The Durbin Amendment: Half a Decade Later

No law in the history of electronic payments has had more impact—or stirred more controversy—than Sen. Durbin’s debit card rules. With emotions running high, will it survive the next half decade?

In 2010, the U.S. Congress succeeded in doing something other Western nations had long since done but had always been thwarted here. It passed a law that put limits on the interchange rates payment networks could set on debit card transactions.

It took an epic financial meltdown to do it. Congress’s response to that crisis was the 848-page Dodd-Frank Wall Street Reform and Consumer Protection Act, a massive bill to which was appended, almost as an afterthought, a 10-page amendment from Illinois Senator Richard Durbin.

That amendment has been the law of the land now for more than five years, and in its wake has come perhaps more commotion than the payments business has seen from any regulation before or since.

That’s because the law pits against each other two politically powerful interest groups, merchants and banks. On most issues, these groups align as part of a pro-business lobby, but on payments policy they’ve historically been at loggerheads. As a result, Sen. Durbin’s regulation is “a very difficult and substantive issue for policymakers,” says a Washington, D.C.-based lobbyist on payments matters who prefers not to be named.

For evidence of that, look no further than the recent effort by Republicans in the House of Representatives to repeal the amendment. The repeal movement, led by Texas Republican Jeb Hensarling, stalled late in May after it failed to win enough support from the Republican House caucus, and Hensarling’s bill to radically scale back Dodd-Frank proceeded to the Senate without the repeal provision.

Close observers of the Washington scene predicted this result weeks before it happened. “Repealing Durbin makes politicians do something they loathe—choose between two moneyed interests,” said Isaac Boltansky, director of policy research at Compass Point Research & Trading, a Washington, D.C.-based trade consultancy, at a payments conference earlier in May.

‘The Right To Choose’

But Durbin involves more complexity, and more players, than a Manichean bank-vs.-merchant drama would imply. Interchange is set by networks, which cater to financial institutions, and is paid by acquirers, which pass on that cost to merchants, sometimes by circuitous routes involving yet other entities, such as independent sales organizations and other processors.

Moreover, debit card transactions come in multiple flavors, involving authentication by PIN or signature, and routing with authorization and settlement executed in one message (single-message format), or separate messages (dual-message). Indeed, the Pulse debit network, owned by Discover Financial Services, counts fully seven types of debit transactions.

The Durbin Amendment tried to account for some of this complexity. Much of the fight over the law since its enactment has centered on its price controls. As interpreted by the Federal Reserve, these controls cap debit interchange at 21 cents plus 0.05% of the transaction, with an extra penny if issuers put in place certain fraud-fighting measures. On the average $38 debit transaction, that comes to a maximum of 24 cents.

But the interchange cap applies only to larger issuers, those with $10 billion or more in assets. Smaller banks collect unregulated interchange.

Moreover, the amendment tries to instill a spirit of competition by mandating that no entity may interfere with a merchant’s choice of network. To make sure the merchant has a choice, the law also requires that issuers work with at least two networks, between which there can be no business relationship.

That’s the smooth-sounding theory of the law. The practice—over the 69 months since the caps and routing choice took effect and the 63 months since the network non-exclusivity provision became law—has been considerably messier.

The big networks have reacted to Durbin’s routing rules with with new options and new fees that, some bankers and merchants say, tend to concentrate volume on their systems while driving up costs. And, with the 2015 rollout of EMV chip cards, routing choice became even more problematic, inspiring major lawsuits by Wal-Mart Stores Inc., The Home Depot Inc., and The Kroger Co.

In this battle, at least some small-bank executives are aligned with merchants. “We need to enforce the right to choose,” says Bob Steen, chairman of Bridge Community Bank, Mechanicsville, Iowa.

‘A Race to the Bottom’

Probably the most controversial network reaction to Durbin was Visa Inc.’s introduction of its FANF regime in 2012. This set of tiered fees encourages merchants to concentrate their volume with Visa to bring down their cost per transaction. FANF, which is paid by acquirers but passed on to merchants, is specifically targeted in the antitrust suit filed a year ago by Home Depot against Visa and Mastercard Inc.

