Capital One Tests a New Type of Debit Card

Unlike the debit cards in use today, Capital One's new product is, in industry speak, a "decoupled" card: It can be linked to any bank account and used for purchases and ATM withdrawals, just like the debit card consumers get from their bank when they open a checking account.

There will be no fees associated with it, according to Capital One, unless the bank imposes its own fees. Right now, the card is only available to select Capital One credit-card users, but will be widely available in 2008, according to the company.

What's the potential appeal of this new card? Better rewards. Unlike debit cards today, which come with little or no rewards at all, the new Capital One MasterCard Debit Card will offer rewards nearly as generous as those consumers get from their credit cards. Consumers who have a Capital One credit card, for example, will be able to pool their rewards from the two products, earning the same level of points, miles or cash back no matter which type of card they use. And those who don't have a Capital One credit card will be able to choose from a number of co-branded debit cards issued in partnership with various retailers (not yet announced). The rewards structure will be similar to that of the typical retail co-branded credit card today: Users will earn bonus points at the retailer in question and regular rewards (say, one point per $1) anywhere else. Rewards can then be redeemed at the retailer associated with the card.

"The rewards value of [the new Capital One debit card] will be two to five times superior to the rewards you get with any other debit card," says Gwenn Bezard, research director at Aite Group, an industry research firm. In other words, many folks who today use credit cards solely for those points, miles or cash back, might consider a switch to that new debit card, Bezard says. So could consumers who already use debit cards for budgeting or any other reason.

At least that's what Capital One is banking on. "This type of card gives consumers the choice of using a debit card vs. a credit card," says Pam Girardo, a Capital One spokeswoman.

But that has consumer advocates concerned. "I think consumers are going to be totally confused by the concept," says Linda Sherry, a spokeswoman for Consumer Action, a consumer advocacy group. If your card is stolen and used fraudulently, for example, who should you call: Capital One or your bank? (The answer, surprisingly, is Capital One. For more details on the card, see our table.)

Here's what consumers should know about the new Capital One debit card and how it could change the marketplace.

The Capital One debit card could accelerate the growing popularity of debit, according to Bezard. In 2005, rewards cards accounted for 77% of all credit-card purchases, according to Aite Group. This year, the firm estimates that 84% of credit-card purchases will be placed on rewards credit cards and by 2010, a whopping 94%.

Debit cards, meanwhile, have lagged behind. Only 20% of debit-card spending was on rewards debit cards in 2006, according to Aite Group. In other words, consumers who use debit cards now don't do it to rack up rewards, but for other reasons, such as avoiding credit-card debt. But with the introduction of a debit card that offers rewards that are similar, if not the same as those offered by credit cards, that could easily change, Bezard says. "I do expect some credit-card users will switch to debit cards," he says.

That said, don't expect debit cards to take over the marketplace entirely. The majority of credit-card users — 69%, according to CardTrack.com, an industry web site — carry balances, which means they still use credit cards as a financing vehicle, not a rewards cash cow. And of those who pay off in full each month, many use credit cards to cover everyday expenses, while their cash earns interest in a high-yield savings account until the credit-card bill's due date.

This emphasis on debit rewards will likely have more banks looking into so-called "relationship" rewards. With relationship rewards, bank customers earn points on debit card purchases, plus additional points for having a savings account and other bank products, such as CDs, mortgages, lines of credit, and so on. Typically, the more accounts a customer has with the bank, the more points he or she earns each month. Citibank is currently the only large bank to have a relationship rewards program.