debit card is more than three times the average interchange revenue per active consumer debit card. Not surprisingly, more than 20% of FIs named business debit as one of their top three growth opportunities for 2011, though this will likely change post-Durbin.
Figure 8: Business vs. consumer debit card interchange revenue per year
Month Annualized $87 per active consumer card per year

Consumer PIN

32%

$0.31
$0.43

16.3

12

Consumer signature

68%

$0.49

Business PIN

21%

$0.31
$1.72 13.2 12 = $273 per active business card per year

Business signature

79%
Transaction mix

$2.10
Interchange rate Blended ($ per transaction) interchange rate ($ per transaction) Transactions per active card Gross interchange revenue per active card per year

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6. Debit P&L
Debit is a significant contributor to FIs non-interest income, with an average active consumer debit card generating $87 of interchange revenue per year. The average gross debit interchange rate is $0.31 per PIN transaction, $0.49 per consumer signature transaction, and $2.10 per business signature transaction. Post-Durbin, regulated FIs will lose at least an average of 76% of their interchange revenue (see Figure 9).
Figure 9: Gross interchange rates pre- and post-Durbin11

Business signature interchange rate (at least 94% decrease)

In $ per transaction

Consumer signature interchange rate (at least 76% decrease)

In $ per transaction

$0.49

$2.10

Pre-Durbin Post-Durbin

$0.07 $0.12
Signature (Business)

$0.07 $0.12
Pre-Durbin Post-Durbin Signature (Consumer)

PIN interchange rate (at least 61% decrease)

In $ per transaction

Blended interchange rate (at least 76% decrease)

In $ per transaction

$0.31

$0.49 $0.43

$0.07 $0.12
Pre-Durbin Post-Durbin PIN Pre-Durbin (Consumer & Business) Overall Pre-Durbin (Consumer)

$0.07 $0.12

Post-Durbin

11

Percent decrease is for $0.12 interchange rate 2011 Debit Issuer Study Executive Summary

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The average gross margin on signature and PIN debit transactions is currently $0.33 and $0.23, respectively (see Table 3). Gross margin is reflective of many of the per-transaction economics, but does not capture an FIs full cost structure. Important additional costs include customer acquisition, card production and fulfillment, debit program staff and marketing costs, customer service and channel operating expenses (branch network, call center, etc.).
Table 3: Signature and PIN debit margin (in bps per GDV and $ per transaction) Signature debit (consumer) 140 bps ($0.49) NA 18 bps ($0.07) 10 bps ($0.04) 616 bps ($0.02) 7.50
18

Category Revenues15 Costs

Line item Interchange rate13 Cardholder pricing Network fees Processing fees Rewards Fraud

PIN debit 74 bps ($0.31) 2 bps

14

Consumer blended12 119 bps ($0.43) 0.64 bps ($0.002) 14 bps ($0.06) 9 bps ($0.03) 4 bps ($0.01) 5.50 bps ($0.020) 86 bps ($0.31)

($0.01)

6 bps ($0.03) 7 bps ($0.03) 017 bps 1.26 bps ($0.005) 58 bps ($0.23)

bps ($0.027)

Gross contribution margin

99 bps ($0.33)

7. The Durbin Amendment

Ninety-six percent of FIs cited the Durbin Amendment and other regulatory pressures as a key challenge for 2011. The Durbin Amendment, signed into law as part of the Dodd-Frank Act on July 21, 2010, primarily aims to regulate the interchange revenue that large FIs can receive from debit transactions and eliminate network restrictions, such as network-FI exclusivity agreements. On December 16, 2010, the Federal Reserve released its draft rules to regulate the debit card market, as required by the Amendment. For each of the two key provisions (interchange fee regulation and network exclusivity), the Fed proposed two alternatives, soliciting feedback from the industry to guide their final rulemaking. FIs are highly critical of the interchange cap proposed by the Fed in response to the interchange provisions. They argue that the rate is too low and the enforcement of a cap is inconsistent with free market principles. There is consensus that the proposed cap of $0.07 to $0.12 displays a lack of consideration of the full costs required to operate a debit business and provides for no return to FIs. However, of the two price structures proposed by the Fed, all FIs prefer the alternative of a flat rate of $0.12 per transaction (plus allowable fraud prevention costs) since it provides a higher rate and does not require them to document their costs on an ongoing basis. FIs argue that the Fed has taken an inappropriately narrow view of which costs are allowable in setting debit interchange rates. First, FIs believe that the Fed should consider fraud costs within allowable costs. These fraud costs include expenses related to fraud detection systems, compliance with security standards, customer outreach due

