Strategies for Fading Fee Income

Don’t wait for the Fed’s final interchange rule or legislative action to prepare for lost fee income.

May 1, 2011

Bill Lehman’s warning to credit unions concerning the debit interchange fee debate: “Make changes today.”

He urges credit unions not to wait for the Federal Reserve Board’s final interchange rule or for legislation delaying its implementation to determine how to recoup millions in lost debit interchange income.

“Take your foot off the brake,” says Lehman, vice president of portfolio consulting for Card Services for Credit Unions. “There will be ongoing pressure on our industry. Whether the interchange rules are delayed or refined, our revenue will be attacked.”

Interchange fee income


  • Don’t wait for the Fed’s final interchange rule or legislative action to determine how to recoup potential lost debit interchange income.
  • Take a broad-based approach to recoup lost income; don’t focus solely on debit cards.
  • Board focus: Tell members that CUs aren’t out to make more money, but that regulatory changes are forcing your hand.

Under the Fed’s proposal, interchange fees will decrease from an average 44 cents per debit card transaction to 12 cents. “That doesn’t begin to account for the actual debit card service costs, such as those related to fraud and systems support,” says CUNA President/CEO Bill Cheney.

Although financial institutions with less than $10 billion in assets (all but three credit unions) are exempt from the proposal, Cheney calls the exemption “fatally flawed” because there’s no mechanism for enforcement or oversight.

“Over time, smaller institutions will lose out, too,” he says. “Market pressures will force the interchange price that smaller institutions receive toward the lower, 12-cent rate.”

Plus, the regulation’s network exclusivity and routing provisions would allow merchants to route transactions to the lowest-cost network, Lehman explains. This affects all financial institutions, not just those $10 billion or more in assets, he emphasizes.

As a result, credit unions stand to lose two-thirds of their interchange income—a possible $1.7 billion blow, warns Mike Schenk, vice president of CUNA’s economics and statistics department.

“It’s one of the bigger special-interest battles I have seen in quite some time,” Travis Plunkett, legislative director of the Consumer Federation of America, told USA Today. “It’s like World War I out there. The trenches are dug, and anyone who wanders into no man's land gets shelled.”

CUNA has repeatedly asked the Fed and Congress to “stop, study, and start over” on the interchange regulations—and the message may be getting through.

The House and Senate have introduced bills that would delay implementation of the Fed’s proposal for either one or two years. Both bills propose studying how the interchange fee cap would affect card issuers, consumers, and merchants.

And on March 29, Fed Chairman Ben Bernanke told House and Senate leaders the agency couldn’t meet the April 21 deadline for its final interchange rule. However, Bernanke says the Fed will complete its interchange fee rules “in advance” of July 21, and finalize rules rules on routing and exclusivity provisions by that date.

“We appreciate that the Fed is spending the time necessary to very carefully consider the issues raised by the comment letters and is holding off on issuing final interchange standards on April 21,” Cheney says. “Nevertheless, the Fed’s admission that it can’t meet the deadline imposed on it by Congress is further proof that Congress must take action now to postpone this entire matter.”

While Cheney applauds the Fed’s announcement, he’s concerned the agency could issue a final rule without giving credit unions sufficient time for compliance if Congress doesn’t act.

And while delays in the rule’s implementation are “promising, they’re not an excuse to put off planning,” says Lehman. “Start planning today to recoup some of the money you’ll lose in the future. Now is the time to make changes.”

Next: Plan now

Plan now

“Contingency planning” is the new mantra at $700 million asset USE Credit Union, which stands to lose $1 million per year in debit interchange fee revenue.

In preparation, the San Diego-based credit union is considering a variety of cost-saving and revenue-generating measures across all business lines rather than focusing solely on debit cards, says CEO Jim Harris.

Such measures include lowering dividends on share certificates, increasing interest rates on certain loans, and—reluctantly—increasing nonsufficient funds and courtesy pay fees. These measures are consistent with those credit unions nationwide plan to implement, according to CUNA’s 2010-2011 Credit Union Fees Survey Report ("Changes CUs would make to recover lost interchange income").

The problem is there’s little wiggle room in today’s low-rate, low-demand lending environment. Nationally, credit unions’ average share deposit rate was 0.36% and the average one-year certificate rate was 1.17% as of January, according to CUNA.

“How do we take them even lower?” Harris ponders. “That’s why it’s important not to rely on a single source, but to look at this very broadly.”

And on the lending side, he says, “demand is so low that increasing rates would be counterproductive. It might make things even worse when we’re trying to generate loan demand.”

On the expense-reduction side, USE has already eliminated obvious inefficiencies, and it will continue to examine its cost structure and cut costs wherever possible.

“At some point, however, you start to cut into the core of what it takes to really serve your members,” Harris says.

New sources of revenue

Another way to approach this issue is by seeking out new opportunities, says Doug Fecher, CEO of $2 billion asset Wright-Patt Credit Union, Fairborn, Ohio.

Based on its current cardholder and transaction volume, it stands to lose $5 million per year in debit interchange fees—roughly 25% of its bottom line.

“We would prefer not to levy new fees on members because only members who are unable to maintain compensating balances would pay such fees,” Fecher says. “This means we need to look for new sources of revenue through loan growth, which is difficult in these days, or through other new business lines.”

