The Changing Value of the PIN Debit Network

Smart Investments Also Help Institutions Fight Fraud
The Durbin Amendment to the Dodd-Frank Act brought enormous change to the payments industry. But within this change comes a whole new value proposition for the PIN debit network - and for institutions' efforts to fight fraud.

"Historically, issuers chose a PIN debit network based on interchange pricing," says Kevin Barry, GM of STAR Network. "Now the criteria are based more on the best overall value that can be realized over the life of the partnership."

Banks now have the opportunity to select a PIN debit network that can create value for them, Barry says.

And what it means to the fight against fraud? "We expect the impact on interchange revenues to cause financial institutions to more closely examine how debit transactions are authenticated in order to better control fraud losses," Barry says. "Short-term, issuers will be taking stock to determine which networks provide the most cost-effective fraud prevention tools."

In an exclusive interview about debit networks and fraud, Barry discusses:

  • Top fraud threats to debit networks;
  • The new value proposition for PIN debit networks;
  • The criteria that financial institutions should use in choosing a PIN debit network.
  • Barry joined First Data's STAR Network in 2009 with more than 20 years of executive experience in financial services and debit processing. As general manager for STAR, the second largest PIN debit network in the U.S., Barry oversees a management team focused on STAR's market leadership in innovation and quality customer experience, developing strategies to deliver the highest levels of acceptance and value for STAR members. He has written articles, presented at industry conferences and meetings, and been quoted in industry trade publications on the topics of debit and value creation for financial institutions.

    Before joining STAR, Barry spent 12 years in an executive role overseeing retail products for a top 10 debit issuer. He also served on multiple executive boards, advising a major card network on issues related to ATM networks, point-of-sale debit, and debit processing.

    Barry has a bachelor's degree from the Wharton School of Business at the University of Pennsylvania. TOM FIELD: How have the Federal Reserve Board's regulations changed the landscape for issuers as it relates to debit networks?

    KEVIN BARRY: The Durbin Amendment has caused tremendous change in the payments industry. The law and the regulations that followed have two major provisions that affect debit issuers directly. The first is the capital and debit interchange rates for issuers with over ten billion in assets. Second is the prohibition on network exclusivity. Merchants have been also given a great deal more power around how that transaction will be routed and these change the dynamics of the whole network environment.

    Now many issuers are faced with the challenge of complying with the regulation. Those that had exclusive relationships with a debit payment network are now required to add at least one other unaffiliated network in order to provide choice to these merchants, and then for the larger FIs - the ones over ten billion - the economics of debit have changed dramatically. The loss of revenue due to the rate caps may mean that some FIs need to manage their debit programs more closely, and we think one solution may be shifting debit transaction volume away from signature toward less costly PIN debit.

    FIELD: Given that as context, what would you say is the new value proposition for debit networks?

    BARRY: Historically, issuers often choose a PIN debit network based on interchange pricing. Now the criteria for selecting a PIN debit network are based more on the best overall value that can be realized over the life of the partnership and less on the highest revenue potential a network can deliver at the lowest cost.

    Banks have an opportunity to choose a PIN debit network that will create value for them. As I noted before, some banks are now required to add another debit network to comply with network non-exclusivity, but even without that immediate requirement, evaluating a choice of debit network against the new value proposition could be a good strategic move. Now is a good time for issuers of all sizes to form strategic partnerships with networks that provide a greater breadth of options and deeper value, especially in an environment that seems to be a volatile one for the foreseeable future.

    In the coming months, we will see a lot of market uncertainty as people adapt to this new regulatory environment, as they face increasing competitive pressures in a rapidly evolving customer base. There's a strong case for financial institutions to make proactive decisions so they can be well positioned for whatever industry changes lie ahead.

    FIELD: I'm going to come back to the topic of PIN debit networks, but right now I want to ask you about a topic that's very much on the mind of our audience, and that's fraud. What impact do we expect to see on institutions' efforts to fight fraud?

    BARRY: We expect the impact to interchange revenue will cause FIs to more closely examine how debit transactions are authenticated in order to better control fraud losses. The extra penny for fraud prevention and the broad nature of fraud prevention standards provide an added incentive to banks and credit unions to continue to fight fraud. But from a revenue perspective, the interchange cap that the final regulations put in place was not as stringent as the cap the Federal Reserve Board initially proposed. By including the ... fraud prevention components, the Federal Reserve has provided increased revenue opportunity to subsidize the level of card fraud over the original proposed twelve-cent cap. In a short term, issuers will be taking stock to determine which networks provide the most cost-effective fraud prevention tools. That is, clients will be looking for solutions that give them the most functionality for their dollar, provide a superior return on investment and align with the Federal Reserve's requirement for fraud prevention. This cost-benefit analysis based on the transaction authentication method and broader network value will help them retain more interchange and benefit from the additional penny for fraud prevention.

    FIELD: That's good, and as promised I'm going to come back to this topic of PIN debit network. What are the criteria that financial institutions should be using when choosing a PIN debit network?

