Durbin's Impact on FraudDodd-Frank Amendment Aims at Prevention, But Raises Questions
That reduction could impact fraud prevention investments - a reality the Federal Reserve is closely considering. But complexity and contention surrounding the debit interchange debate has complicated an already touchy issue, says Mike Urban, senior director of fraud product management at FICO, which provides card fraud analytics for financial institutions.
"What the Fed was talking about was taking money from interchange fees and using it toward fraud prevention," Urban says. But with the amendment's call for a drastic reduction in the fees banks and credit unions collect, Urban says most bankers don't see how they can make future preventative investments affordable.
"A critical distinction in the fraud discussion around Durbin was the difference between detection and prevention," Urban says. "The detection is the part of the equation that figures out what is getting around the current prevention measures. Fraud detection is a critical area of investment for financial institutions. Generally, the more invested you are in that area, the lower your losses and the more likely the criminals are going to move on to easier targets. You let that guard down and then the fraud will surge back in."
And another amendment, this time tied to a small business bill [S. 493], could delay the Fed's rule on debit card interchange even further. Proposed by Sen. Jon Tester, D-Mont., the so-called Tester bill would give the financial industry two years to evaluate the impact a reduction in debit interchange will have on consumers and the economy.
"With both sides of the aisle looking at the amendment, and with all of the questions that have come out from the House and the Senate about the bill, I think any additional time would be worthwhile," Urban says.
During this interview [transcript below], Urban discusses:
- Implications of the Durbin amendment;
- Stipulations for fraud prevention and fraud detection; and
- How the Durbin amendment could be a catalyst for EMV-like payments in the U.S.
Urban serves as senior director of fraud solutions for FICO, where he analyzes fraud issues and trends to provide improvements in fraud detection technology. He also regularly works with law enforcement to help prosecute criminals and has been responsible for uncovering several crime rings in the United States. Urban regularly speaks about fraud trends, best practices and solutions to industry groups and association. He has been quoted in numerous publications, including The New York Times, MSNBC, Computer World, American Banker and ATM & Debit News.
TRACY KITTEN: Regulatory reforms are raising a number of questions within financial institutions, especially when the topic of the Durbin amendment comes up. The Durbin amendment's impact on interchange fees associated with debit transactions is concerning, but what impact could Durbin and other legislation have on fraud detection and prevention? That's a question many thought leaders are pondering and their views vary greatly. I'm here today with Mike Urban, senior director of fraud product management at FICO, which provides card-fraud analytics for financial institutions. Mike, before we jump in, could you give some insight into the Durbin amendment? What are some of the key concerns you see facing the financial industry?
MIKE URBAN: I think the obvious concern here is the reduction in debit card interchange. Right now, there is talk about a 12-cent per transaction cap, and many financial institutions have used that interchange to fund checking accounts to consumers, and it's generally one of the most profitable products that they have in their checking account relationship, with interest rates at all-time lows, lulls in the housing market, and consumers and businesses that either don't meet lending requirements or those that do meet holding off on acquiring more loans and debt. Financial institutions are facing a squeeze on the revenue side of the house. The other big implication is the removal of network exclusivity, which means that an issuer has to have at least two different networks, which allows the merchant to decide which network they're going to route to, based on the least cost of routing per particular transaction network.
Durbin and FraudKITTEN: A number of questions have been circulating about the Durbin amendment and its impact on interchange revenue, as you've noted. In fact, many institutions are already taking steps to prepare for the lost income by tapping debit transactions and/or limiting ATM withdrawals. But what about the fraud implications? With lost interchange and increasing rates of debit fraud, might banks and credit unions just deem debit too costly to manage?
URBAN: I don't think that anyone is going to cast away debit card transactions. It's really going to turn into a minimums game for debit card customers. So, there's going to be minimum balances required, a minimum number of transactions, because the more transactions the more interchange, even though it's lower. Higher transaction levels actually become more important to profitability. So, there may be few financial institutions covering foreign ATM fees associated with non-owned ATM transactions, and then if use of cash actually goes up, there could be a big increase in the ATM transactions. I think that debit cards are a fundamental product in our society, and we've seen that with the growth rates in the dollar and the transaction volumes. Any financial institution that significantly penalizes the use of debit is going to lose customers. That said, debit card losses will certainly be more painful for financial institutions with the reduction in interchange. Simple math shows that one $200 fraud event wipes out the interchange in excess of 1,000 good transactions at 12 cents per transaction. So what we may see is a migration to PIN debit, which has lower basis points of loss than signature debit transactions.
KITTEN: And might there be incentives, Mike, in the amendment for banks and credit unions to increase fraud prevention and detection investments?
