A Guide to the ATM and Debit Card Industry

A Guide to the ATM and Debit Card Industry


Fumiko Hayashi, Richard Sullivan, and Stuart E. Weiner1



First Draft: 20 December 2002
This Version: 7 April 2003



WP02-03





Abstract

The ATM and debit card industry is undergoing significant change. Some of
the most dramatic changes include the sharp growth in point-of-sale debit card
transactions, the intense competition between online and offline debit, the heavy
consolidation of regional EFT networks and third-party service providers, the
growing importance of nonbank ownership of networks, and new pricing structures
and strategies. This paper provides a guide to the current structure of the ATM and
debit card industry. It also highlights some key economic and public policy issues.
Among the issues addressed are market concentration, vertical integration and
economies of scope, pricing, access, and risk.



1 Hayashi: Payments System Research, Federal Reserve Bank of Kansas City, 925 Grand Blvd., Kansas City, MO,
64198, Email: fumiko.hayashi@kc.frb.org, Phone: (816) 881-6851. Sullivan: Banking Studies and Structure,
Federal Reserve Bank of Kansas City, 925 Grand Blvd., Kansas City, MO, 64198, Email: rick.j.sullivan@kc.frb.org,
Phone: (816) 881-2372. Weiner: Payments System Research, Federal Reserve Bank of Kansas City, 925 Grand
Blvd., Kansas City, MO, 64198, Email: stuart.e.weiner@kc.frb.org, Phone: (816) 881-2201. Web site:
http://www.kc.frb.org/frfs/PSRhome.htm. The views expressed in this article are those of the authors and do not
necessarily reflect those of the Federal Reserve Bank of Kansas City or the Federal Reserve System. The authors
wish to thank numerous individuals for their valuable input and discussion in preparing this paper. These include:
Jeffrey Green (ATM & Debit News); James Judd, Paul Tomasofsky, Susan Zawodniak (NYCE); Paul Albright
(Pulse); Julie Saville (Star); Chris Truelson (TSYS); Tom Ammann (Effective Shareholder Solutions); Lee Manfred,
Scott Reaser (First Annapolis Consulting); as well as numerous colleagues at the Federal Reserve Bank of Kansas
City.

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TABLE OF CONTENTS

1 INTRODUCTION................................................................................................................. 1
1.1 RECENT CHANGES IN THE ATM AND DEBIT CARD INDUSTRY............................................... 1
1.2 ISSUES AND IMPLICATIONS................................................................................................... 3
1.3 SCOPE AND ORGANIZATION.................................................................................................. 5
2
OVERVIEW OF THE ATM AND DEBIT CARD INDUSTRY ...................................... 6
2.1 GENERAL DESCRIPTION OF ATM AND DEBIT CARD TRANSACTIONS..................................... 6
2.2 INDUSTRY INFRASTRUCTURE ............................................................................................... 8
2.2.1 EFT
networks.............................................................................................................. 9
2.2.2 Offline debit card networks ...................................................................................... 10
2.2.3 Third-party
service
providers.................................................................................... 12
2.2.3.1 Third-party processors.......................................................................................... 12
2.2.3.2 Independent sales organizations (ISOs) ............................................................... 17
2.2.4 Summary ................................................................................................................... 18
2.3 BRIEF HISTORY OF THE INDUSTRY...................................................................................... 19
2.3.1 Box 1: ATM and debit card timeline ........................................................................ 20
3 ATM ..................................................................................................................................... 24
3.1 INTRODUCTION .................................................................................................................. 24
3.2 TRANSACTION VOLUME, TERMINAL GROWTH, AND TERMINAL FUNCTIONALITY ................ 25
3.3 INDUSTRY STRUCTURE ....................................................................................................... 26
3.3.1 Number and size of shared ATM networks .............................................................. 26
3.3.2 Concentration............................................................................................................ 27
3.3.3 Top ATM networks................................................................................................... 28
3.3.4 ATM terminal coverage............................................................................................ 31
3.3.5 Ownership
structure .................................................................................................. 33
3.3.6 Scope and consolidation of third-party service providers......................................... 34
3.4 INDUSTRY PRICING............................................................................................................. 36
3.4.1 Retail
ATM
fees........................................................................................................ 36
3.4.2 Wholesale
ATM
fees ................................................................................................ 38
3.5 ATM AUTHORIZATION, FEE, AND SETTLEMENT ROUTING ARRANGEMENTS ....................... 41
3.5.1 Four categories of ATM transactions ....................................................................... 42
3.5.2 Routing arrangements for a network on-us ATM transaction .................................. 44
4 DEBIT
CARD...................................................................................................................... 47
4.1 INTRODUCTION .................................................................................................................. 47
4.2 TRANSACTION VOLUME, DEBIT CARD ISSUANCE, AND TERMINAL GROWTH ....................... 47
4.3 INDUSTRY STRUCTURE ....................................................................................................... 49
4.3.1 Number and size of online debit card networks........................................................ 49
4.3.2 Concentration............................................................................................................ 50
4.3.3 Top online debit card networks................................................................................. 51
4.3.4 Online debit card coverage ....................................................................................... 52
4.3.5 Ownership and third-party providers ........................................................................ 52
4.3.6 Three competitive battlegrounds............................................................................... 52

