ith the card Associations going public, there is much speculation that interchange rates have nowhere to go but down. Whether that will play out was a key concern of institutional investors at a Morgan Stanley payments conference on Nov 8.

In a variety of scenarios, fund managers repeatedly asked presenters, Will interchange come down?

"If it does, you should buy every merchant processor you know, even if it's not us," said Paul R. Garcia, Chairman, President and Chief Executive Officer of Global Payments Inc.

Garcia explained: "If you're my merchant, and I'm charging 200 basis points ... and interchange goes down significantly, I can offer you a big reduction in price right away. A handful of basis points on tens of billions of dollars is real money, and it just falls to the bottom line."

Processors can still be generous with their merchants, support the card brands and earn from two to 10 basis points, which is "an unbelievable amount of money," on billions of dollars, Garcia said.

Morgan Stanley analyst Dhruv Chopra said in an interview with The Green Sheet he agrees that lower interchange rates would be good for acquirers and processors.

"Merchants have little negotiating power with rising interchange rates, and therefore tend to push back on processing fees," he said. "If interchange rates were to decline, it should ease the pressure on processing fees."

Sustainable living

"If I were running those organizations [the card Associations]," Garcia said, "I'd say to the financial-institution partners that perhaps it would be better to have lower interchange and have a sustainable model forever, as opposed to maintaining or potentially raising interchange, thereby creating a tremendous opportunity for other competitors to come in.

"If merchants are saying, 'This is too expensive; please see me with other offers,' I don't think that's in anybody's long-term interests, particularly the [card] Associations'," he said. "So encourage them to drop interchange immediately, would you please?"

"Every day, people come up with new [payment] alternatives," said Pamela Joseph, Chairman, President and CEO of Nova Information Systems, the processing business of U.S. Bancorp.

"Every retailer is trying to figure out how to reinvent ACH [automated clearing house payments]" as a way to steer customers toward lower-fee payments options, she said.

Merchants are becoming adept at guiding customers to debit, Garcia said, noting that biometrics may catch on with merchants who see it as a way to bypass card systems entirely and go directly to ACH withdrawals.

Joseph reported that a partnership with a third party has enabled some of Nova's merchants to offer their own rewards programs to customers. This allows Nova to "split the bill for the discounts" with the merchants.

While either card Association could exploit the current market dynamic by raising interchange to encourage banks to issue its brand, competitive pressures in the new landscape will force rates down, Garcia said.

Although banks always issue the brand that pays them greater returns, litigation and international market pressures should keep that in check, he said.

Referring to 125 current interchange levels, Garcia said, "Just common sense says everything becomes more competitive and comes down over time. Interchange hasn't."

He noted that rates are currently higher than they were before litigation against the card brands began. Over time, the rates should drop, he said.

"It is creating too much of an opportunity for lots of competitors to fill that vacuum," Garcia said. "Developing countries could conceivably skip the whole model" and go direct to debit systems.

Cracks beginning to show

As a former member bank of MasterCard, U.S. Bancorp and its Nova subsidiary have a changed attitude toward the card Association. MasterCard's practice of funding promotions out of the assessments paid by banks and processors is causing division among its old allies.

"I ask MasterCard regularly, now that they're public and I'm not a member anymore, What do I get in return for my assessments?" Joseph said.

She described a recent MasterCard meeting with business partners that she attended. "I said, 'I pay a lot of money so you can drive promotions out to merchants that give business to Chase, and that's something I need you to look at.'"

With Nova providing card services to small businesses, but brand promotions going only toward national retailers served by other banks, Joseph argued that U.S. Bancorp should get a discount because its assessments are benefiting its competitors.

"I don't want you to think that if assessments don't go down, we're going to walk," Joseph cautioned institutional investors, who asked if the company would consider other options.

Launching a competing payment brand would pose enormous difficulties, she said, and acknowledged that the card brands can exploit this leverage. Paying increased card network processing fees would be preferable to supporting card brand promotions, Joseph said.

"The other thing you have to wonder [is] will [MasterCard] keep those railroads and infrastructures in place purely for the brand?" Joseph said.

A question that both card Associations must answer for merchant acquirers is whether they consider their companies to be brands or processing entities, she said. "If I pay assessments, it's important for me to know what I'm paying for.

"It's a great time to be in the payments biz, because ultimately there has to be change."