URBAN: Well, there has been a lot of talk about incremental provisions for fraud costs, and regardless of whether there is a provision or not, financial institutions realistically wouldn't say that they're not going to make investments in fraud detection. We have seen financial institutions who have turned off fraud detection tools and the criminals immediately start to slam them with fraud. So fraud detection investments are critical to minimizing losses. Now, that said, what the Fed was talking about was fraud prevention, and so their view is that incremental investments in things like encryption and chip and PIN could be invested with that incremental increase in the interchange rate -- taking some of that money and having financial institutions make some investment in that for future fraud prevention. The issue is that each of these fraud prevention technologies solves a particular area or type of fraud, and encryption applies to encrypted data in transit. Chip and PIN solves card-present counterfeit transactions, not card-not-present transactions; and in other markets, where chip and PIN comes in, we've seen that the fraud migrates. So it migrates across borders through the magnetic stripe fallback on the chip card, and the PINs are comprised in a similar manner at the ATM. That data is then sent cross-border to other countries where a magnetic stripe transaction is performed.
Prevention technologies are good and they do reduce particular types of fraud, but they don't eliminate all types of fraud. The criminals figure their way around the prevention technologies. What happens is you wind up making investments all over the place to stop each variation of fraud. So a critical distinction in the fraud discussion around Durbin was the difference between detection and prevention. The detection is the part of the equation that figures out what is getting around the current prevention measures. Fraud detection is a critical area of investment for financial institutions. Generally, the more invested you are in that area, the lower your losses and the more likely the criminals are going to move on to easier targets. You let that guard down and then the fraud will surge back in.
KITTEN: And do you think the amendment could offer a cushion or a way for financial institutions to pass some of their security and technology investments on to the consumer?
URBAN: One way or the other, the consumer pays for these things. So anything the financial institution or the merchant needs in the role of risk mitigation ultimately comes out and the price is paid by consumers. Each side has to maintain or increase profits.
KITTEN: And what seems to be the biggest misconception, Mike, or unknown when it comes to the impact the Durbin amendment could have on fraud detection and deterrents?
URBAN: Well, there is a piece of the interchange added that is expected to be invested in fraud reduction, and that's not a bad investment to make. The question becomes, do we all agree to make the same fraud prevention and detection investments? Everyone still has to agree. Maybe all the banks say they're willing to use it to fund a migration to chip and PIN cards, when the merchants decide they don't want to invest in chip and PIN terminals. Maybe the merchants need an additional discount in the interchange to make their investment in chip and PIN terminals. That example might seem a little ridiculous, but the point is that everyone has to agree on the specifics, and regardless of the prevention technologies used, there will still be a need for fraud detection system investments.
KITTEN: Now, when we take a look at debit fraud, the losses can be devastating, since debit links directly to a consumer's bank account. How risky are debit transactions for banks and credit unions?
URBAN: A financial institution is only as good as the trust their customers have in their ability to protect their funds, right? No one puts their money into a financial institution that they don't think is doing whatever they can to protect their money. So it behooves financial institutions to manage their fraud loss. A likely scenario here is going to be financial institutions looking at products that actually reduce the level of fraud, and, in many cases, even just adding a PIN to a transaction, even if there isn't a chip, will lead to reduced levels of risk.
New Payments?KITTEN: And do you think, Mike, that the amendment could possibly open doors or new opportunities for credit or prepaid services? Could the legislation actually lead to a reduction in debit offerings and transactions?
URBAN: There is a tremendous amount of interest in figuring out how credit and prepaid can be used in lieu of debit cards. However, that could lead to additional scrutiny by the Fed, if they see that financial institutions are using debit card replacements. However, the political environment today seems less likely to put any additional restrictions around this. This amendment went in without a debate and both sides of the aisle are very aware of that fact.
KITTEN: And I understand that a recent proposal by Sen. John Tester, called the Tester Bill, would give the industry two years to review the impact a reduction in debit interchange could have on financial institutions. What can you tell us about this bill?
URBAN: With both sides of the aisle looking at the amendment, and with all of the questions that have come out from the House and the Senate around the amendment and the implementation of it, I think that even the Fed has said they don't have a lot of time and they haven't really been able to look at all aspects of this. I think that having a little more time to really understand what the impacts are all the way around in the industry, not just for financial institutions, would be worthwhile.
KITTEN: And from a fraud perspective, where do you see the Durbin amendment having the greatest impact?
URBAN: It really depends, again, on specific prevention technology that's going to be identified for the investments to be made. I think the other side of it is going to be, are financial institutions going to look to particular products that are going to reduce the level of fraud? Again, there are a lot of financial institutions looking at PIN debit, where the basis points are lower, so there could be some impacts there.