Debit Closing the Gap on Cash and Credit

CU360
May 28, 2007

Debit cards are quickly catching up to credit cards and cash as a primary means of point-of-service and online transactions. Total transaction volume in the U.S. debit card market reached a phenomenal $907 billion in 2005, up 18.6% from 2004.

Projections are that debit cards will continue to enjoy strong growth and annual debit transactions will exceed $2 trillion by 2010, according to a recent study by the research company Packaged Facts.

Nearly one-half (48.2%) of U.S. adults carry debit cards, according to the study reported in Cards International, a London-based financial publication.

Increased use among young consumers and the growing use of recurrent bill payments and online transactions are helping debit cards close the gap on credit card transactions, the study said.

Behind the scenes, however, all that glitters is not gold, as merchants, card networks, and financial institutions have battled in the courts over interchange rates, processing fees, and other issues for over a decade. Such internal warring, however, has not slowed down card issuers' innovative new plans to increase debit volume.

Despite the battle between merchants and financial institutions over off-line (signature-based) versus online (PIN-based) transactions, both categories have grown exponentially, recording compound annual growth rates of 22% and 19.2%, respectively. The study notes that off-line debit's share of the market reached its peak in 2003 and since then has been slowly yielding ground to PIN-based transactions.

Rewards Moving from Credit to Debit

The success of rewards programs in the credit card industry is prompting financial institutions to seriously look at programs that will link rewards programs to debit cards. "Rewards linked to debit cards are a logical progression from the explosion of credit card rewards programs, the importance consumers place on rewards, and the increasing use of debit," Bruce Cundiff, research analyst for Javelin Strategy & Research, tells Bank Systems & Technology newsletter.

Executives with MasterCard say most large banks have begun offering rewards tied to their debit cards. By year-end 2006, MasterCard predicts the top 10 debit issuers all will have some kind of debit card rewards program in place. Currently, 36% of banks offer debit rewards, according to Dove Consulting.

Debit and credit card rewards programs don't differ much in how they work. A key difference, however, could be the value of the rewards because of the profitability of credit cards versus debit cards. A debit program, for example, might give one point for every $2 spent, rather than for every $1, as is the case with most credit card programs.

Another difference is that most debit programs restrict rewards to signature debit purchases only, not PIN-based transactions. "Financial institutions earn more money on signature transactions," says Cundiff. "This leads to cardholder confusion. If consumers don't read the fine print, they won't know that PIN transactions are ineligible for rewards points. This needs to be explained clearly to them."

Merchant involvement in debit rewards initiatives, however, could alleviate some of the confusion. This would come in the form of affinity debit programs in which merchants--not the financial institution—fund the rewards. This, Cundiff explains, would open the door to PIN-based transactions in the rewards game. "The majority of rewards programs are paid for by interchange fees. If a merchant receives large volumes of PIN transactions, their costs go down. So they can potentially take some of these savings and offer affinity programs," he says.

Regardless of the signature-based versus PIN-based debit rewards issue, financial institutions still stand to gain from a debit card rewards program. MasterCard is looking at ways to help financial institutions optimize their efforts by linking credit and debit card rewards in a kind of packaged solution.

Although there's not quite as much visibility with debit rewards as there is with credit card rewards, Cundiff thinks the idea will have mass appeal for consumers once financial institutions get them up to speed.

"Debit rewards is a concept that resonates with consumers," Cundiff states. "It will spur debit use and is a big retention play. It's still limited to the large financial institutions, but it might be something the mid-tier and smaller institutions need to implement to remain competitive over the next 18 to 24 months."

The Next Frontier

"Rewards, already a proven seller with credit cards, should become the next big frontier for debit cards," noted Don Montuori, author of the Packaged Facts study. "Prepaid debit is also poised to become popular by offering an estimated 48 million unbanked consumers a convenient payment alternative to cash."

Debit's greatest catalyst for the near future is increased use by young consumers, who embrace debit at levels far surpassing their elders. The study found that debit cards will enjoy greater acceptance with each new generation of adult consumers. And today's young debit users will shift more of their purchasing and monthly payments to debit products as the market evolves.

As everyday debit use has increased, issuers and processors have moved to eliminate, or at least substantially increase, daily transaction limits. Networks can now easily set different limits tied to distinct transaction categories—a key step in making debit cards available for big-ticket retail items.

At the other end of the spectrum, micropayments represent an even larger opportunity especially if linked to contactless devices that offer rewards at the point of sale.

Rewards will be a major differentiator in the hotly competitive debit market in the years to come. Many issuers said they were evaluating or getting ready to launch comprehensive rewards programs in the mold of Citibank's wildly popular Thank You program. For financial institutions, rewards provide a new way to highlight investment or loan services that consumers might be unaware of, and to bring a greater percentage of household financial services to the institution.

This story first appeared on cu360.cuna.org and is reprinted with permission.