12 13 14 15

Consumer blended is the weighted average of signature (consumer) and PIN debit Based on the average ticket for signature and PIN POS purchases Refers to revenues from charges on PIN debit transactions, averaged across all FIs and all PIN debit transactions Overdraft fees are not explicitly included in the P&L calculation. For more information on the revenue generated by FIs on overdrafts, please refer to the Reg E section Rewards cost is the industry-wide expense associated with signature debit rewards programs, and reflects the percentage of FIs with a program, the percentage of their cardholders enrolled in the program and the cost. The actual cost for any individual FI will vary widely The study sample did not include a sufficient number of FIs who offer PIN rewards to determine the average cost Refer to fraud section for further details 13

16

17 18

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to fraud, card-reissuance, chargeback and other dispute processing, and conversion to chip and PIN technology. Second, in addition to fraud prevention costs, FIs argue that fraud losses also should be included in the definition, since they are significant and not always in the FIs control. Fraud was cited by 72% of surveyed FIs as a key challenge for 2011. Third, on top of fraud costs, the industry has argued that allowable costs should include all incremental costs associated with processing debit transactions. These additional incremental authorization, clearing and settlement costs include production and delivery costs, network fees and attributable processing costs (and fraud losses and fraud prevention), thereby raising allowable costs to a level much higher than the Feds prescribed $0.07. Even FIs exempt from the interchange cap do not believe that the carve-out will help them since, over time, market forces will drive down interchange. Of the exempt FIs that participated in the 2011 Debit Issuer Study, 70% expect their debit interchange to decline by more than 50% (see Figure 10). FIs are critical of the network exclusivity provision and believe it is unnecessary in light of the interchange cap. They believe, that by establishing a cap of $0.12 per debit transaction, the Federal Reserve is negating some of the perceived need for additional network choice at the point-of-sale. They also state that the option of having two signature and two PIN networks on each card is impractical and will create significant operational challenges. Hence, of the two options, all surveyed FIs prefer Alternative A two unaffiliated debit networks per debit card.
Figure 10: Decline in interchange revenue expected by exempt FIs (% of respondents) 70%

20% 0%
0%

10%
0 10% 10-50% 50+%

The Durbin Amendment is expected to dramatically change the payments landscape, with implications that will be felt across every aspect of the debit industry and several aspects of the broader DDA business. On average, FIs expect a 79% decline in interchange revenue post-Durbin; regulated FIs expect an 80% decline in interchange revenues, while even FIs exempt from the interchange cap expect a 73% decline (see Figure 11).
Figure 11: Expected decline in interchange revenues (% of current revenues) 80%

73%

79%

Regulated FIs

Exempt FIs

Overall

Since debit is a key component of the DDA, FIs are already working to retool their existing product set and to reposition its value proposition, including introducing additional fees, reducing or eliminating rewards programs and offering more profitable alternatives to consumers, such as charge cards and prepaid cards. Fifty-four percent of regulated FIs are evaluating charging additional fees in order to make up for lost interchange revenue. Even exempt FIs are rethinking the DDA and debit value proposition with 27% evaluating additional fees. Furthermore, FIs expect to eliminate or significantly reduce benefits provided by current rewards programs 67% of regulated FIs and 30% of exempt FIs are evaluating changes to their current rewards programs.

