Remember When Debit Didn't Need Interchange?

Amid a lot of wailing among bankers over the 21-cent cap on debit interchange fees—and now the threat that the cap could be pushed even lower by a Washington, D.C., federal judge—a little bit of inconvenient reality has shown up. Mark Horwedel, CEO of the Merchant Advisory Group, actually remembers why banks started using debit cards in the first place. More to the point, he remembers that debit interchange fees weren't capped at all back then—because there wasn't any debit interchange.

Yes, that interchange-free time is ancient history—way back in the 1990s. It was also a time when big retail chains actually had some control in a major part of the payment system. If you want a clear picture of how chains are capable of losing that kind of self-determination—and how it's likely to happen again with whatever new payments systems retailers adopt in the next few years—this is a useful reminder.

Horwedel's story at PaymentsSource is worth reading all the way through, but to recap: Banks created PIN debit (and PIN debit networks) in the 1970s because it was cheaper than tellers or checks. Big retailers adopted it in the 1980s and 1990s because it had a very attractive business case: Banks saved money, customers didn't have to carry checkbooks, and merchants got paid quickly and without interchange.

Then Visa (NYSE:V) and MasterCard (NYSE:MA), who had never been able to interest anyone in debit cards on their own, began offering new debit cards and partnering with PIN debit networks. Eventually the card brands built a big enough presence that they didn't need their partners, and by requiring that retailers accept debit cards if they wanted to take credit cards, the card brands were able to collect debit interchange—and lock in the banks.

"Debit interchange became a new source of revenue that today is viewed by the banks as a natural right," Horwedel writes. Then he goes on to try to remind banks that debit was a good cost-reduction idea, and still is—with or without interchange.

Maybe he was just being polite. It's pretty hard to believe any bank isn't going to fight tooth-and-nail to keep as much of interchange fees as it can, since fees seem to be the only income banks are getting these days.

And it's worth keeping in mind that while Horwedel ran a debit network back in the pre-interchange days, he also spent five years as director of payments for Walmart (NYSE:WMT) until 2011. It's really hard to believe some of this history didn't go into the early thinking about MCX.

But for retailers, the lessons of the story don't necessarily revolve around MCX or any of its alternatives.

The first and biggest lesson is that, if it has to do with retail payments, Visa and MasterCard want in. And they want in all the way, regardless of whatever sweet deal they make with anyone to get into a new business. It's no coincidence that the highly touted mobile wallet initiatives from Google and Isis started by cutting out the card brands and ended up carrying enough of an interchange load that in Google's case, at least, every transaction lost money.

It may be a coincidence that mobile wallets haven't gained any traction. Realistically, that's probably more related to the fact that nothing besides mag-stripe plastic cards have gained much traction on a cross-retailer basis. When Starbucks handles its own payments, it's good business. If it has to go on the network, somehow retailers aren't interested.

That's the second lesson: Retailers will buy in if they see a good business proposition in a new payments approach. But it also ties in closely with the third lesson: U.S. retailers have learned that anything running through the card brands' networks isn't likely to be a better business proposition than the devil they currently know well—mag-stripe plastic.

Which may explain the hit-a-wall status of not only mobile payments in the U.S., but also contactless and chip-and-PIN too. At this point, there's so little trust that the card brands won't make things worse that even Visa can't get merchants to move forward. And whether reducing debit interchange will actually change that at this point remains to be seen.