New Assessment of Durbin’s Effects Warns Fixed Network Fees Could Crimp Competition

A sweeping review by the Federal Reserve Bank of Kansas City of the Durbin Amendment’s effects warns that competition could be harmed if more payment card networks adopt fixed-pricing plans as they compete for merchant business in the newly regulated debit card environment.

The new report is the first of a two-part series and appears in the latest issue of the Kansas City Fed’s quarterly Economic Review. The first part looks at the Amendment’s effects on networks and banks; the second will focus on merchants and consumers, report author Fumiko Hayashi, a senior economist at the Kansas City Fed, tells Digital Transactions News.

Now a household term in the payments industry, the Durbin Amendment in 2010’s Dodd-Frank Act has two major components. The first, price controls for purchase transactions originating on debit cards issued by financial institutions with more than $10 billion in assets, took effect in October 2011 and cut big issuers’ interchange revenue by 52%, the report says.

The second part, the so-called network-exclusivity and transaction-routing rules, kicked in last April and gave merchants more freedom to route debit card transactions onto the networks of their choice, potentially lowering their interchange expense. Previously, issuers and networks controlled routing, with issuers sending as many transactions as possible to the networks that would generate the most merchant-paid interchange revenue for them.

Visa Inc., whose signature debit card and Interlink PIN-debit card dominated the pre-Durbin debit scene, had the most to lose under the Durbin rules promulgated by the Federal Reserve Board. Interlink, in fact, lost more than half its volume, and PIN-debit networks competed vigorously for business from Interlink issuers, according to the report.

In response, Visa created new pricing plans and incentives for issuers and merchants to bolster its debit business. These include the Fixed Acquirer Network Fee (FANF), which rewards merchants with lower variable pricing if they commit certain transaction volumes to Visa. Several other networks, including MasterCard Inc. (which owns the Maestro PIN-debit network), Star, NYCE, and Pulse also have implemented pricing plans with fixed components, but not on the scale of Visa’s, according to Hayashi.

The danger in pricing plans with fixed elements is that they might reward big networks at the expense of small ones. That’s because the fixed components tend to be expensive for large merchants, thus giving merchants a reason to consider fewer rather than more networks for routing.

“These fees may decrease competition among card networks for merchants,” the report says. “Prior to Visa’s recent introduction of its fixed network fee, merchants traditionally were assessed only per-transaction fees to accept payment cards. With per-transaction fees only, merchants could accept as many types and brands of payment cards as they wished. However, if it becomes more common for networks to assess fixed fees, merchants may limit their card acceptance to fewer networks. This will play to the advantage of networks currently holding large market shares, because merchants are more likely to accept the cards of networks with large market shares than those with small market shares. Fixed network fees are thus likely to limit competition to only a few large networks.”

(Visa’s FANF has created intense debate among debit card issuers and merchant acquirers, and the U.S. Department of Justice is investigating the fee. Visa has said it is cooperating with the DoJ.)

A separate force, in contrast, is likely to drive more network competition: the coming of Europay-MasterCard- Visa (EMV) chip cards to the U.S. This competition will play out in various ways, according to the report. The PIN-debit networks, however, are trying to protect their interests as they resolve thorny issues involving the rights to the EMV technology, which Visa and MasterCard own, while still meeting the transaction-routing dictates of the Durbin Amendment.

Hayashi expects to publish the second part of her Durbin review in March.