First, the only cards that provide this debit or credit option are debit cards with a credit card company logo – also called check cards or electronic checks.  Online (not to be confused with ecommerce) debit transactions require a PIN authentication (like an ATM transaction) and are processed through debit networks (i.e., NYCE, CIRRUS).  Offline debit transactions require a signature and are processed through card association networks (i.e. Visa or MasterCard).  All transactions from a debit card are tied to the cardholder’s bank account.

The Bank Side

Card issuing banks earn most of the revenue when their cardholders use their cards, whether they are debit or credit.  Some banks entice customers to use their check card by offering incentives, such as rewards and cash back.  Most rewards programs require the consumer to use the credit/signature option, which enables the bank to collect interchange fees from the merchant, helping to offset the cost of the rewards.  Acquiring banks also earn revenue when either the credit or debit option is used.

Overall, card issuing banks prefer PIN-based debit transactions, hands down.  Even though they pay debit transaction fees, banks save money by not paying fees to the card associations.

The Consumer Side

Consumers like using debit cards mostly to avoid writing paper checks.  Many brick and mortar retailers no longer accept checks and banks are following suit.  Banks in the U.K. decided to phase out their check clearing process by 2018, citing cost savings.

As stated above, consumers can be enticed with rewards.  With Bank of America’s ‘Keep the Change’ program, check card purchases (using the PIN or credit option) are rounded up to the next dollar and the difference is transferred into the account holder’s savings account.  The bank then matches the transfer amounts up to $250 a year.

Using funds that already exist (i.e. in a checking account) for purchases instead of buying on credit also helps keep the cardholder out of future debt.  The cash back option is free with debit purchases and the funds are also deducted immediately from the cardholder’s account – instead of a few days later for credit card purchases.  For cardholders who monitor their bank accounts closely, this option is best for them.  However, banks do charge fees for insufficient funds on debit transactions.

From a fraud perspective, PIN-based transactions are the most secure.  However, cardholders are not protected from fraudulent debit transactions as they are with credit card transactions.  If a thief uses a cardholder’s debit card and cleans out their bank account, the cardholder will likely not be able to recover those funds (aside from legal action).  If a cardholder uses Verified by Visa, an optional service requiring a personal password, the cardholder is protected under the Fair Credit Billing Act when making purchases online.

By choosing the credit option, as with normal credit cards, cardholders also have the right to do a chargeback if there are issues with a return, fulfillment or satisfaction with a purchased product or service.

“…cardholders are protected under the Fair Credit Billing Act”

The Merchant Side

Merchants prefer PIN-based debit transactions for a few reasons.  Debit network fees are lower, there is an instant guarantee of funds and funds settle faster into the merchant’s bank account.

Merchants, particularly ecommerce, like offline debit transactions since they are able to tap into consumers who receive prepaid debit cards or payroll cards, or are unable to obtain credit cards.  For those consumers, card branded debit cards are the only option for electronic payments.  Meanwhile, settlement takes a little longer with offline debit transactions, but usually only by a few days.

While consumers can often make larger purchases with credit, there is always the chance that the customer will do a chargeback.  Unfortunately for merchants, chargebacks are allowed with offline debit cards, since transactions are processed through the credit card networks and cardholders are therefore protected under the Fair Credit Billing Act.

The Card Associations and Merchant Processors Side

Offline debit card transactions are processed through the card networks so the card associations, like Visa and MasterCard, prefer this option – for obvious reasons. Merchant processors earn revenue from either option, but there could be more revenue for them with offline debit transactions (depending in the pricing structure).  For this reason, some processors fail to offer the PIN-based option to merchants.  Sometimes it may be due to an inexperienced salesperson, or the processor not fully understanding the merchant’s processing abilities.  While other times, the merchant processor does not even offer the option, hoping the merchant will be none the wiser.

Merchants’ Choice

What merchants do have is the choice to be able to offer PIN-based transactions (again, if their processing system is enabled to accept PIN-based debit) and thereby incurring lower processing fees.  Some merchant processors don’t offer this option, so merchants may need to ask.  PIN-based debit transaction fees are typically less than for credit card transactions, but PIN pad equipment is required.  Hopefully soon, some form of PIN-based option will be available for ecommerce as well.

In the end however, if the option is there, it is still up to the consumer to choose.  Even if a POS system defaults to debit or credit, a merchant cannot dictate which option the consumer is to use.

This blog refers to debit and credit transactions in the U.S. at this time. Fees and acceptance rules vary in other countries.

MasterCard also presented on the change in debit and credit card volume and transactions.  According to their research, both debit and credit card usage declined from Q3 2008 to Q4 2008.  Debit card usage has since increased, almost to the Q3 2008 level, while credit card usage has remained close to flat.   Between 2007 and 2009, debit card usage has increased 15-18%, while credit card usage has remained flat; cash usage declined 12-14%; and check usage declined as much as 5%.  (Retail categories included supermarket/grocery, department store, sit-down dining, gas/gas station and drug store.)

“Between 2007 and 2009, debit card usage has increased 15-18%, while credit card usage has remained flat”

This movement from credit to debit could be closely related to the closure of credit lines. The Equifax Credit Trends Report (September 2009), indicated that bankcard issuers are continuing to close accounts and reduce credit lines.  It might be assumed that credit lines are being closed mostly due to the increased in card issuer charge-offs (loans the companies do not expect to be repaid on), as well as to the lack of usage on some accounts.  The Dec 16 charge-offs report included:

• JPMorgan (JPM) charge-offs increased to 8.81% from 8.02%.
• Charge-offs at Capital One (COF) increased to 9.6% from 9.04%.
• Bank of America (BAC) saw a slight decrease to 13% from 13.22%.
• Discover Financial (DFS) saw an increase to 8.9% from 8.5%.
• American Express (AXP) saw a slight decline to 7.6% from 7.8%.