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2011 Debit Issuer Study Executive Summary

8. Regulation E
On November 12, 2009, the Federal Reserve revised requirements for Regulation E to require opt-in consent from cardholders before any overdraft fees can be charged for one-time debit purchases or ATM transactions. At that time, most FIs expected the impact of the revised rules to result in reductions in debit transactions, interchange income and overdraft fee revenue. Now that the changes to Reg E have been implemented, we are able to report on the actual impact to FIs.
Figure 12: Percentage of FIs that allowed cardholders to overdraw their accounts (pre-Reg E) 60%

Prior to the Reg E changes, 74% of FIs allowed their cardholders to overdraw their accounts using their debit cards, either at the point-of-sale and the ATM, or POS only (see Figure 12). To comply with the Reg E revisions, FIs reached out to their customers and offered the opportunity to opt-in for overdraft service. The opt-in rates for the overall DDA base came in below initial FI forecasts. In total, 24% of debit cardholders opted in to continued overdraft coverage, lower than the 29% projected in the 2010 Debit Issuer Study (see Figure 13). It is important to note that opt-in rates include all cardholders; many cardholders did not respond to the communication and were classified as opting out by default, as per the regulatory rules.

26% 14% 0%
POS & ATM POS only ATM only Cannot overdraw

% of issuers

Figure 13: Opt-in rates projected versus actual 56% 49% 35% 27% 24% 20%

29%

24%

Large banks

Credit unions

Community banks

Overall

Projected for 2010

Actual 2010

The effectiveness of FIs opt-in campaigns can be illustrated by looking beyond overall opt-in rates, since overdraft revenues are not evenly distributed across the customer base for most FIs. Rather, overdraft revenues are concentrated among a subset of high-frequency overdraft users; 84% of overdraft revenue is accounted for by only 9% of customers19. Among heavy overdraft users, defined as account holders incurring more than five overdrafts per year, 45% opted in for continued overdraft coverage (see Figure 14).

19

Source: 2008 FDIC Study of Bank Overdraft Programs 15

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Figure 14: Overdraft opt-in rates for heavy overdraft users

Overdraft opt-in rates20 for heavy overdraft users21

Transaction growth

Overdraft opt-in rates

Public data22

Chase Customer opt-in rates

95%

# overdrafts/year Opt-in rate Less than 4 4-9 10 or more 21% 41% 53%

56% 44% 45% ~50%

As high as 53% As low as 21%

Large banks

Credit unions

Community banks

Overall

Regions

Chase

The best opt-in results were achieved by issuers that segmented their outreach efforts according to overdraft incidence, placing greater emphasis on reaching customers more inclined to use overdraft facilities. Of issuers that employed more targeted efforts, the opt-in rate for heavy overdrafters was 52% (versus 43% for FIs that did not segment their communication approach). The data on the right-hand side of Figure 14, drawn from publicly available sources, helps validate the effectiveness of this approach. On average, 1.6% of all attempted POS transactions would produce a negative balance. As tracked through this study, FIs saw a substantial increase in the number of declined transactions after the Reg E changes were implemented. Of attempted transactions that would result in a negative balance, the percentage of declines rose from 22% to 57%. As a result of the increased rate of declined transactions, overdraft revenue declined by an average of 45% of its levels prior to the new regulation (see Figure 15). The increase in declined transactions is due to a large segment of customers who would have overdrawn their account prior to the regulatory changes, but opted out of receiving overdraft services.
Figure 15: Overdraft revenue per average transaction (pre- and post-Reg E changes)
% of transactions that produce a negative balance % of transactions producing a negative balance that are approved

Average overdraft fee

Overdraft revenue per average transaction (pre-Reg E changes) Overdraft revenue per average transaction (post-Reg E changes)

1.6%

78%

$29

$0.36 per transaction

1.6%

43%

$29

$0.20 per transaction

20 21 22

Weighted by cardholder volume Defined as cardholders generating over 5 overdrafts per year Source: Customers opt in for overdraft protection, The Wall Street Journal, Nov. 26, 2010 2011 Debit Issuer Study Executive Summary

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9. Rewards
Fifty-six percent of FIs currently offer a debit rewards program but, in light of the Durbin Amendment, more than half (54%) plan to terminate or restructure their program (see Figure 16). In fact, of regulated FIs, 67% plan to make changes to their rewards program versus 30% of exempt FIs.
Figure 16: Rewards program changes
(of FIs with a debit rewards program)