Since Durbin became law, new network fees in general have become a sore point for merchants and even some banks. Merchant advocates argue rising network fees have even offset their Durbin savings.

While Durbin has cut merchants’ debit-interchange tab by $36 billion, they’ve actually seen more than half of those savings eaten away by a one-two punch of higher network costs and a decision by some processors not to pass on the full savings, according to CMS Payment Intelligence Ltd., a Manchester, U.K.-based firm that works to reduce merchants’ transaction costs.

“There’s no way merchants have received $36 billion in savings since Durbin came in,” says Callum Godwin, research manager at CMS, which estimates network costs alone have risen at the rate of $3 billion per year. “The [network] fees are astronomical compared to other countries,” Godwin says.

All told, CMS estimates Visa and Mastercard alone have introduced or amended some 16 network fees since Durbin became law. “We don’t see any justification by cost, other than rent-seeking,” says Godwin.

But it’s not just merchants who may be affected by new or rising fees. At least some community banks, too, are feeling the heat. Steen of Bridge Community Bank points to a 20-page invoice from the Iowa-based Shazam network that contains mostly charges from other networks. “It’s page after page of this stuff,” Steen says.

Overall, financial institutions in the Pulse network that are exempt from Durbin’s price controls have seen their average costs for all networks for dual-message transactions remain constant at 6.1 cents. These are generally signature-authenticated payments. But on single-message debit, which typically involves PIN authentication, their costs shot up 13% in one year, to 3.4 cents in 2015.

Meanwhile, interchange income for exempt issuers across the country generally stayed constant between 2011 and 2015 on dual-message transactions, at 51 cents per transaction, according to Federal Reserve research. But over that same period of time, these smaller institutions saw their single-message interchange drop from 30 cents to 26 cents as merchants were able to direct at least some traffic to less-expensive networks.

With that kind of squeeze affecting smaller institutions, most observers might expect them to favor repealing Durbin. But, while they are not subject to the law’s interchange caps, they are not unanimous on scrapping the routing-choice rules.

For some, the requirement for two or more unrelated networks has become a sunk cost. “Unaffiliated networks, we’ve already absorbed that into our cost structure. It would cost me money to take away a network now,” says John Schulte, chief information officer at Grand Rapids-based Mercantile Bank of Michigan.

But for others, large-merchant interchange has plummeted. The State Bank, based in La Junta, Colo., is getting a dime on each transaction from big retailers, compared to a range of 16 cents to 19 cents before Durbin took effect, according to Brad Rose, a vice president at the bank. “Whether it’s card-present or online, we only get 10 cents,” he says. “We actually lose money on those transactions now.”

Now, Rose is starting to see the effects of smaller merchants taking advantage of routing choice, as well. The rule “has enforced a race to the bottom,” he laments.

As for Steen, he feels on balance that the routing-choice rule should be kept in place for the sake of smaller debit networks and the competition they offer. “There are pieces and parts we shouldn’t repeal,” he says. “If we lose that routing choice, I don’t know what the future is.”

Suit And Countersuit

What Steen and others see as the threat to routing choice came into sharp relief last year with the spread of EMV across the country. The global EMV protocol, devised in the 1990s and implemented first in Europe, did not readily accommodate a market like the United States with its multiplicity of networks.

To allow Durbin’s network-choice requirement to work with EMV cards, the nation’s networks settled on chip programming that would, in theory, give merchants two routing choices. One selection, called the Global application identifier (AID), sends transactions only to Visa or Mastercard. The other, the Common AID, is capable of routing transactions not only to Visa and Mastercard but also to any of the PIN-debit systems the issuer may have contracted with.

