Credit unions stand to lose significant interchange fee income in the event that big retailers follow the lead of Walmart in switching from signature debit transactions to PIN-based transactions when customers swipe their debit cards upon making purchases.

Jack Gill, president and CEO at First Community Credit Union of Beloit, a $100 million institution based in Wisconsin, told Credit Union Journal that he noticed that during the month of February, he noticed a "significant" decrease in signature debit transactions among his members shopping at Walmart and a corresponding "significant" increase in PIN-based transactions.

A debit card can be processed either as a signature debit transaction or a PIN-based transaction. Under the signature debit option, the transaction is routed to a bank through a Visa, MasterCard or Discover interchange rather than through a PIN debit network. Under a PIN-based debit transaction, after the customer enters their personal identification number (PIN) on a point-of-sale (POS) pad, the transaction is routed to the issuing bank through a debit network.

Generally speaking, signature debit transactions are more costly for merchants like Walmart which tend to sell small-ticket items.

Gill estimates that when more big retailers join Walmart in choosing the PIN-based debit routing option, credit unions could lose one-half of their interchange fee income. At his credit union, Gill noted, they earn about $30,000 per month on interchange fees alone — or $360,000 a year.

Brian Scott, vice president of sales at The Members Group (TMG), told Credit Union Journal merchants would save, on average, about 10 cents per transaction by opting for debit transactions routed through the PIN-based system, versus the signature-based transaction — reflecting the gap in processing fees between PIN debit and signature transactions.

To give an idea of the magnitude of these developments, Scott estimated that at the average credit union, a member uses his debit card about fifteen times every month.

For the moment, PIN networks such as Star, Shazam and Pulse appear to have limited imposition of the PIN-based debit transactions to purchases totaling $50 or less. "And what would scare me is if those PIN networks would adopt new rules allowing the practice for higher dollar amounts," Scott said. "And it's already allowed for payments such as utilities."

Of course, as Gill points out, the member who swipes their debit card when making a purchase does not know nor care what routing system their transactions will go through — they are not charged additional fees. But it makes a lot of difference to the merchant who will be levied a fee for processing the cards.

"It is inherently unfair," Gill added. "This will pose a significant challenge for the credit union industry in the coming years."

Barney Moore, manager of portfolio consulting services at Card Services for Credit Unions (CSCU), said that a gradual migration to PIN-based debit transactions from the signature-based model could be very "damaging" to credit unions.

"Interchange fee income is counted as non-interest income for credit unions," he said. "Interchange fees are the second largest component of such non-interest income for the industry, so it's a very significant part of a credit union's total revenue."

Norm Patrick, Director of Strategic Consulting at Advisors Plus, a part of PSCU, estimated that interchange fees for debit cards account for some 18% to 20% of an average credit union's annual non-interest income.

Indeed, according to Callahan Associates, for 2013, the largest component of non-interest income for credit unions came from debit card and interchange fee income, comprising 23.8% of total non-interest income. In addition the total card-related interchange and fee income accounted for 34% of total non-interest income in 2013, up from 32.3% in 2012.

Moore called it an "absolute certainty" that more big retailers will follow Walmart's practice.

The switch to PIN-based debit transactions by Walmart is likely a direct result of a January 2015 decision by the U.S. Supreme Court to reject a bid by large retailers calling for a reduction in debit-card processing fees charged by the big banks. Specifically, retailers, represented by the National Retail Federation, which includes Walmart, claimed that Federal Reserve regulations which set a maximum fee of $0.21 per debit processing transaction was too high.

Under the Durbin amendment to the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve was mandated to establish interchange fees that were in line with the supposed actual cost of processing debit transactions. That amendment capped debit fees at 0.05% plus a $0.21 transaction fee for larger banks (those with assets of $10 billion or more).

With billions of such transactions annually (i.e., every time consumers swipe their debit cards at stores when buying items), financial institutions makes untold billions of dollars, all paid for by the retail merchants.

According to figures from the Federal Reserve, debit-card issuers received about $16.3 billion in interchange fees in 2013.

Now that the Durbin amendment appears to be on the books for a while, retailers will likely seek to continue seeking ways to reduce their debit processing fees any way they can.

"Not only did the Supreme Court reject the retailers, they refused to even consider their application," said Scott. "So, for now, businesses will go for the least-cost route."

Mark Atchison, vice president of portfolio management at the Credit Union Solutions division at Fiserv, said the Court's decision essentially brought this litigation to a close. "They basically said that with respect to debit fees, the status quo will be preserved," he said, but added that "the door is not necessarily closed to future litigation."

Interestingly, Scott noted that over the past few years, the total interchange fee earned by credit unions has been increasing. But, conversely, on a per-transaction basis, such fees have been falling — and that trend appears to be continuing.

But one avenue credit unions may take with respect to recouping interchange fees would be to offer their members incentives, including rewards programs for every $50 they spend on merchandise using their signature debit cards.

The issue is far more likely to have an impact on credit unions than on banks, Moore said, because only a handful of CUs have more than $10 billion in assets-the threshold at which an institution must institute the Durbin Amendment caps.

"[Institutions with $10 billion or more in assets] don't have a lot to lose in terms of interchange [fees] because they are already at Durbin cap levels," Moore said. "If it has the effect of driving down interchange for exempt issuers, it's just leveling the playing field in their eyes."

Moore added, however, that this trend is going to diminish one of the few competitive advantage credit unions have.

"Perhaps credit unions should collectively (though trade associations) reach out to their EFT networks and request that PIN-less capability not be enabled on their cards," he added.

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