Evolving Payment Systems Mean Big Changes for Financial Institutions

July’s U.S. district court ruling on debit card interchange fees leaves some financial institutions – including credit unions – crying foul and worrying about their bottom lines. But this ruling is just one of many developments that will, over time, bring significant changes to the payments field and challenge any institution seeking to stay competitive and relevant to consumers.

This is true especially for credit unions. Member-focused, often smaller than other institutions and historically challenged by thin margins, credit unions will need to reevaluate their practices and consider ways they can adapt to the changing payments market. NAFCU is working at the front lines to protect credit unions’ ability to generate the income they need to keep serving their members, and that includes the ability to receive fees that cover their significant costs in offering card services. But time and progress will bring changes to the current infrastructure, and credit unions need to prepare.

On July 31, Judge Richard Leon of the U.S. District Court for the District of Columbia said the Federal Reserve Board’s debit interchange rule does not comply with the Dodd-Frank Act’s debit interchange provisions, or the Durbin amendment. He said the Fed set the debit interchange fee cap, 21 cents per transaction for institutions with more than $10 billion in assets, too high and that its requirements on non-exclusivity were inadequate. That is seriously bad news for all card providers, especially if they look to interchange income as a key component of yearly revenue.

The Fed is appealing Judge Leon’s decision and has asked that a stay remain in effect while the appeal goes forward. The judge may grant that request, or he may not. Regardless of the outcome, other developments in the market make it clear that changes are ahead for card services providers.

One growing market is prepaid cards. They are already in use for some receiving government benefits and those working for certain employers. If debit fees are cut so low they cannot sustain current services, more financial institutions might see prepaid cards as one way to deliver essentially the same benefits. The Consumer Financial Protection Bureau (CFPB) has recognized this market as largely unregulated and is expected to come up with a proposed rule soon under Regulation E, which implements the Electronic Fund Transfer Act.

Another apt example of coming change for the financial industry is the EMV card. While not in widespread use in the U.S., this smart-chip card is gaining popularity. Visa, MasterCard and Discover are already making the switch to EMV cards, which offer more safeguards and ease of use internationally for consumers.

EMV technology – the acronym stands for Europay, MasterCard and Visa – reduces fraud risk through enhanced card security features, and a liability shift to EMV is set to occur in October 2015. By then, any card issuer or merchant that does not have an EMV-enabled terminal will assume liability for counterfeit card transactions. This shift alone may be encouragement enough to persuade financial institutions to plan to adopt EMV technology, but if that doesn’t persuade, consumer preference may.

While EMV is safer and more secure for consumers, the cost to switch systems and issue new cards to customers is more expensive than the traditional magnetic strip credit and debit cards. A recent article in NAFCU’s The Federal Credit Union magazine, “Get Smart: 7 things you need to know about EMV,” notes that card issuers can expect to pay at least double the cost of magnetic-strip cards to switch to EMV. It also warns that rolling out an EMV system may require more time than a traditional card system. Financial institutions will have to prepare for these changes and be ready to incur the extra costs.

NAFCU will continue efforts to ensure credit unions’ interests in Washington, but adapting to new technologies and consumer demands is something credit unions will be dealing with head-on – as they have always done.