While this setup sounds reasonable, it has been fraught with complications. For one thing, because of the time it took to work out the Durbin complications, EMV debit arrived later than EMV credit, and on top of certification queues that had already formed to approve terminals for EMV credit.

At the same time, merchants like Wal-Mart that wanted to secure EMV debit transactions with PINs accused Visa of interfering with that choice. With the arrival of EMV Wal-Mart began requiring PINs with chip cards in some stores. In May 2016, it sued Visa, accusing the network of requiring a signature option and thus violating its Durbin routing rights. In June, Visa countersued Wal-Mart, saying the retailer was violating a previous agreement to support signatures with EMV.

But probably the biggest complication came to light in November, when the Federal Reserve ruled that EMV screen prompts in some stores that asked cardholders to select either a “Visa Debit” or “US Debit” option violated the Durbin Amendment. The routing choice, the Fed ruled, belongs to the merchant, not the customer.

Earlier, the Federal Trade Commission got involved, as the agency began investigating whether the confusing screen prompts improperly shuttled EMV transactions to Visa.

But the prompts are reportedly still popping up. “It hasn’t stopped anywhere in the country,” notes Terry Dooley, executive vice president and chief information officer at Johnston, Iowa-based Shazam. “Merchants have to go back to their acquirer and pay to have that taken out, in many cases.” The terminal would then require recertification, Dooley adds.

‘A Colossal Failure’

Despite the complexities, many of them unanticipated, that the Durbin Amendment has introduced, one unavoidable feature of network economics remains as true as it ever was: networks compete for issuers, and they do so not by lowering interchange, but by raising it. That’s because interchange represents not a cost for issuers, but a source of revenue.

Some observers may see this as a perversity of payment-network economics. Whether it is or not, it represents yet another complication merchants, networks, and regulated and exempt issuers alike must contend with when reckoning with the Durbin Amendment. That’s because the interchange caps directly, and the routing rules indirectly, both work against this fundamental fact of payment networking as it has historically been practiced.

At least partly for that reason, the advocates for repeal insist their quest is far from over. “We are not dead. This is an ongoing fight,” says Molly Wilkinson, executive director of the Electronic Payments Coalition, a Washington, D.C.-based lobbying group that represents financial institutions and networks. “Durbin debit is a colossal failure.”

With the failure of repeal this spring, the EPC is redoubling its educational efforts, pointing in particular to studies that show either that merchants aren’t passing on interchange savings to customers or that banks, to recoup lost interchange income, are eliminating free checking and other perks. “What I’m focused on is walking members of Congress through this,” Wilkinson says. Then, she adds, “People get it.”

And some groups that see themselves on the sidelines in this fight are uneasy with aspects of the Durbin law. While the Electronic Transactions Association takes no official position on Durbin, the Washington-based trade group for transaction processors and payment-technology providers takes a dim view of price regulation. “Bad things happen when the government sets prices,” says Scott Talbott, senior vice president for government relations at the ETA.

But merchant groups have been busy making counter-arguments to support Durbin, and indeed many would like to see Durbin’s rules extended to credit cards. Merchants would be in position to pass on far more of their savings, these advocates say, if the Fed had set the Durbin caps lower. Some argue 7 to 12 cents is much closer to what the law intended than the existing limit. The Fed re-examines the interchange cap every two years, but has so far left it unchanged.

Merchant operatives have also proven to be wily partisans for their cause. When the House began considering the Financial Choice Act, the bill that originally included Durbin repeal, merchant groups ran multimedia advertising campaigns to stir up anti-repeal sentiment in districts represented by pro-repeal Congressmen.

‘Call Me’

If indeed the failure of repeal was just the latest skirmish in a long-running battle over transaction costs, ultimate victory will go to the side that can win over the players in the field who contend with payment economics every day. In this context, size may determine what side issuers themselves align with.

“When I get to $9.9 billion in assets, call me,” says Schulte of Mercantile Bank of Michigan. “I’ll definitely feel differently then.” At the latest reckoning, the bank has about $7 billion to go.