Consumer interest fuels acceptance of decoupled and co-branded debit

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14 February 2009 | TRANSACTION trends Consumer interest buels acceptance o b decoupled and co-branded debit cards, yet obstacles prevent bast growth I n recent years, consumers 9 ever- increasing interest in debit cards 4 and card issuers 9 push to capitalize on that interest 4has sparked the introduction of new debit options to the market. Decoupled debit, one of those options, holds signiIcant promise. Unlike traditional debit cards, issued by the owner 9s bank, decoupled debit cards are not linked to a demand-deposit account.

Transactions are settled over the branded payment networks, with funds deducted from consumers 9 checking accounts and paid to an intermediate service provider using the ofJine ACH network. Most decou- pled debit cards offer enhanced rewards to users, such as points redeemable for mer- chandise and services. Some decoupled debit cards are co- branded, issued in conjunction with a merchant, which have the advantages of eliminating interchange fees, bolstering customer loyalty, and potentially expand- ing the customer base beyond a single bank.

Who 9s in the Game McLean, Virginia-based Capital One Finan- cial Corp. generated big waves in the market in 2007 when it launched a co-branded de- coupled debit card program in partnership with Sheetz Inc., ... more. less.

the Altoona, Pennsylvania- based convenience store chain, and Ukrops, the Richmond, Virginia-based supermarket chain. Consumers using the MasterCards received bonus points redeemable for gift cards good at their particular stores. At the same time, an undisclosed number of ex- isting Capital One credit cardholders were offered a decoupled MasterCard-branded debit card. Both products were marketed as providing users with three to Ive times [ FEATURE ] decoupling odd not so By Julie Ritzer Ross Todd Davidson/Images.com KEY NOTES 8 When Capital One ended its decoupled debit card pilots last May, industry players speculated that it had acceded to pressure brom competing banks that perceived a threat to their demand-deposit bases. 8 HSBC Retail Services and PayPal are both ofering decoupled debit card programs. 8 The enhanced rewards aspect o b decoupled debit will be an irresistible lure bor consumers and, in turn, a catalyst bor the growth o b decoupled debit products. 8 Obstacles remain, however, and account settlement ranks at the top o b potential glitches. 16 February 2009 | TRANSACTION trends [ FEATURE ] the actual value of traditional reward debit cards. Capital One abruptly ended the tests in May 2008, touching off speculation that Capital One had acceded to pres- sure from competing banks perceiving a threat to their demand-deposit bases. Other observers blamed a new interpre- tation of a rule set by NACHA-The Elec- tronic Payments Association, which states that transactions that require settlement to payees within 14 days (primarily, those tied to debit cards) cannot be processed in bundles because aggregating these payments means the loss of merchant and other information needed for risk assessment. However, at the time, a Capital One spokesperson said the tests had ended as originally planned, with neither pres- sure from competitors nor any interpre- tation of NACHA rules Iguring into the equation. cThese were small pilot origi- nation programs designed to inform our broader decoupled learning agenda that are complete, d she said, declining to dis- close the number of cards issued or any other details. Meanwhile, other forms of decoupled debit continue to enter the marketplace. Notably, HSBC Retail Services is testing co-branded decoupled debit cards in partnership with CVS Caremark Corp. of Woonsocket, Rhode Island, and Path- mark Stores, a regional supermarket chain based in Cateret, New Jersey. San Mateo, California-based Tempo Payments Inc. (formerly Debitman) handles the pro- cessing of HSBC cardholders 9 decoupled debit transactions. Tempo has also begun marketing its decoupled debit platform to other institutions, according to CEO Mike Grossman. In another twist, the PayPal unit of eBay now offers participants a decoupled deb- it card that doubles as a MasterCard Pre- mier BusinessCard; funds are deducted di- rectly from cardholders 9 PayPal accounts. Users receive one percent cash back on all purchases made with the card if they select the ccredit d rather than the debit option during the checkout process. Meanwhile, Capital One continues to apply a ctest-and-learn d strategy with re- gard to decoupled debit, and is exploring decoupled and co-branded decoupled possibilities. Reason to Cheer Some analysts and experts envision a rosy future for decoupled debit, co-branded, and otherwise. cThere are reasons to be excited about this product, d says Gwenn Bezard, research director at Boston-based consulting and research Irm Aite Group LLC. Aite 9s research points to a csizeable potential market d for decoupled debit cards in the United States. One third of consumers are cinterested d or cvery inter- ested d in decoupled debit card concepts, according to a 2008 Aite study. Further, 36 percent of respondents would accept a debit card from a bank other than the bank where they hold a checking ac- count if they could receive four to Ive times the rewards afforded by a tradi- tional debit card. The appeal of decoupled debit cards will be such that cincumbent Inancial in- stitutions will [Ind themselves needing] to react to the risk of disintermediation of their business model, d suggests Bezard, adding that decoupled debit cards will calso expose Visa, MasterCard, and incum- bent EFT networks to new competition in the debit arena. d The enhanced rewards aspect of de- coupled debit will be an irresistible lure for consumers and, in turn, a catalyst for the growth of decoupled debit products, agrees Paul Tomasofsky, president of Montvale, New Jersey-based Two Spar- rows Consulting. cWithout question, the consumer payments world is in transition, d writes Ariana-Michelle Wittlake, a senior analyst with the banking group of Boston-based research Irm Celent LLC, in a report en- titled, cDisruption in the Payments World. d Unquestionably, she notes, economic Research points to a csizeable potential market d for decoupled debit cards in the United States. One third of consumers are cinterested d or cvery interested d in decoupled debit card concepts, according to a 2008 Aite study. 