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Ken Chenault: Card Industry Regulation

October 21, 2010 -- The American Express Company third-quarter earnings conference call included a discussion of regulatory, legislative and legal changes affecting the payments industry. Text of the remarks by chairman and chief executive officer, Kenneth I. Chenault, appear below.



Good afternoon. Thank you for joining our call today.

I’m going to spend a few minutes sharing my views on the various regulatory and legislative changes that have occurred over the last two years, including the DOJ lawsuit. I’ll discuss the issues raised by all of these changes – not just for our company, but for the payments industry.

First, I want to assure you that we’re taking the DOJ lawsuit very seriously. However, a number of the changes we’re currently seeing are likely to have far greater impact on industry growth, pricing, consumer behavior and merchant relationships than the DOJ suit alone. The lawsuit, after all, is about steering between credit products.

Merchants are already allowed to offer a discount or incentive for customers who pay by cash, check or debit card, but few do. For bank issued credit products there is some rate differential between products. For example, for Visa credit products the difference between their high and low interchange rates is approximately 90 basis points. That’s 90 cents on a $100 purchase. All things being equal, it seems questionable whether merchants would disrupt a transaction at the point of sale and risk a potential loss of customer goodwill for the sake of a relatively small differential.


For me, the core issue of the lawsuit is a simple one – it’s about consumer choice and the right of a customer to select the card they want to use at the point of sale. I don’t believe the government or the merchant should be making this choice – the choice should belong to the customer.

I also believe that we – American Express -- should have the right to negotiate freely with our merchants on the terms of our contract. Our contract requires the welcome acceptance of our card products and our customers at the point of sale, and I don’t believe government intervention in this matter – or in any legal commercial negotiation – will lead to a positive outcome.

Finally, I disagree strongly with the DOJ’s assertion that we have market power – that merchants are forced to accept our products. This is not the case and, I believe, it’s one of many reasons why we’ll win this suit. In terms of merchant acceptance we are the smallest network, smaller even than Discover, who is not a party to this suit. In the DOJ’s own antitrust case against Visa and Mastercard several years ago they explicitly stated – and the courts agreed – that we did not have market power. Merchants choose to accept American Express because they understand the value we bring them – higher spending customers, our superior service and our marketing expertise to help them expand their business. Our actions in the marketplace are all about competition, not coercion.

Perspective on Legislative and Regulatory Change

As I said earlier, while we certainly take this lawsuit seriously, it is also essential to put it into perspective against all of the changes across the payments and card industry in recent years.

Just over the last two years we’ve seen – the CARD Act, the Dodd-Frank bill, which included the Durbin amendment on debit, and new regulatory limits on overlimit fees. This regulation and legislation has clearly been the most significant in the history of the card industry.

Each clearly reflects the political environment and a turn back towards regulation rather than competition in the banking, financial services and card industry. While they share a common starting point, each one is likely to have a different impact on the market, on the consumer and on different players in the industry.



For example, among other impacts, the CARD Act has changed how some consumer products are priced. On one side:


  • It has simplified terms/conditions and made disclosure more transparent.
  • It has insulated some consumers from higher interest rates and fees if they fall behind on payments.
  • And, it forced some issuers to stop practices that were misleading or, at best, very hard for customers to understand.

On the other side:

  • It may cause some lenders to limit access to credit to all but the most financially secure borrowers.
  • It may increase the overall cost of borrowing from some banks as they offset their inability to charge higher rates for riskier customers.
  • It’s made the traditional, mass-market credit card business less attractive.
  • It’s caused some issuers to re-orient their sights on the premium sector.
  • And it may cause others to scale back investments in the card business – perhaps significantly.

We’ve noted before that, because of our spend-based model, we’re less impacted by the CARD Act than our bank issuing peers. For example, while we did have a significant impact within our yield because of the Act, we’ve worked to mitigate it through our re-pricing activities over recent quarters.

The financial impact on many issuing banks from the CARD Act is substantially greater and therefore harder to mitigate. During the second quarter earnings cycle a number of our issuing peers disclosed that after mitigation they would have net income losses of several hundred million dollars as a result of the CARD Act.


The Dodd-Frank Act, which included the Durbin amendment and the creation of the Consumer Financial Protection Bureau, coupled with the Reg E changes to overdraft practices, are likely to have an equally broad impact on issuing banks.

While the Consumer Financial Protection Bureau will represent continued uncertainty until its approach and regulatory program are clarified, the combined effects of Durbin and Reg E are easier to see.

On one side:

  • It’s eliminated high, frequent overdraft charges to consumers (Reg E).
  • It’s eliminated the practice of processing high-ticket debit transactions out of sequence in order to generate multiple overdraft fees.
  • It may provide merchants a lower interchange and/or transaction fee for debit and certain prepaid cards.
  • And it’s given consumers the choice of whether to accept – and pay for – overdraft protection.