    BARRY: We think there are five top things that banks and FIs should look for as they evaluate their choice for PIN debit network. They are operational capacity, acceptance, industry relationships, potential for future positioning and of course fraud mitigation solutions. Let's start with operational capacity.

    Operational capacity is important because it's likely that any new network partner is going to see an influx of transaction volume as issuers end their exclusive arrangement and transactions shift to the new unaffiliated network partners. At the same time, trends and consumer payment preferences continue to favor an increase in debit volume industry-wide. Much of that growth is shifting toward PIN so it's imperative that banks consider the system integrity of any new PIN debit partner to make sure they can handle processing, settlement and support for this increased volume.

    Next is acceptance. Financial institutions should consider partnering with a PIN debit network that can demonstrate superior merchant acceptance throughout the country, helping to ensure a good experience for card holders at the point-of-sale. Broad acceptance at a variety of merchants will also help to encourage consumers to adopt new form factors and technologies like STAR CertiFlash. CertiFlash is STAR's contactless solution that protects against fraud by creating a one-time card number with each transaction, and we think consumers will more readily adopt contactless technology, for example, if they have places to use it consistently.

    Like acceptance another important network criterion is relationships. In the post-Durbin landscape, merchants will be a newly empowered driving force as they'll now be able to choose the routing for debit-card transactions among the networks enabled on the card. For this reason, banks will want to consider selecting a network partner that already has deep relationships on both the issuing and the acquiring side of the payment system.

    The fourth criterion I call future positioning. A number of factors are changing the payment landscape, including the migration from mag-stripe to contactless, and potentially to chip and pin, the broad acceptance of mobile payment and increase of card-not-present transactions for e-commerce. There's significant innovation underway in the financial services industry and financial institutions need to develop strategies and make plans about how to deploy emerging solutions as they become available. A component of any new debit network strategy should include choosing a partner that's positioned to build and deploy new solutions in the future.

    Then last but not least is fraud mitigation and risk reduction. Financial institutions need to look for a network partner that has innovative, yet cost-effective, fraud mitigation and risk reduction solutions that can help drive out fraud.

    FIELD: I'm going to circle back to that topic of fraud again. How can this choice of network help financial institutions reduce their incidence of fraud?

    BARRY: A network that's committed to reducing risk in the payments system can drive innovation and security that move the industry forward to a safer environment. But the network also has to go beyond innovating and make the technology relatively easy and cost-effective for an FI to implement. While every bank and credit union is concerned about security, no one has time or the financial resources to spare on huge, expensive conversion projects. So being able to integrate solutions within other processing systems gives the technology a greater chance of being used and being effective. In many cases, the network also needs to work within the entire payments process and have a strategy to help drive cardholder adoption and merchant acceptance. Ultimately, the network has to offer functionality and the flexibility needed to help FIs combat the ever-evolving threats from fraud.

    FIELD: We've tackled a lot in this conversation. Just to wrap things up here, what do you see as the top fraud threats to debit networks in this coming year and how would you advise institutions to tackle these threats?

    BARRY: For our issuers there's nothing more alarming than a large compromise that takes place at a national or regional merchant inquirer. While they are really at the mercy of the retailer's security standards, there's no event that causes more work for FIs and they tend to take us all by surprise. Large-scale, compromised events can take months to resolve and repairing the reputational damage can take even longer.

    Domestically, we don't see any signs that counterfeit fraud, or other types of card fraud that have been on the rise over the past three years, are decreasing. Our data shows that card-present fraud is rising in California, Florida and Texas. In fact, California stands above the rest. It's responsible for about 20 percent of our total confirmed fraud cases. Grocery stores and supermarkets, department stores and gas stations consistently show up as problem merchant categories across the states. While this isn't a new trend, it's a problem for issuers responsible for cost associated with that reported fraud. So when trying to fight counterfeit card fraud practices, banks and credit unions need sophisticated tools. Financial institutions need flexible CV validation measures to watch for failed testing attempts. Any custom tools the network can provide in addition to simple CV validation are also a plus. The client also needs the flexibility to produce custom rules. They may want to track information like the amount of money spent over specified periods of time at a given location, times visited in a day or cardholder's distance from the location, those are specific merchant categories. Finally, banks and credit unions need to act quickly on any listing of compromised cards they receive from the association or network.

    FIs also need to have a way to isolate compromised cards without adversely impacting their general cardholder base. FIs also can educate cardholders about security measures they can take, encouraging them to protect their cards and to use PIN debit transactions when possible. Fraudsters continue to be clever, which makes fraud threats tough to predict. Banks and credit unions need to align themselves with a network that gives them multiple tools for use in their fraud fight. They need to maximize the protection, the decision functionality, offered by their vendor. FIs also need to be extremely comfortable with the relationship they have with their vendors, because those are the people they'll be working with if they have to manage sensitive issues. Finally, they should make sure they're receiving proactive communication and collaboration from their network fraud team.

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