4Gwenn Bezard, research director , Aite Group LLC TRANSACTION trends | February 2009 17 pressures and consumers 9 push toward debit transactions as an alternative to in- curring additional credit card debt will spur additional efforts by ccredit-only or credit-centric issuers & to diversify their payments mix and focus on building their debit payment options by way of decou- pled debit programs. d Other reports bear out this contention. Branded decoupled debit products pro- vide a more consumer-centric approach to the concept of debit, cwith broader merchant acceptance, d according to the Mercator Advisory Group report cDecou- pled Debit: Let 9s Take a Closer Look. d Warning Flags Nonetheless, several issues surrounding co-branded decoupled debit, and de- coupled debit cards in general, must be resolved before a market niche emerges. While a few of these issues may be of little concern to ISOs, others warrant consideration. Some observers say co-branding may not be the right catalyst for fostering the growth of decoupled debit card pro- grams. cBecause co-brand(ed) cards usu- ally restrict the scope of the rewards as opposed to non-branded cards & the co- branded approach might not be the best path to marketing decoupled debit cards, d suggests Bezard. As for decoupled debit as a whole, ac- count settlement ranks at the top of the list of possible glitches. In late 2007, NA- CHA initiated an analysis of transaction aggregation at the request of a member bank. While the Inancial institution had not experienced difIculty with aggre- gated transactions, its principals were concerned that the inability to identify such transactions would invite consumer disputes, according to a NACHA spokes- person. Bank officials also contended that performing risk assessments on aggregated transactions would prove problematic. NACHA was also worried about the effect of aggregated transactions, even- tually sparking its decision to enact the rule. cWe didn 9t think we could analyze the data because merchant identiIcation would not appear on the transaction, d the spokesperson explains, adding that had Capital One continued with its decou- pled debit program, it would likely have been compelled to reIne its processes to adhere to the rule. Tempo, for its part, does not aggregate transactions. Moreover, in the traditional debit sce- nario, card issuers can determine whether a given account contains sufIcient funds prior to authorizing the transaction. Is- suers of decoupled debit cards have no access to such information until a trans- action is settled, generally two days after it is executed. HSBC reportedly sidesteps this roadblock by analyzing transactions at the point-of-sale using proprietary risk algorithms and authorization data, while observers say Capital One approved or declined transactions in accordance with a daily spend limit of $500, rather than with the balance in customers 9 checking accounts. The potential for fraud comes into play as well, according to Daniel Schutzer, executive director of the Financial Ser- vices Technology Consortium in New York City. cWhen you have a relationship with a bank, it is so much easier to vali- date who you are, as the bank knows the customer 9s address and details and can validate who is the legitimate holder of the bank account, d he notes. Although it is too early to say whether the decoupled sector has seen the signiIcant incidence of fraud, most cases will probably not be reported unless their magnitude renders them newsworthy, says Schutzer. Some experts cite other factors that, if not mitigated or addressed, may also limit merchant and consumer accep- tance of decoupled debit. For example, although merchants Ind favor with any product that reduces card-acceptance costs, they may need to invest time and money in training employees to man- age decoupled debit transactions at the point-of-sale. This is especially true in cases where transactions are run on a proprietary network, according to the Celent report. Many merchants are a bit fearful about the rewards side of decoupled debit, feeling they 9ve been burned by rising interchange rates to sup- port credit card rewards programs. Postings on the site www.merchant accountblog.com indicate a sense among merchants that debit card interchange fees will increase to pay for equally gen- erous debit card reward programs. cUn- til consumers stop buying into reward cards d as a whole, cinterchange can 9t go anywhere but up, d comments one mer- chant on the blog. The growth of co-branded decoupled debit will be limited to cards associated with very large merchants, contends Bob Giltner, a consulting partner for Austin, Texas-based debit rewards program pro- vider My Rewards. It is unlikely consum- ers will ccarry too many credit cards around in their wallets, d unless some manner of significant incentive spurs them to do so. Additionally, Giltner says many consumers are wary of acquiring a debit card issued by an entity other than the Inancial institution with which they have a checking account. Still, Tempo 9s Grossman remains con- vinced that the outlook for decoupled debit remains rosy. cThe evolution will follow the pattern we have seen with debit cards, d he asserts. cThere will be cer- tain winners and certain losers, but at the end of the day d decoupled debit will have a true presence. cIt 9s coming and it 9s out there. Once the genie has emerged from the bottle, it 9s hard to get it back in. d TT Julie Ritzer Ross is a contributing writer to Transaction Trends. Reach her at julieros@aol.com. Economic pressures and consumers 9 push toward debit transactions& will spur ccredit-only or credit-centric issuers& to diversify their payments mix and focus on building their debit payment options by way of decoupled debit programs. d 4Ariana-Michelle Wittlake, senior analyst, Celent LLC

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