An essential link in the U.S. banking system, payments account for nearly a quarter of all banking industry revenues, according to David Stewart, Senior Payments Expert at consulting firm McKinsey & Co. And acquiring is integral to payments.
"The acquiring business is an incredibly lucrative business for banks, far more so than many realize," said Paul Martaus of Martaus & Associates. "You have to have acquirers to get the critical mass of acceptance." A well-run merchant portfolio will add 50 to 75 basis points to a bank's bottom line, Martaus noted.
Yet, with the exception of a handful of institutions, the relationship between card-acquiring banks and card-accepting merchants today is tenuous at best. "Imagine how better-positioned the banks would have been today had they not driven the [acquiring] business to nonbanks and ISOs," said industry veteran Linda Mahy, President and Chief Executive Officer of Connective IQ, an Austin, Texas-based consultancy.
Today, five of the top seven acquirers are owned by banks: Chase Paymentech Solutions (JPMorgan Chase & Co.), BA Merchant Services (Bank of America Corp.), Elavon Inc. (a unit of U.S. Bancorp), Fifth Third Processing (49 percent owned by Fifth Third Bank of Cincinnati) and First National Merchant Solutions (a unit of First National Bank of Omaha).
"Where would Citibank be today if it hadn't created CES?" Mahy said. CES, short for Card Establishment Services, was a merchant acquiring business set up in the late 1970s by what is known today as Citigroup Inc.
Eventually, CES was sold to First Data Corp., which combined it with several other acquisitions to create First Data Merchant Services. Today, Citigroup's merchant services operations are outsourced to First Data under the latter company's bank "alliance" program.
Plenty has happened to each of these companies over the ensuing years, as well as to an army of other companies attracted to merchant services. At one point, First Data was even owned by American Express Co.
However, many of the most important changes in acquiring are related to technology, and more recently, economic turmoil and government oversight.
"There are some unusual forces being marshaled against the business," Martaus said.
Feeling economically pinched or just fed up with banks, consumers are closing down card accounts, he noted. Even card issuers, like AmEx, are encouraging some customers to send their cards back. Meanwhile, consumers are using debit cards more frequently, either because they can't or won't run up credit card balances.
Key dates in history of acquiring1920s |
What's more, Martaus' research suggests increasing numbers of merchants are saying no to bankcard acceptance. The two reasons cited most often by merchants are the proliferation of fees and a tendency on the part of some acquirers to place what merchants consider inordinate holds on card receipts, he said.
And according to most industry experts, The Credit Card Accountability, Responsibility and Disclosure Act of 2009 (Credit CARD Act) - legislation signed into law by President Obama in May 2009 that takes aim at card issuer practices - will only exacerbate the situation by forcing card issuers to drop lower-income and other less profitable cardholders.
"Right now, folks are focused on how [the new law] impacts issuers," said Ken Musante, Vice President and Chief Sales Officer at Moneris Solutions Inc., and a former banker. "But it's going to impact us, too. All kinds of [consumers] are going to be shut out of the market."
Bob Bucerri, General Partner, Chaddsford Planning Associates LLC, a West Chester, Pa.-based consultancy said, "the Credit CARD Act is going to change the business model for credit cards."
The Credit CARD Act establishes a host of restrictions on credit card-issuer practices. (See "Congress hammers issuers, acquirers spared" under News in this issue of The Green Sheet.) One possible result of the ensuing changes could be a greater reliance on prepaid card products, Musante suggested. "There are huge opportunities with prepaid," he said.
Steve Streit, CEO of Green Dot Corp., a prepaid card company, is banking on that. He said Green Dot already serves a growing number of bank customers who have grown weary of costly bank account policies. Green Dot sells branded prepaid cards through retailers and operates a corresponding card reload network. About 40 percent of consumers who use Green Dot card products are homeowners, according to Streit.
Bankcards sprang from the post-World War II economy. First introduced under the names BankAmericard (now Visa Inc.) and MasterCharge (now MasterCard Worldwide), bankcards began picking up steam in the 1960s as banks across the country began pitching card acceptance to local merchants.
"This all started as retail banking," Bucceri said. Individuals opening businesses would typically set up store accounts at the banks they already used, and card services were often part of the deal, he said.
Cardholder numbers picked up in the mid-1970s as U.S. consumers, faced with double-digit inflation, came to realize it was often cheaper to buy on credit than to save up and buy with cash. At about the same time, the bankcard associations were building sophisticated networks to support high-speed electronic authorization and settlement.
Card issuance gained more steam in the 1990s as card affinity and rewards programs began to flourish.
The companies known today as Citigroup and First Data were among the first to recognize the opportunities in bankcard acquiring and processing. In the early 1980s, when the card associations began pushing hard for electronic draft capture (EDC), plenty of other banks and nonbanks began placing their stakes in the market, too.
Although banks were successful in selling bankcard acceptance to local merchants, efforts to grow their portfolios beyond their home markets were frustrated by several factors, including limited branch networks and required technology investments.
Paul H. Green, founder, President and CEO of The Green Sheet Inc., opened the first ISO, Amcor, in 1982; scores of others soon followed. By the turn of the century, ISOs and other nonbanks had become dominant players in the acquiring space, with First Data being the largest among them.
In the early days, "the acquiring side of the business was like the Wild West," Bucceri said, echoing sentiments expressed by many industry veterans interviewed for this article. And that attitude was driven in large part by rapid-fire technology advances.
Meanwhile, lawmakers and regulators were largely unaware of bankcard acquiring. "A lot of stuff flew under the radar," said Kurt Helwig, President and CEO of the Electronic Funds Transfer Association.
"Acquiring has been an area that has not seen extensive legislation, unlike the card-issuing side of the house," said Joe Samuel, First Data's Senior Vice President for Public Policy and Community Relations.