Along this vein, SeaComm Federal Credit Union, Massena, N.Y., plans to introduce prepaid debit cards, which generate fee income and are exempt from the Fed’s proposal, says Scott Wilson, CEO of the $400 million asset institution.

In 2008, SeaComm Federal reorganized and examined every aspect of its operations as it looked for ways to streamline processes, diversify income streams, and add delivery channels and products to attract new members. This will continue in the interchange aftermath.

Wilson says he’ll leave “no rock unturned” as he prepares to replace a potential $500,000 in lost interchange revenue. “We’ll become even more prudent at diversifying our interest and noninterest income streams, improving on our cross-sales efforts, and putting more products into our members’ hands. As time goes on and we see how the loss of interchange income affects our net margin, we might have to look at other alternatives,” which could include adding a checking-account fee.

USE aims to increase checking account penetration among members by implementing a debit rewards program at a time when several megabanks, such as Chase, are pulling the plug on their rewards programs.

“Checking accounts open the door to a variety of cross-sales opportunities that build more profitable relationships with members,” Harris says. “Having a rewards program on your debit card helps you do that. And it gets back to a broader, relationship-based solution to the interchange issue.

“There are so many implications in making a few pricing changes,” he adds. “We don’t want to be an early adopter of fees or other significant changes because the market is watching closely. There will be opportunities to differentiate ourselves if we do it astutely and in a way that doesn’t damage our member relationships.”

Next: Avoid collateral damage

Avoid collateral damage

Damaged member relationships are a valid concern given that financial services will cost more if the Fed adopts its current proposal. Harris fears credit unions’ image could suffer as a result.

“I don’t believe the retailers will pass the cost savings on to consumers,” he says. “This will take money out of consumers’ pockets and out of the economy at a time when both can least afford it.”

If credit unions are forced to bring their product pricing and fees more in line with banks to recoup lost interchange income, Harris worries credit unions might be viewed in the same light as banks.

Interchange fee income“The major banks are using this as an opportunity to significantly raise their fee structures—they’re being blatant about it,” he says. “The Dodd-Frank legislation reflects big banks’ poor image because of the bailouts. I would hate to be painted with the same brush as the big banks and Wall Street firms.”

That’s why credit unions should let members know what’s happening and why they might have to raise rates and add fees. “Tell members the credit union isn’t out to make more money, it’s that regulatory changes are forcing our hand,” Harris explains. “That’s an important message.”

Credit unions should carry this message to Washington, D.C., Wilson adds. “We must continue to put our face in front of the decision-makers in Washington. Talk about how regulations like the Durbin Amendment affect those who live in their districts.

“We’re in the business of working with legislators’ constituents to improve their financial lives,” he continues. “Adding costs for members to do business with us will adversely affect them. We will do everything in our power to offset that. Every dollar counts for them and for us.”

Next: Nine steps to recoup lost interchange income

Recoup Lost Interchange Income: Nine Steps

Don’t wait for the Fed to issue final debit interchange fee rules to determine how to recoup lost income, advises Bill Lehman, vice president of portfolio consulting for CSCU.

He says credit unions should take these steps now:

1. Segment members into relationship pools. Develop rate and fee structures based on members’ account value. “As their value diminishes—say a member has only a checking or saving account—consider ways to charge them for inactivity, or develop less-expensive products for them,” Lehman explains. “Understand who’s profitable.”

2. Encourage use of cost-effective delivery channels. Offer members incentives to use debit cards, for example, and charge for more expensive channels, such as checks. Move members away from the teller line and toward online banking.

3. Consider adding fees to generate revenue: annual fees for cards, card replacement, account inactivity, and surcharges for foreign ATMs. Let members avoid fees, and charge less than other providers—such as $10 or $15 for a late-payment fee, not $39, which is the industry average, Lehman advises.


• CSCU, Clearwater, Fla.


1. 2010-2011 Credit Union Fees Survey Report

2. 2011-2012 Credit Union Environmental Scan

3. Celent Research Reports

“Credit unions invest a lot of money in a surcharge-free network to make sure we have a significant footprint of ATMs,” Lehman says. “Why do members use Bank of America terminals instead of walking a block to use a free terminal? This is an opportunity to create the activity we want: using a credit union ATM.”

4. Leverage your card processor. Consider consolidating debit and credit card processing with one provider and outsourcing collections or other functions. “Investigate your options and make an educated decision,” Lehman says.

5. Increase debit and credit card penetration, activation, and use. Growing your plastic programs will help compensate for lost revenue.

6. Re-evaluate your rewards programs. Don’t eliminate rewards; make them more affordable through merchant-funded and relationship-based rewards.

“Provide more opportunities for rewards by basing them on activity across the credit union,” Lehman advises. “This lets you spread the expense across more business lines.”

Also, consider adjusting rewards downward—banks already are. “Do this in a way that’s not extremely visible and that doesn’t affect members too negatively,” he says.

7. Tackle fraud. Examine processes and procedures to find areas to reduce fraud and its related costs.

8. Consider a general-purpose reloadable card, which is exempt from interchange regulations. Target certain markets, especially students, travelers, and the under-banked.

9. Attack expenses. “Review invoices regularly to make sure you’re being billed for what you should be,” Lehman advises. “Do this for all vendors—make sure you pay for what you get.

“Regardless of the outcome of the interchange issue, we need to rethink our business model and how we grow revenue,” Lehman says. “We don’t know what the next attack will be. But it’s important to be ahead of the curve.”