Merchants received a long-awaited holiday present in December in the form of proposed rules regulating debit interchange fees. The Federal Reserve proposed new rules to govern debit interchange fees and network routing. These proposed rules are subject to a 60-day comment period, and the Fed is scheduled to issue a final version by April 21, 2011, with the rules for interchange fees going into effect June 21, 2011.
As background, the Federal Reserve was empowered to implement the Durbin Amendment, a provision of the Dodd-Frank Wall Street Reform Act of 2010 signed into law in July 2010 that regulates debit interchange fees and network routing.
The salient points of the Fed proposed rules that pertain to most merchants along with our analysis are as follows:
Debit (signature and PIN) interchange fees are capped at $0.12 per transaction.
In setting this cap, the Fed considered the “incremental cost” of authorization, clearance, and settlement of a particular transaction. The Fed left room to increase this cap to include costs relating to fraud prevention. Small bank-issuers (assets less than $10 billion) are excluded from this cap, so the card networks likely will have two debit interchange tiers—the current debit interchange fees for small issuers and the lower/capped debit interchange fees for large issuers.
Small bank-issuers will have tremendous incentive to maintain the current interchange and will exert pressure on their card networks to develop a two-tier debit interchange system. In fact, Visa issued a statement recently confirming that it would develop a two-tier interchange system, and MasterCard stated that it was still studying the matter. We estimate that large banks account for more than two-thirds of the debit transactions in the U.S., so the average merchant will see a significant reduction in their debit interchange fees.
According to the Federal Reserve, the average debit ticket size is $39 and its associated interchange fee is $0.44 or 1.14 percent. Capping debit interchange fees to $0.12 will result in an average fee reduction of 73 percent. Merchants with average tickets over $60 will see their debit interchange fees reduced by 83 percent or more. Similarly, merchants with smaller average tickets will see a smaller decrease.
It is possible that merchants who operate businesses where the average ticket is below $5 could actually see an increase in their debit interchange fees. Currently, Visa and MasterCard have a signature debit rate of 1.55 percent + $0.04 for small tickets (<$15). The current interchange fee for a $5 ticket is $0.12 (1.55 percent x $5 + $0.04) and interchange fee for a $2 ticket is $0.071. So a city running parking meters with an average ticket of $2, the cost of accepting debit cards could increase from $0.071 to $0.12, a 69 percent increase.
However, Tim Attinger, former Global Head of Product Innovation and Development for Visa, notes that networks must achieve an rate of not more than $0.12 across the entire portfolio and that they may have different rates that address various scenarios—lower rates for smaller tickets and a higher one for all other ticket sizes, lower rates at the point-of-sale and higher ones in card-not-present environments, lower rates for PIN and higher for signature, etc.
Overall, the Fed took a very aggressive approach in outlining the contours of debit interchange fees. This is very good and welcome news for merchants. Banks have used debit interchange revenue to subsidize various features of demand deposit accounts like free checking, free online billpay, etc. A potential downside of low debit interchange fees will be the elimination of these free banking services for consumers. The card networks have brought this legislation on themselves and their issuing partners by increasing debit interchange fees without restraint over the last decade.
This rule states that every financial Institution, regardless of asset size, must participate in at least two, and possibly more, unaffiliated debit payment networks. Here the Fed is actively soliciting comments between two alternatives it offered. The key difference between the two alternatives is whether the use of a single signature debit network and an unaffiliated PIN debit network is adequate, or whether issuers should be required to have two signature and PIN debit networks.
The second alternative (two signature and two PIN debit networks) would be more favorable to merchants but either scenario may allow retail merchants to adopt least cost routing strategies. Either approach may create a competitive dynamic between signature and PIN networks in conjunction with their issuers. Since each network will try to create demand for its brand, it may have to compete for merchants by offering competitive pricing and/or value.
Since Visa is the largest signature debit network and also the largest PIN debit network through its ownership of Interlink, it will have the most significant impact from this rule, under either alternative. With this rule, any debit card bearing the Visa logo will not be able to have Interlink as a PIN debit network. This is a significant development for merchants and departure from current practice as one network will not be able to control both authorization routes (signature and PIN) on a single debit card.
There are two other important provisions of the Durbin amendment. These provisions took effect last July upon the passage of Dodd-Frank. The first relates to a merchant’s ability to offer discounts/incentives to its customers for payment by cash, check, debit card, or even credit card, as long as all cards within a payment type are treated equally. So if merchants wanted, they could offer a 2.0 percent discount for a private label card, 1.0 percent discount for payment by cash, and 0.50 percent discount for payment by debit card. In the long run, merchants will be able to influence the mix of their payments. However, the benefits of “steering” customers to lower cost tender types must be balanced with the costs of implementing and managing incentives, in addition to managing and responding to competitive pressures.
The last provision allows merchants to set a $10 minimum for credit card purchases, as long as there is no distinction for different types of credit cards. This provision also allows higher education and federal agencies to set a maximum dollar value for acceptance of credit cards.
Anand Goel is managing partner of Optimized Payments. Reach him at email@example.com. The opinions of this article are solely those of the author.