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4.4 INDUSTRY PRICING............................................................................................................. 54
4.4.1 Retail debit card fees................................................................................................. 54
4.4.2 Wholesale debit card fees ......................................................................................... 55
4.5 EMERGING PAYMENTS ....................................................................................................... 58
4.6 DEBIT CARD AUTHORIZATION, FEE, AND SETTLEMENT ROUTING ARRANGEMENTS............. 59
4.6.1 Four categories of online debit card transactions ..................................................... 60
4.6.2 Routing arrangements for a network on-us online debit card transaction ................ 62
4.6.3 Offline debit card transactions .................................................................................. 64
4.6.4 Routing arrangements for an offline debit card transaction...................................... 64
5
ECONOMIC AND POLICY ISSUES............................................................................... 66
5.1 INTRODUCTION .................................................................................................................. 66
5.2 MARKET CONCENTRATION................................................................................................. 67
5.2.1 Recap of developments ............................................................................................. 67
5.2.2 Contributing
factors .................................................................................................. 68
5.2.3 Potential
implications................................................................................................ 70
5.3 VERTICAL INTEGRATION AND ECONOMIES OF SCOPE.......................................................... 72
5.3.1 Change in network ownership .................................................................................. 72
5.3.1.1 Recap of developments.......................................................................................... 72
5.3.1.2 Contributing factors.............................................................................................. 73
5.3.1.3 Potential implications ........................................................................................... 76
5.3.2 New processing services and payments methods ..................................................... 78
5.3.2.1 Recap of developments.......................................................................................... 78
5.3.2.2 Contributing factors.............................................................................................. 78
5.3.2.3 Potential implications ........................................................................................... 79
5.4 PRICING ............................................................................................................................. 80
5.4.1 Wholesale
prices ....................................................................................................... 80
5.4.1.1 Recap of developments.......................................................................................... 80
5.4.1.2 Contributing factors.............................................................................................. 82
5.4.1.3 Potential implications ........................................................................................... 86
5.4.2 Retail
prices .............................................................................................................. 91
5.4.2.1 Recap of developments.......................................................................................... 91
5.4.2.2 Contributing factors.............................................................................................. 92
5.4.2.3 Potential implications ........................................................................................... 93
5.5 ACCESS.............................................................................................................................. 96
5.6 RISK................................................................................................................................... 99
6 FUTURE
RESEARCH..................................................................................................... 102
TABLES, CHARTS, AND FIGURES..................................................................................... 104
APPENDICES ........................................................................................................................... 146
Appendix A. Timeline of regional EFT networks.................................................................... 146
Appendix B. Schematic diagrams of ATM and debit card routing arrangements.................. 150
REFERENCES.......................................................................................................................... 173


