Quick Thoughts: Visa and WMT – The Beginning of the End for Signature Debit

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Howard Mason



May 11, 2016

Quick Thoughts: Visa and WMT – The Beginning of the End for Signature Debit

The Congressional intent of the Durbin Amendment, part of the 2010 Dodd-Frank Act, was to promote competition at the network level in the debit business and, in particular, to allow those networks that extended into debit from ATM franchises (such as NYCE owned by FIS, PULSE owned by DFS, and STAR owned by First Data) to challenge the emerging duopoly from those networks (i.e. Visa and MasterCard) that extended into debit from credit franchises. Indeed, Durbin explicitly looks to give merchants more choices over how a debit transaction is processed (or “routed” in the industry vernacular) and prohibits issuers and networks from restricting merchants in exercising a legislative right to route a debit transaction over any available network.

To that end, the Durbin Amendment requires that any Visa- or MasterCard-branded debit card be capable of processing transactions over at least two unaffiliated networks. This ended Visa’s practice of providing incentives to its bank-issuers who enabled Visa-branded debit cards only for the Visa network when the cardholder chose to authenticate with a signature and for the Visa-owned Interlink network when the cardholder chose to authenticate with a personal identification number or PIN. These cards, which accounted for ~70% of Visa-branded debit cards in circulation in the US prior to the Durbin Amendment, gave the merchant no choice over network provider.

Visa-branded debit cards must now be enabled for an unaffiliated PIN debit network. However, charged with implementing the Durbin Amendment, the Federal Reserve chose not to interpret it as meaning that a debit card had to be enabled for more than one network for each cardholder verification method[1] which would have meant that debit cards had to be enabled for more than one network supporting signature-authentication and more than one network supporting PIN authentication. Rather, debit cards on which are represented one network supporting signature-authentication and at least one unaffiliated network supporting PIN authentication are Durbin compliant. WMT’s complaint filed on May 10th in New York Supreme Court over Visa’s resistance to the store’s initiative to insist that cardholder verify debit transactions with a PIN rather than a signature is the result.

WMT’s point is that on a Visa-branded debit card, even if Durbin compliant, the cardholder choice of signature as a verification method is dispositive in regard to processing: the transaction then has to be routed over the Visa network since there are no debit cards that are enabled for both Visa and MasterCard. This is less true when a cardholder chooses PIN as a verification method since debit cards are typically enabled for more than one PIN debit network giving the merchant more routing choices as contemplated by Durbin. Along with lowering fraud costs, this explains why WMT has adopted a “chip-and-PIN” protocol for debit card transactions and insisted that cardholders presenting a chip-enabled debit card authenticate with PIN. This is standard practice in other parts of the world, such as the UK, Canada, and Australia, because PIN-verification is more secure than signature-verification and so generates meaningfully lower fraud costs. It also allows WMT to route debit transactions over PIN network rather than the Visa signature-based debit network which saves the company ~5 cents/transaction.

To protects its pricing and volumes, Visa has objected to the chip-and-PIN protocol and insisted, presumably as a condition of WMT’s continued acceptance of legacy debit cards that encode account information on a magnetic stripe rather than a chip, that WMT allow cardholders presenting a chip card to verify with a signature. As WMT notes in its complaint, this has the effect of undermining the intent of Durbin: “if merchants cannot require PIN verification their routing options on a Visa-branded debit card are limited to only one network because of Visa’s exclusivity with signature debit”. It is hard to see how Visa prevails given that the Federal Reserve, in its rule implementing Durbin, comments that “merchants may not be inhibited from encouraging the use of PIN debit by, for example, setting PIN debit as a default payment method or blocking the use of signature debit altogether”.

Regardless of the outcome of the lawsuit, it is also hard to see how the US does not over time move towards exclusively PIN debit as has largely occurred in the UK, Australia, and Canada. Now that Durbin has regulated interchange so that it is the same across PIN and signature debit, banks have the same incentives as merchants to reduce fraud and processing costs and hence themselves prefer PIN debit over signature debit. In short, interchange regulation means that bank and Visa incentives are no longer aligned around signature debit and we believe that, within five years, signature-debit will have substantially disappeared.

©2016, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. The analyst principally responsible for the preparation of this research or a member of the analyst’s household holds a long equity position in the following stocks: JPM, C, BAC, WFC, and GS.

  1. As consumers, we can typically use a debit card at point-of-sale in one of two verification modes: we can “sign” for a transaction as we would for a credit card or we can enter a PIN to verify a transaction as we would when withdrawing cash from an ATM. It turns out that our choice of verification method has significant ramifications for transaction processing and merchant economics.
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