FIs plans for their rewards programs

FIs evaluating changes in current rewards program

25% 46% 29%

67%
54% of FIs plan to restructure or terminate their rewards programs

54%

30%

No changes planned Plan to terminate Plan to restructure

Regulated FIs

Exempt FIs

Overall

The Durbin Amendment will shift the rewards landscape away from issuer-funded points programs and toward merchant-funded offerings and/or relationship-based programs (See Table 4).
Table 4: Post-Durbin rewards program outlook Rewards Program Regulated FIs outlook for issuer interest in rewards programs Percentage of regulated issuers not making changes to rewards program Percentage of unregulated issuers not making changes to rewards program Points Cash-back Miles Merchantfunded Relationshipbased

23%

50%

33%

60%

100%

71%

50%

50%

100%

NA

Similar to past years, most FIs are unable to quantify the impact of their rewards programs on key performance metrics. FIs will need to better quantify the true value add of their rewards programs as they seek to make decisions about their programs in the post-Durbin world. Moreover, FIs rewards programs tend to suffer from low cardholder engagement in terms of enrollment and registration (cardholders often need to register for the program in order to view their points and redeem rewards). Fee-based programs tend to have lower enrollment rates, but generate higher registration rates.

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10. Fraud
More FIs track debit fraud losses than in the past, as 88% of FIs now monitor fraud losses in some form. Credit unions showed the biggest improvement: only 7% of credit unions do not track fraud losses, compared to 19% in the prior year and 38% in 2008. However, the level of detail available on sources of fraud has not improved. Sixty-four percent of FIs that track fraud losses are unable to fully identify the point of use of transactions resulting in fraud (ATM vs. PIN debit vs. signature debit). FIs signature fraud loss rates stayed consistent with 2009 at 7.50 bps, and PIN POS fraud loss rates increased by 27% from 0.99 bps in 2009 to 1.26 bps in 2010. Figure 17 shows the fraud unit loss rates for signature and PIN debit. FI effectiveness at detecting and preventing debit fraud varies widely best-in-class FIs have been able to reduce their PIN debit fraud to nearly zero.
Figure 17: Signature and PIN net fraud loss rates (in bps per $) 7.50 7.50

Overall, issuers have a higher recovery rate on their PIN debit gross fraud losses than on their signature losses (78% of gross PIN fraud losses are recovered versus 56% for signature debit). Approximately half of all FIs (49%) implemented new fraud tools in the past year. The most effective tools, according to FIs, are processor tools, Falcon and enhancements to in-house fraud monitoring processes (see Figure 18). In addition to the use of fraud tools, many FIs have found success by investing in their fraud monitoring workforce. Overall, 51% of FIs expect their signature debit fraud loss rates to increase over the next two years and 43% expect PIN debit fraud loss rates to increase.

0.99
Signature PIN

1.26

2009

2010

Figure 18: Most effective fraud prevention tools23

Processor tools Falcon In-house monitoring Real-time txn monitoring Trend watching Daily limits Neural network

34% 32% 30% 28% 20% 14% 12%

% of FIs using as tools

23

Does not sum to 100% because FIs were asked to indicate several tools 2011 Debit Issuer Study Executive Summary

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FIs cite data breaches as the biggest source of fraud, although fraud from card skimming and lost/stolen cards are also concerns. Ninety-four percent of FIs were affected by a data breach in 2010; 9% of those FIs cards were potentially compromised but, on average, only 2% of their total card base subsequently experienced fraudulent activity. Thirty-one percent of FIs that were affected by a compromise reissued all of the affected cards; other FIs reissued some of the compromised cards depending on certain criteria. In deciding whether to reissue compromised cards, FIs should weigh the expected fraud losses against the costs of reissuance and impact to their cardholders.