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LIST OF TABLES, CHARTS, AND FIGURES


Chart 1: ATM Transactions ........................................................................................................ 104
Chart 2: ATM Terminals ............................................................................................................ 105
Chart 3: Number of Shared ATM Networks............................................................................... 106
Table 1: Top 10 ATM Networks by Number of Transactions.................................................... 107
Chart 4: Concentration of ATM Transaction Volume................................................................ 108
Chart 5: Concentration of EFT Switch Volume ......................................................................... 109
Table 2: Top 10 ATM Networks by Share of Total ATM Transactions .................................... 110
Table 3: Top National and Regional Networks by Number of ATM Terminals........................ 111
Chart 6: Ownership Structure of Top 20 Regional ATM Networks........................................... 112
Chart 7: Concentration of EFT Transactions Among the Top Five Processors ......................... 113
Chart 8: Ownership Concentration of ATM Terminals.............................................................. 114
Table 4: Types of ATM Fees ...................................................................................................... 115
Table 5: Retail ATM Fees........................................................................................................... 116
Chart 9: Trends in Wholesale ATM Fees ................................................................................... 117
Figure 1: ATM Transaction—Network on-us ............................................................................ 118
Chart 10: Debit Transactions ...................................................................................................... 122
Chart 11: Online Debit Share of Total Debit .............................................................................. 123
Chart 12: Cards with a Debit Function ....................................................................................... 124
Chart 13: Online Debit Terminals............................................................................................... 125
Chart 14: Number of Online Debit Networks............................................................................. 126
Chart 15: Concentration of Online Debit Transactions Among the Top EFT Networks ........... 127
Chart 16: Concentration of Debit Card Transactions Among the Top 10 Debit Card Issuers ... 128
Chart 17: Concentration of Debit Cards in Circulation Among the Top Debit Card Issuers ..... 129
Table 6: Top 10 EFT Networks by Number of Online Debit Transactions................................ 130
Table 7: Top 10 EFT Networks by Share of Online Debit Transactions.................................... 131
Table 8: Top 10 Online Debit Networks by Number of Cards................................................... 132
Chart 18: Online Debit Card Coverage Among the Top EFT Networks.................................... 133
Table 9: Types of Debit Card Fees ............................................................................................. 134
Chart 19 Trends in Switch Fees for Online Debit Transactions ................................................. 135
Chart 20: Acquirer and Card Issuers Responsibility for Online Debit Switch Fees................... 136
Chart 21: Online Debit Interchange Revenue to Card-Issuing Bank.......................................... 137
Figure 2: Online Debit Card Transaction—Network on-us........................................................ 138
Figure 3: Offline Debit Card Transaction................................................................................... 142


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1 Introduction
1.1 Recent changes in the ATM and debit card industry
The U.S. payments system is going through a period of rapid change. Paper checks are
increasingly giving way to electronic forms of payment, which themselves are being transformed
as new products, new players, and new industry structures arise. Some of the most dramatic
changes are being seen in the automated teller machine (ATM) and debit card industry.
Installation of ATMs has been particularly rapid in recent years. ATM growth was 9.3
percent per year from 1983 to 1995 but accelerated to an annual pace of 15.5 percent from 1996
to 2002. Much of the acceleration is due to placing ATMs in locations other than bank offices.
These off-premise ATMs accounted for only 26 percent of total U.S. ATMs in 1994, but now
account for 60 percent.
On the debit card side of the industry, growth has been extremely rapid in point-of-sale
(POS) debit card transactions. With an annual growth rate of 32 percent from 1995 to 2002, POS
debit is the fastest growing type of payment in the U.S. Today it accounts for nearly 12 percent
of all retail noncash payments, a fivefold increase in just five years.2 Growth has been sharp in
both online (PIN-based) and offline (signature-based) debit. From 1995 to 2002, annual growth
of online debit was 29 percent, while offline debit grew at 36 percent.
The ATM/debit card infrastructure has also undergone significant change, including
consolidation, nonbank ownership, and increased transaction processing located at nonbank
(third-party) processors. Consolidation of ATM and debit card networks began in the mid-1980s
and continues today. One result is that the top three regional networks (Star, NYCE, and Pulse)