But that situation has been changing with the introduction of industry rules - like the Payment Card Industry Data Security Standard - and increased government attention to card data breaches and notifications. The focus on data security and breach notifications has been "creeping its way from the states to the federal government," Samuel added.
Washington's attention was first drawn to bankcard acquiring in the mid-1990s by the U.S. Department of Justice, which challenged MasterCard and Visa rules that banned bankcard-issuing banks from also issuing nonbank cards, such as those issued by AmEx and Discover Financial Services. The final blow came when those "exclusionary rules" were struck down in 2002 by a federal court, and that ruling was upheld by the U.S. Supreme Court two years later.
Banks need acquirersWhile many banks have sold or outsourced merchant acquiring over the years, there's growing pressure for banks to get back into the business. "As we move in the direction of check electronification, it becomes even more important, because now you're talking about deposit relationships," said Ken Musante. Musante ran Humbolt Merchant Services for several years, until that bank-owned acquirer was sold to Moneris last year. "Banks are starting to realize that they need to turn their branches into sales channels," said consultant Linda Mahy. Many small business customers of banks are also high net-worth individuals, so it's appropriate that banks offer these individuals a gamut of services, including payments, Mahy noted. |
At about that same time, the Federal Trade Commission started fielding complaints from merchants and consumers concerning ISOs and processors.
In early 2002, the agency seized the Texas-based ISO Certified Merchant Services for unfair and deceptive practices with regard to merchant account processing fees.
In 2004, the FTC slammed several other companies in the acquiring sector, taking them to task for processing electronic payments on behalf of deceptive telemarketers. The FTC has jurisdiction over card acquiring businesses under a variety of fair competition and consumer protection laws, like the Telemarketing Sales Rule, but it wants broader powers.
In early 2009, the FTC delivered to Congress a wish list of sorts, detailing additional powers it considers necessary, especially "given the current state of the economy and consumers' financial situation," said FTC Chairman Jon Liebowitz in testimony before the House Subcommittee on Commerce, Trade and Consumer Protection. "To be effective in doing more to protect consumers, the commission will need more resources."
Washington insiders say Congress is especially keen these days on mandating changes in banking practices, and that includes payment acquiring.
Helwig, who has spent more than 15 years in government and government relations, said, "I have not seen this kind of action, this level of involvement in an industry, on the part of Congress in my career. ... The payments business at large" is coming under increased scrutiny in Washington, he added.
Samuel, whose 20-year career has included stints on Capitol Hill, agrees. "We have yet to see what happens when Congress tackles the broader issues of financial services regulatory reform," he said. "It's likely there will be big changes."
While nobody can predict with certainty what Congress and the Obama administration will demand, the rhetoric suggests the government's $700 billion-plus bailout of a financially floundering banking industry came with many strings attached.
"The Feds are now the banks' largest shareholders, which means they can get into issues like pricing," Helwig said.
The government may even start dictating operations, suggested Mahy. Like many other industry experts, Mahy rails against the technology silos that dominate banking and make it difficult to integrate processing platforms and other operations in an era of rapid consolidation. "It's going to take the federal government to bust the silos, especially if they take over any of the TARP banks," Mahy said.
Introduced in the fall of 2008, TARP - the Troubled Asset Relief Program - is the federal government's program for purchasing hard-to-liquidate mortgages and related securities from banks and other financial institutions.
Industry executives who have met with leaders of the new Congress and administration warn there's not much receptivity to arguments against new banking regulations. "It's no longer enough to quote Adam Smith" on free market economics when pleading the industry's case in Washington, Helwig said.
Sen. Chris Dodd, D-Conn., author of the Credit CARD Act, described the mood of Congress in a May 19, 2009, blog post titled "Reform in the age of plastic." "Over and over we've heard that consumers should act responsibly when it comes to credit cards," Dodd wrote. "I agree - but it's time we held the card companies to the same standard."
There is one hot-button issue Congress doesn't seem eager to tackle, however: interchange. "They kicked that can down the road," Samuel said.
Efforts on the part of the Merchants Payments Coalition to get Congress to add language to the Credit CARD Act that specifically authorized surcharging of credit card payments were defeated. This is in large part because of pressure from community banks, according to those familiar with Congressional negotiations.
Bucceri said Congress doesn't appear eager to address interchange for fear of alienating important local constituencies: merchants and community banks. Either way, some constituents are going to be on the losing side. "Ultimately, if the federal government decides it's going to do something, neither the retailing nor the financial institution industries are going to have pricing powers," he said.
"That money [from interchange] drives a lot of the technology and access to credit," he noted. "It subsidizes a lot."
The Credit CARD Act, however, does request that the GAO conduct a study on the impact of interchange fees on merchants and consumers. That study must be completed by late November 2009, according to the final bill.
Another explanation for why interchange legislation may not be on the Beltway fast track is that issues related to interchange cross jurisdictional lines. At least three sets of congressional committee chairs could claim jurisdiction over such legislation: banking, commerce and judiciary.
"Congress doesn't do well settling jurisdictional disputes," Bucceri said.
That, however, doesn't preclude Congressional action, on interchange or any banking-related issue. "We're paying very close attention to what's going on" in Washington, First Data's Samuel said. One way the company does that is through participation in industry associations, like the EFTA and the Electronic Transactions Association, based in Washington.
"It's important for the acquiring community to have groups like the ETA and EFTA to help educate policymakers and the public" on the business, he said.
Helwig agrees, although he cautions that it will not be business as usual for industry lobbyists. "This is going to require a dramatic change in the mindset of government relations people," he said. "We need to appreciate the sweeping nature of the change in the direction of Congress.
"The Credit CARD Act is just one part of that."
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