11. ATMs
On average, active cardholders performed 2.6 ATM transactions per month in 2010. ATM cardholder activity has steadily declined, dropping from 3.0 ATM transactions per active card per month in 2008 to 2.7 in 2009 to 2.6 in 2010 (see Figure 19). Some of the decline in ATM use can be attributed to the displacement of cash in favor of debit cards and to the use of cash back at the point-of-sale. FIs reported off-us transaction growth of 1.6% in 2010, but a 1.8% decline in on-us volume. For 2011, however, FIs anticipate a decline in on-us and off-us ATM transactions of 1.7% and 4.2%, respectively. Credit unions tend to have the busiest ATMs, correlated with the highest number of cards per ATM. Meanwhile, large banks dominate the ATM deployment market, accounting for more than 90% of total FI ATMs. On average, FIs charge their cardholders $1.65 per foreign (off-us) ATM cash withdrawal within the United States, an increase from $1.57 in 2009. The distribution of such fees also reveals a shift toward the higher-end range of $1.75 to $2.00 (see Figure 20). Thirty-nine percent of FIs, mostly large banks, charge a higher fee for withdrawals at international ATMs versus off-us withdrawals at domestic ATMs.
Figure 20: Distribution of foreign ATM fees for domestic transactions 43% 30% 34% 28% 21% 29% 23% 24% 21% 11% 10% 11% 3%
$0.00

Figure 19: ATM transactions per active card per month 3.4 3.0 2.7 2.6

2007

2008

2009

2010

7%

4%
$0.75 $1.00 2008 $1.25 $1.50 2009 2010 $1.75 $2.00 > $2.00

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12. Prepaid cards

Prepaid cards are pay before payment card instruments spanning gift cards, GPR cards, payroll cards, flexible spending account (FSA)/health spending account (HSA) cards and other types of prepaid cards. Seventy-six percent of FIs currently offer some type of prepaid card, with the most popular being gift cards offered by 73% of FIs (see Figure 21).
Figure 21: FIs offering prepaid cards 67% 73%

27% 29%

22%

27% 9% 14% 6% 10%

Gift cards

FSA / HSA cards

Payroll cards

GPR cards

Other prepaid cards

2009

2010

Figure 22: Prepaid gift cards sales per branch (of FIs that sell through branches) 9%
< 100 100 300 300 500 500 +

16%

However, an increasing number of FIs are re-evaluating their gift card programs, in light of both poor program results and the gift card provisions in the CARD Act. For FIs that sell prepaid gift cards through their branches, 47% sell less than 100 cards per branch per year (see Figure 22).

GPR cards are effectively checkless checking products, replicating many of the features of a typical DDA, just without checks and without access to branches. GPR prepaid cards have more functionality than single-use gift cards, offer various potential sources of revenue and can substitute as lower-cost alternatives to checking accounts/debit cards. GPR prepaid cards are especially gaining momentum due to their exemption from the interchange regulations under the Durbin Amendment. Fourteen percent of FIs offer GPR prepaid cards, up from 9% in 2009.
47%

28%

Among other types of prepaid cards, FSA/HSA cards and payroll cards are the most popular, offered by 29% and 27% of all FIs, respectively. FIs are divided on the growth opportunities for these types of programs. In general, since such prepaid cards are not seen as core products, they are not strong areas of focus for most FIs.

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2011 Debit Issuer Study Executive Summary

13. Alternative payments

Contactless cards Interest in contactless debit cards continues to erode 22% of FIs offer at least some contactless debit cards, but 18% of these FIs plan to discontinue doing so (see Figure 23).
Figure 23: Contactless cards

FIs contactless debit card o erings

FIs plans for contactless cards

(of FIs who currently o er contactless cards)

22% 2% 76% 18%

Currently o er Planning to o er No plans to o er

82%

Plan to stop o ering Plan to continue o ering

Only 9% of cardholders with cards with contactless capability actually use the contactless feature. In total, contactless transactions represent just 0.03% of total debit card transactions. In general, FIs are discouraged by the incremental cost of contactless cards, their low level of merchant acceptance and weak cardholder interest.