2 Gerdes and Walton (2002).

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now have a 70 percent market share in switch volume, while the top three networks in 1995 had
a market share of just 39 percent.3 Along with consolidation has come a significant change in the
ownership structure of networks. In 1985, banks or bank associations owned all of the top ten
regional networks, while today nonbank organizations own five of the top 10.4 Acquisition of
networks by nonbank companies that provide payment processing services, such as Concord EFS
and First Data Corporation, reflects the growing importance of third-party processors in network
ownership, driven by the desire of these organizations to expand the scope of their operations.
Further, there has been horizontal integration among third-party payments providers, as
organizations such as Concord EFS and First Data acquire smaller payments processors and
organizations such as E*Trade and eFunds expand their ownership of ATMs or the ATMs they
service through merger and acquisition.
A number of changes also surround pricing structures and strategies. Over 88 percent of
ATMs add surcharges to users whose access card is not associated with that ATM’s owner, a
practice virtually unheard of 10 years ago. Despite their prevalence, some ATM users continue to
object to surcharges and a few jurisdictions have tried to prohibit them.5 Also controversial is the
recent increase in the use of online-debit fees (PIN fees) by some financial institutions to redirect
their cardholders from online to offline debit. Indeed, the differential pricing of transactions fees
for offline and online debit is the key issue behind a conflict between merchants and card-issuing
banks that is epitomized by the Wal-Mart “honor all cards” lawsuit, whose outcome could have a

3 Switch volume is a measure of the number of payment transactions whose information is carried over the network.
The term “switch” refers to the fact that the information is often switched from one bank to another or one network
to another. The top three networks in 1995 were MAC, Star, and Honor. Today the MAC and Honor networks are
part of Star’s network.
4 The nonbank organizations are EDS, First Data, Concord EFS, Genpass, and Publix Supermarkets.
5 Two cities in California and the State of Iowa have had regulations that prohibit surcharges. However, these bans
have generally not been upheld in legal challenges.

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wide ranging impact on the industry. Another pricing issue has arisen due to volume discounts
introduced by some networks, a practice that might disadvantage smaller users.
Finally, changes have gone beyond the traditional ways of using ATM and POS debit.
There has been substantial innovative activity generating new products and services that use the
ATM/debit card infrastructure. Applications are being developed that allow debit cards to be
used to make payments on the Internet and to convert paper checks into electronic payments at
the point of sale. Another initiative would use ATM and debit card networks to enable person-to-
person (P2P) payments on the Internet.
1.2 Issues
and
implications
Associated with these changes are numerous economic and public policy issues. These
issues include market concentration, vertical integration and economies of scope, pricing, access,
and risk.
Market concentration. Consolidation has occurred at many stages of processing ATM
and debit transactions. To some extent this reflects advantages of size brought on by network
effects and economies of scale. The results could be beneficial because the value of payments
networks to consumers could increase and prices could be reduced. However, there is also a risk
that increased size of providers could result in excessive market power for some firms in the
industry, which could cause prices to rise. A number of issues deserve attention. For example,
could further consolidation cause long-term harm by reducing innovation? Is the tension between
a desire for efficiency and a desire for competition a cause for concern in the ATM and debit
card industry?
Vertical integration and economies of scope. Some recent developments in the ATM and
debit card industry involve expanding the scope of services offered, such as payments processors