On the other side:

  • It’s made the debit card business much less attractive to banks.
  • If banks do end up imposing monthly debit or transaction fees, consumers may shift back to credit or charge products.
  • It may lead some banks to impose higher fees or rates elsewhere in retail banking to compensate for lost debit revenue, but there are competitive consequences to an action like that.
  • And it has the potential to cause a scale-back or elimination of rewards programs that are tied to debit products.

So bank issuers are seeing their debit economics squeezed from two sides – lower interchange rates and lower revenues from overdraft fees. Their previous public disclosures on these changes again projected lost revenue in the billions of dollars.

Our charge and credit products do compete with debit, so the Durbin pricing adjustments will impact competition among payment products. However, whether and to what extent that competition will affect our pricing and revenues will depend on the specific government guidelines and the reaction of consumers to steering.

Depending on where the Fed’s “reasonable and proportional” debit study comes out, there is the potential for a 50-100 bp reduction in debit interchange fees from current levels. This could increase the gap between debit and credit rates to approximately 150 to 200 basis points.

With this potential benefit some merchants may try to steer their customers towards debit. Given this rate differential, it’s possible they could fund some discount or incentive to encourage customers to switch to debit, but there is still a question of whether the amount will be significant enough for merchants to disrupt the sales process and risk a potential loss of customer goodwill.

DOJ Lawsuit

The DOJ case, on the surface, addresses some of the same issues as Durbin. The terms of its settlement agreement with Visa and MasterCard would allow merchants to steer consumers to a lower priced credit or charge product. For example, if a consumer pulls out a Visa rewards product, the merchant has the right to ask a customer to switch to a Visa or Mastercard credit product with a lower rate. The merchant could offer the consumer an incentive for them to switch, or they could just ask.

As I mentioned earlier the gap between a higher-cost Visa and a lower cost Visa is about 90 bps. (And, for context, the Amex average rate is about 25 basis points higher than Visa and Mastercard’s average for credit products, or about 25 cents on a $100 transaction.)

Assuming these differentials remain constant, steering between credit products does not offer a lot of marginal economics for merchants, particularly when weighed against the potential alienation of good customers and the operational difficulties in implementing these actions at the point of sale.

The irony here is that – if the DOJ’s case against us were successful and merchants did engage in steering – it is far more likely for merchants to steer customers to Visa and Mastercard and away from us, thereby making the two dominant players in the industry even more dominant and harming competition. This is why we must defend and win this case – and we will.

So, in my view, as far as the DOJ settlement is concerned:

  • It offers a remedy that could push more business to the two largest networks.
  • And, if it is put into effect, could push consumers to lower-value cards that offer minimal protections, fewer benefits, limited customer service, scaled back rewards and potentially higher interest rates.

Summary of Changes

So, for the card industry over the last two years the impact of the legislative, regulatory and DOJ actions can be summarized like this:


The CARD Act will have biggest impact on:

  • Issuers who relied heavily on interest income from basic revolving credit products;
  • Issuers who relied heavily on back-end and penalty fees; and
  • Issuers that targeted less credit-worthy borrowers.

Durbin will have the biggest impact on debit card issuers and potentially on merchants steering to debit from other payment products.

The DOJ impact is yet to be determined, but it is more likely to have a smaller dollar impact on the industry than the CARD Act or Durbin.

Going Forward

Going forward I believe the traditional, lend-centric models most bank issuers rely on will need to be re-fashioned. Some issuers will focus on low-cost, no frills products. Others will focus on full service, high value alternatives. And this segmentation among issuers is already underway.

Going forward I believe debit-based models will look much different and debit products will likely cost more for consumers to use, while offering fewer rewards.

But, I also believe that, despite all the changes there are some constants. First, that many consumers and merchants will continue to place a premium on superior value and superior service. And second that, regardless of the industry, merchants – while they will always want a lower price -- want high-spending customers and value from the payment networks they choose to accept.

Merchants know how important it is to treat customers well at the checkout counter – particularly in a slow growth economy -- and successful merchants will be reluctant to risk losing the goodwill of their customers, absent a real economic upside for them.

While everyone will need to adapt to a new regulatory environment, long-term success within payments will continue to depend on several factors: treating customers well, delivering superior service, providing value in return for a fair price, innovating and keeping expenses in line.

Superior service and value will continue to earn a premium price from cardmembers and merchants, and I believe we can compete very successfully as a network of choice for high-spending cardmembers.

Our strong recent performance has shown that we have been successful in each of these areas, and I remain highly confident in our ability to compete – and win – in the future.

With that, let me now turn things over to Dan to go into detail on our momentum and our third quarter results.

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