Mobile financial services Mobile financial services span mobile banking and mobile payments. With mobile banking, the customer uses a mobile phone to perform certain functions check balances, perform account transactions/fund transfers, initiate bill payments and locate branches/ATMs. With mobile payments, the consumer uses the mobile device itself to initiate a payment at a physical point-of-sale. Cardholders link card payment information to a mobile device and use the phone to initiate a payment relying either on SMS or near field communication (NFC) capability.

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The number of FIs offering mobile banking has grown from 37% in 2008, to 46% in 2009, and now 62% in 2010 (see Figure 24). Of the FIs that indicated they were planning on introducing mobile banking in last years study, 74% have followed through and launched a mobile banking platform. Mobile web continues to be the most common form of mobile banking supported by FIs, although the popularity of downloadable applications and SMS has grown quickly.
Figure 24: Adoption and interest in mobile banking by FI segment 2010 16% 12% 72% 57% 46% 7% 36% 27% 27% 62% 16% 22%

Large banks

Credit unions

Community banks

Overall

Already o er

Plan to introduce

No plans

The percentage of FIs exploring mobile payments increased from 21% in 2009 to 26% in 2010. While some FIs are looking into ways in which they can participate, many believe that this alternative payment method has a long way to go to become a proven and viable option.

Alternative payments companies Most FIs do not consider any alternative payment companies as material threats to their core debit business. However, of the various alternative payment methods, the most commonly cited concern was PayPal (see Figure 25).
For alternative payments players, Durbin-mandated pricing undermines insurgent business models. The basis for innovation with alternative payments was to generate a lower price point than traditional payment forms. With the Durbin Amendment resulting in substantially lower pricing, merchants no longer have an incentive to look for a cheaper payment option than debit.
Figure 25: Alternative payment methods cited as threats by FIs24 66%

20% 10%
PayPal Decoupled debit / ACH

26%

Other

None

24

Percentages add up to more than 100% because some FIs cited multiple threats 2011 Debit Issuer Study Executive Summary

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About Oliver Wyman and PULSE

Oliver Wyman The 2011 Debit Issuer Study was conducted by the Financial Services practice of Oliver Wyman, a leading independent management consulting firm, and all opinions expressed are solely those of Oliver Wyman. Oliver Wyman serves Global 1,000 clients on a wide range of strategic issues and counts 75 of the global top 100 financial institutions as its clients. The firm has guided some of the worlds most sophisticated institutions on their retail banking and payment strategies. Oliver Wymans staff of 3,000 operates from offices in more than 40 cities in 16 countries. For more information, please visit www.oliverwyman.com.
This report was prepared by Tony Hayes and Inderpreet Batra. Tony is a Partner in the firms Retail and Business Banking Practice, specializing in strategic issues related to retail payments; he can be reached at 617-424-3283 and tony.hayes@oliverwyman.com. Inderpreet is a Principal in the Retail and Business Banking Practice, working across payments, operations and wealth management; he can be reached at 646-364-8789 and inderpreet.batra@ oliverwyman.com.

PULSE As part of its ongoing commitment to industry thought leadership, PULSE commissioned the 2011 Debit Issuer Study and this report, but has no involvement in the execution of the project.
PULSE, a Discover Financial Services (NYSE: DFS) company, is a leading ATM/debit network, serving more than 4,400 banks, credit unions and savings institutions across the United States. The network links cardholders with ATMs and POS terminals at retail locations nationwide. Through its global ATM network, PULSE provides worldwide cash access for Diners Club and Discover cardholders through hundreds of thousands of ATM locations. The company also is a source of electronic payments research and is committed to providing its participants with education on emerging products, services and trends in the payments industry. PULSE provides additional resources through its website to assist participants in responding to the changing debit landscape, including current research and insights from various industry studies. In addition, the online Durbin Amendment Resource Center provides the latest information pertaining to the Durbin Amendment. For more information, go to www.pulsenetwork.com.

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For more information about the 2011 Debit Issuer Study and to discuss its implications for your organization, please contact Steve Sievert at 800-420-2122 and ssievert@pulsenetwork.com.

Copyright May 2011, PULSE. All rights reserved. Reproduction by any method or unauthorized circulation is strictly forbidden and is a violation of federal copyright law.

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2011 Debit Issuer Study Executive Summary