Debit Card Pricing at Full Boil

Ten years on, the Fed is mulling changes to its interpretation of the Durbin Amendment’s debit-routing rules. It’s not likely to make anyone happy.

Of the many consequences of the Covid-19 pandemic, perhaps the biggest one for the payments business is how it has thrown into stark relief the long-festering issue of how debit card transactions are routed and priced. As a result, the big questions for the industry now are, how will regulators change the rules for transaction routing and will the existing limit on interchange pricing be lowered.

Indeed, the Durbin Amendment of 2010—which many observers thought had settled these matters—has done no such thing. The law, part of the massive Dodd-Frank Act, is now undergoing reexamination as the Federal Reserve looks at underscoring its routing rules for Regulation II, the Fed regulation that implements Durbin and that turns 10 years old this month.

In the meantime, nobody is happy. Merchants complain they’re still overpaying for debit transactions all these years later. Many banks are scrambling to keep up with the latest authentication technology. And the nation’s electronic funds-transfer networks—the entities that made debit cards a going proposition a generation ago—are struggling to attract a bigger share of volume.

The upshot, some experts say, is a complicated picture whose contours the Fed may struggle to sort out. “The point is, it’s just a mess,” says Bob Steen, chief executive of Mechanicsville, Iowa-based Bridge Community Bank.

Durbin’s Choice

For now, at least, the Fed is focusing on the routing requirements it set a decade ago for all U.S. banks that issue debit cards. This is the regulation that reflects the Durbin requirement that each transaction offer merchants a choice of at least two “unaffiliated” networks.

The idea is to control transaction pricing by giving merchants the option of a less-expensive network. But merchants complain it hasn’t worked out that way. With the rise of e-commerce—particularly in response to the Covid pandemic—many issuers have automatically routed online transactions to Visa or Mastercard on the grounds that the alternative EFT networks can’t handle PINless debit.

That may have been true a decade ago, but the EFTs have caught up, observers say. “They developed dual-message capability so they can be used in digital channels,” notes Sarah Grotta, director of the debit and alternative products advisory service at Marlborough, Mass.-based Mercator Advisory Group.

“Dual message” refers to the separation of authorization from clearing, as contrasted with the single-message capability EFTs like Shazam, NYCE, and Pulse pioneered, originally for ATM transactions.

Still, observers say, many issuers continue to route debit transactions for e-commerce to the dual-message networks of the two big national systems. This, merchants contend, vitiates their Durbin rights to network choice.

Some observers blame issuers whose technical capabilities have lagged behind the EFT networks’ adjustment to PINless debit. “You have a handful of banks that are dragging the whole industry down,” contends Steve Mott, principal at the payments consultancy BetterBuyDesign.

Advocates for the issuers say there are important differences among networks that merchants are ignoring and regulation should account for. “When Durbin was passed, card-not-present wasn’t much of an issue, so they’re trying to force the Durbin Amendment to accommodate that,” says Jeff Tassey, chairman of the Electronic Payments Coalition, a Washington, D.C.-based trade group for payments networks.

More Investigations

The debit-routing issue has already attracted the attention of federal agencies besides the Fed. News emerged in March that the Department of Justice is probing routing practices at Visa Inc. “We believe Visa’s U.S. debit practices are in compliance with applicable laws. Visa is cooperating with the Department of Justice,” a Visa spokesperson told Digital Transactions News at the time.

The DoJ inquiry followed a Federal Trade Commission investigation into debit-network routing practices at Visa. The network confirmed that probe in November 2019 as part of a filing with the Securities & Exchange Commission. The FTC investigation reportedly is focused on whether Visa is blocking merchants from sending mobile-wallet and contactless transactions to other networks.

Merchants and merchant advocates contend the routing issue goes beyond the PINless debit matter and includes alleged efforts by Visa and Mastercard to use technologies such as tokenization to steer transactions to their own systems. Tokenization veils the primary account number on a card in an effort to thwart fraud.

But the Durbin Amendment—and hence the Fed’s enabling regulation—also mandates a cap on debit card interchange, restricting it to 21 cents per transaction, plus 0.05% of the transaction value and another penny for what the Fed calls a “fraud-prevention adjustment.”

Unlike the routing rules, the cap applies only to what big issuers can collect, those with $10 billion or more in assets. As with credit cards, merchants pay interchange fees on debit transactions.

Merchants have complained for years the cap is too high when viewed in the context of issuer costs. And indeed, the Fed’s own studies seem to bear this out. The latest one, which covers such expenses as authorization, clearing, settlement, fraud prevention and rewards programs, showed a total per-transaction cost of 11.6 cents per transaction—just about a dime below the cap.

‘Not Without Controversy’

But the Fed, which took industry comments all summer on its routing clarification, is silent on the fraught matter of interchange. Some observers argue the regulator simply doesn’t see regulation of interchange as a matter for industry comment.

“The Fed recognizes [interchange] is going to be not without controversy no matter what they do. I’m sure that’s weighing on their minds,” says Paul Tomasofsky, senior vice president for merchant payments at North American Banking Co. and formerly executive director of the Debit Network Alliance, a trade group for debit networks.

Indeed, Tomasofsky argues the Fed’s debit proposal should have been more specific in several respects. “By keeping it at that 30,000-foot level, you don’t really solve the problem,” he notes.

But there’s nothing preventing the Fed from returning to the interchange question later. And for now, the routing clarification may suit merchants that lack the clout of the big chains. “The big merchants don’t like [debit] pricing, but they can negotiate routing,” points out Bridge Community Bank’s Steen. “Small merchants can’t do that.”