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acquiring networks and networks providing additional payment services. This expansion
represents a search for the appropriate scope of operations in payments processing. In addition, it
has brought nonbank ownership to significant parts of the industry. Several important questions
arise. What are the implications of these combinations? Will they be successful in realizing
expected advantages? With banks decreasingly represented in the industry, should there be
concern over who is responsible for ensuring that payments are processed efficiently and safely?
Pricing. Pricing associated with ATM and debit card transactions presents some of the
most challenging areas for analysis. Networks are experimenting with fees that are tied to
transaction value where a fixed fee per transaction has been the norm. Networks have begun to
offer volume discounts to different classes of merchants. Consumers face surcharges for ATM
transactions and PIN fees for online debit transactions. The difference in transaction fees for
online and offline debit encourages the use of one over the other. Critical questions include the
following: Are certain pricing schemes providing some networks with competitive advantages?
Have some fees for network services outlived their usefulness? Are market pressures sufficient
to ensure competitive prices for payment services? Are pricing schemes providing incentives that
propel the payments industry toward safe, efficient, and accessible methods of payments?
Access. In general, access to the payments system appears to have become easier over
time. But access is more complex than simply counting the number of outlets or alternatives
available to consumers, financial institutions, and merchants. A better framework may be to
consider the cost of accessing payments. For example, quantity discounts imply that larger banks
may obtain relatively low-cost network services. In turn, smaller banks may face relatively high
costs, which they would have no choice but to pay because a connection to networks is an
increasingly crucial requirement for banks. A key question is whether trends in consolidation and

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pricing are placing some banks at a disadvantage for accessing networks. Similarly, smaller
merchants may find it increasingly costly to conduct business due to a high price of payment
services.
Risk. Evolution of payments methods and industry structure necessarily means that
established rules and regulations that mitigate risk must also evolve to account for new and
emerging risks. In light of these changes, it is important to consider how the rules and regulations
that provide consumer protection, control operational risk, and limit fraud should be adapted.
1.3 Scope and organization
This paper, the first in a series, provides a guide to the current structure of the ATM and
debit card industry and highlights important economic and public policy issues. Future papers
will build on the information and analysis presented in this paper and address specific issues in
greater detail.
Because the ATM and debit card industry is highly complex with specialized
terminology, it may be helpful for readers first to acquire a general understanding of the ATM
and debit card industry. Section 2 of this paper provides a broad overview of the industry. The
section describes how ATM and debit card transactions take place, outlines the major
components of the industry’s infrastructure, and traces how the ATM and debit card industry has
evolved to its present state.
Sections 3 and 4 use the information in the overview as a springboard for providing
detailed information on ATMs and debit cards. Included are discussions of key trends and
developments, more detailed discussion of the activities and interrelationships of major
participants, and descriptions of the principal authorization, fee, and settlement routing
arrangements.

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Section 5 discusses in greater detail key economic and public policy issues. Among the
issues covered are market concentration, vertical integration and economies of scope, pricing,
access, and risk.
Section 6 provides closing remarks and suggestions for future research. The overall
message of the paper is that the ATM and debit card industry is undergoing significant change
along a number of dimensions. These dynamics raise important economic and policy issues
requiring continued monitoring and analysis of developments in the industry.
Two appendices provide supplementary information. Appendix A provides additional
information on the evolution of ATM and debit card networks over the last 30 years. Appendix B
contains additional schematic diagrams of transaction routing, fees, and settlement for several
types of ATM and debit card transactions.
2 Overview of the ATM and Debit Card Industry
2.1 General description of ATM and debit card transactions
ATM and debit card transactions take place over a complex infrastructure. To the
consumer and merchant, they appear seamless and nearly instantaneous. But, in fact, a highly
complex telecommunications infrastructure links consumers, merchants, ATM owners, and
banks. The common attribute of all ATM and debit card transactions is that the transaction is
directly linked to the consumer’s bank account, that is, the amount of a transaction is deducted
(debited) against the funds in that account.
An ATM transaction typically involves withdrawing cash from an ATM machine.6 The
consumer presents an ATM card, which is issued by the bank holding his checking account, at an

6 ATMs offer other services but the most common transaction is cash withdrawal. The 2002 ATM Deployer Study
(Dove Consulting) found that 77 percent of the average transaction mix at financial institution ATMs are cash

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