The Dodd-Frank Act that was enacted in July this year has targeted credit card companies by slashing the interchange fees on debit card transactions. Particularly, card giants MasterCard Inc. (MA) and Visa Inc. (V) are reported to be the wary victims of the interchange fee cuts, since being one of the key revenue drivers, this regulation is expected to adversely impact future revenue of the card companies.
The furor has been caused with the proposal passed by the Federal Reserve last week that elucidated the urgent requirement of making modifications to the debit-card interchange fees.
Basically, each time a consumer makes a payment with a card, the merchant pays a fee to the bank or credit union that issued the card. This interchange fee is typically in the range of 1%–2% of the purchase amount. Card companies such as MasterCard and Visa earn through a part of this fee by collaborating with the 16,000 or so US banks and credit unions that issue cards. Hence, the cycle of actions put an uncertainty on Visa and MasterCard’s future revenue performance.
Accordingly, last week the Federal Reserve recommended that the interchange fee on debit transactions, charged by banks on the merchants, should be restricted to about 7–12 cents, against the average debit card interchange fee of 44 cents or 1.14% of the purchase price charged in 2009.
This profound slashing will hamper revenues of the banks, which in turn will affect the card companies as banks would now try to trim the fee that they pay to use the respective card networks. A final decision is, however, not expected before April 2011.
Besides, MasterCard and Visa, being the two dominant players in the card industry, are expected to bear the maximum brunt from the implementation of the new regulation. On the other hand, to make matters worse for the card giants, merchants will now have the choice of processing transactions through unrelated networks. This may also hamper the number of transactions processed along with the cost of such transactions, which is again a key growth component for the card companies.
Further, the Consumer Protection Act signed in July 2010 (also known as the Dodd-Frank Act) would not only compel the trimming of debit/credit processing fees but is also expected to contract credit offerings from financial institutions, including banks and card companies.
However, the Act has come to the rescue of the merchants and consumers in one way or the other. The recent proposal is a victory for merchants who have for years protested against high interchange fees on debit card transactions. The financial overhaul, post the global credit crisis, is now expected to encourage consumers to use credit cards effectively and also ease the pressure on the merchants, while creating healthy competitive environment.
Conversely though, the legislation is expected to slice out revenues for the card companies, although the full impact will not be felt before mid-2011. While Visa has already estimated that about 16% or less of its revenues will be affected from the adverse impact of these regulations, its net income is projected to be reduced by about 6% in 2012.
Meanwhile, prime peerMasterCard has yet to assess its share of loss, yet it is expected to have a neutralizing effect on its income at least through 2012. This is due to the fact that MasterCard has limited exposure in the debit card market compared with Visa, which is intensely penetrated and holds a vast market share.
Another prime peer, American Express Co. (AXP), does not issue debit cards but is yet fighting a Federal anti-trust litigation against the Department of Justice that alleges that the company’s contract with merchants deliberately discourages the customers to use cheaper cards. MasterCard and Visa have already settled this case in October this year, thereby allowing discounts even on less expensive cards.
The situation is expected to get grimmer, should other countries follow suit and cap the interchange fee charged internationally by the card companies. This US regulation could raise global anti-bank sentiment, which could be devastating for the card companies.
Based on an anti-trust action, Visa and MasterCard have already agreed to cut the fees by 0.2% in Europe. The US banks, including Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC) are also estimated to incur an annual revenue loss of $12 billion from the proposed fee cut.
Going ahead with the financial overhaul reforms, the US Senate Democrats are also reported to have proposed to cap the fee charged on prepaid cards, a market which MasterCard and Bank of America has been exploring progressively. MasterCard has been pursuing acquisitions such as that of Travelex’s prepaid card division in order to shift from the higher-charged card markets where regulations have been hindering future growth.
MasterCard had recently projected that prepaid volumes would reach more than $840 billion by 2017, immensely up from $37 billion 2010. However, such a regulation in prepaid card market could further curb the income sources of the card companies and banks, thereby limiting growth. A final decision presently remains far from sight, but the bill would require issuing of regulations within nine months of enactment.
However, there lies some light at the end of tunnel, since the other side of the picture reveals that such laws would ultimately will non-beneficial to the consumers, for the protection of whom all the regulations have been proposed. This is due to the fact that the cycle of cost shift is eventually projected to lie on the consumer’s shoulders, thereby making this pricing policy anti-competitive, anti-economic and vicious, according to the card companies and bankers.
Overall, although we remain at the periphery, presently, to notice further developments and the impact of the final decision, we believe that the regulators are required to perform a balancing-act so as to provide benefit to both the financial institutions and the consumers.
Nevertheless, fundamentally, card companies such as American Express, MasterCard and Visa are generating sound growth amid the volatile market flow. However, an anti-growth regulation could be a direct shot in the arm of these companies.
AMER EXPRESS CO (AXP): Free Stock Analysis Report
BANK OF AMER CP (BAC): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis Report
MASTERCARD INC (MA): Free Stock Analysis Report
VISA INC-A (V): Free Stock Analysis Report
WELLS FARGO-NEW (WFC): Free Stock Analysis Report
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