According to the Equifax report, new accounts, opened between July, 2008 and July, 2009 were 54 percent lower.  “American consumers are making the most fundamental change in the way they handle their finances we have seen in a decade,” said Dann Adams, president of Equifax’s U.S. Consumer Information System. “They are conserving cash and reducing debt across the board. We haven’t seen savings rates this high since shortly after the third quarter of 2001 – just after 9-11 – when they were at 3.25 percent.”

While consumer may be losing credit lines, they are not going back to checks and cash.  These bank activities have created a push towards debit cards, since consumers today prefer cards to cash and checks.  Consumers are either using check debit cards (tied to their bank accounts) or switching to open loop, reloadable prepaid cards.  The latter card type is especially increasing in popularity amongst teens, college students and the unbanked segment.

All reports on bank card usage make it pretty clear that card usage is not declining and shows no signs of disappearing.  With checks soon becoming a payment method of the past, payment cards usage will increase even more. The most recent action comes from the UK Payments Council, the body for setting payment strategy in Britain.  Comprised of Britain’s leading banks, the council agreed on Dec 16 to set a target date of October 31, 2018 for closing the check clearing system. UK supermarkets, high street retailers and petrol stations have stopped accepting checks, but they are still a popular form of payment among elderly people, many of whom find the idea of using automated cash machines intimidating.  “The next generation probably won’t even have a checkbook,” said Addy Frederick, a spokeswoman at the payments council.  Checks have all but disappeared in high-tech countries like Sweden and Norway and their use is under review in Ireland, South Africa and Australia, Frederick at the council said.

It is estimated that PIN-based debit transaction Interchange costs have gone up nearly 85% in the last year alone. The rise could be attributed to a large consolidation between debit networks. Whenever there is consolidation, there is typically less competition and the result is higher PIN-based debit costs to processors and higher interim costs to merchants. Interlink’s current fee is nearly $0.76 per transaction and Pulse’s is over $0.64. Many merchants have become accustomed to paying flat fees for PIN-based debit transactions but in the coming years that will be a thing of the past.

Online merchants can take advantage of PINless debit solutions by having the option of using networks such as Star, NYCE, and Pulse and not having to pay traditional Interchange fees. This is beneficial to e-commerce merchants because payment is immediate, unlike e-check or ACH which can take a few days. The funds are also verified and clients do not have to give out checking account information. These features are currently limited to certain business types, such as utilities (water, gas and waste management), Education, government payments (taxes, fines, licenses), insurance (auto, life, and health), health club memberships, and internet service providers.

It is still beneficial to add a PIN pad to your terminal if you are a large ticket business. This will ensure you are paying the lowest rate possible. Some processors will offer a low PIN-based debit transaction fee. Often the merchant will still have to pay debit network pass-through fees.  If the PIN-based debit fee you are quoted sounds too good to be true, it probably is.

Retailers had to resort to drastic sales and discounts to draw shoppers in. Although the sales receipts and purchases were reported to be high, the profits were low. ComScore, an Internet research company, reported Sunday that online spending was up a modest 2 percent for the combined Thanksgiving Day and Friday, compared with the same period last year. Karen MacDonald, a spokeswoman at Taubman Centers Inc., which operates 24 malls in 11 states, said that based on a sampling of malls, Friday’s business was anywhere from unchanged to up mid-single digits. Saturday’s sales were unchanged to down slightly.

Large retailers such as Wal-Mart estimate that November sales fell .01 percent at its US stores. Wal-Mart says this is the company’s first monthly same-store sales decline since April 1996. Although the stores had big crowds, people were not spending.

Overall spending by large retailers, such as Best Buy and Macy’s, was reported to be down by 50% over last year and is considered to be the largest drop in over a decade. Ultimately, the credit card companies will be taking the biggest hit. Many shoppers are resorting to paying with cash, check or debit card. Both Visa and MasterCard rely heavily on credit card sales vs. debit card sales. There is no telling what percentage of the credit card sales will simply become debit card sales or just cash.

Many people are trying to avoid using credit cards by turning to debit cards instead.  Some banks have turned to prepaid programs tapping into the unbanked markets – the millions of people who don’t have a bank or credit card account – and some employers are turning to employee payroll debit cards. Employees have their paychecks deposited onto a card which they use for all their purchases to try to avoid debt. According to The Nilson Report, debit purchases are expected to climb 13% in 2008, to $1.2 trillion. According to Visa, debit spending could surpass credit this year.

Retailers pay over 2% of credit card purchases to banks, three times the amount for debit cards. This is good news for merchants because their fees on transactions over the holidays could decrease significantly. However, banks are not going to go quietly into the night just yet. Be prepared to see an increase in overdraft fees. Typically, a bank would decline a debit transaction if you did not have enough money in your account to cover the transaction. Now, we could see banks allowing transactions to go through and hitting the customer with many more overdraft fees.

Like with any fees charged by the card processing industry, the government is attempting to regulate this money maker as well. Banks are having to come up with creative ways to enhance consumer spending and collect fees in trying times. MasterCard launched its Savings program that offers debit users discounts on luxury brands, as well as at retailers such as Home Depot and Target. Some banks pay higher interest rates to consumers when they use their debit card.

Are debit cards becoming the payment method of choice by consumers?  Will banks push for debit pay off?  These days debit cards are widespread and seem to outweigh the number of credit cards being used. Only time will tell what new programs the banks have in store for consumers and merchants alike.