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Understanding Feds Proposed Rules on Debit Interchange Fees & Routing

Merchants finally received a long awaited holiday present last month in the form of proposed rules regulating debit interchange fees.  The Federal Reserve proposed new rules on December 16th, 2010, 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 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:

1. Debit (both signature and PIN) interchange fees would be 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 < $10 billion) are excluded from this cap so it is possible that the card networks (Visa/MasterCard) 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 keep the current interchange and will exert pressure on their card networks to develop a two-tier debit interchange system.  We estimate that large banks account for more than 2/3 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%.  Capping debit interchange fees to $0.12 will result in an average fee reduction of 73%, a tremendous amount.  Merchants with average tickets over $60 will see their debit interchange fees reduced by 83% or more.  Similarly, merchants with smaller average tickets will see a smaller decrease.

It is possible that merchants who operate businesses (coffee shops, parking meters/garages, vending machines, music or app download websites, etc.) 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% + $0.04 for small tickets (<$15).  The current interchange fee for a $5 ticket is $0.12 (1.55% 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% increase.  However, Tim Attinger, former Global Head of Product Innovation and Development for Visa, notes that networks must achieve an average 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.

Optimized Payments has provided analysis and specific recommendations to the Federal Reserve in hopes they codify a lower debit interchange fee structure for smaller ticket items.  As consumers displace cash and use debit cards for even smaller and smaller purchase amounts, the cost of processing these transactions should decrease, not increase.

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 financial institutions have brought this legislation on themselves by greedily and without restraint increasing debit interchange fees over the last decade.

2. Network Non-Exclusivity

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 will allow retail merchants to adopt least cost routing strategies.  Either approach will 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 will 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 provisions of the Durbin amendment that are important to note.  These provisions became effective last July upon the passage of the Dodd-Frank Wall Street Reform Act.  The first of these provisions relates to a merchants ability to offer discounts/incentives to their 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 a merchant wanted, he could offer a 2.0% discount for a private label card, 1.0% discount for payment by cash and 0.50% 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.

What merchants can do today:

  1. Become familiar with the Durbin amendment – click here to read.
  2. Read the Fed’s proposed rules discussed above – click here to read.
  3. Provide your comments to the Federal Reserve on their proposed rules – click here to go to Fed’s website.  Comments are due by February 22, 2011.
  4. Analyze your merchant statement to see what percentage of your sales are coming from signature and PIN debit cards to quantify the impact of this legislation on your organization.

Share your thoughts below.

3 Responses to “Understanding Feds Proposed Rules on Debit Interchange Fees & Routing”

  1. Rob Johnson says:

    I am deeply concerned about this amendment that was passed in near secrecy in the final hours to get the financial reform bill passed. What ever happened to free enterprises and the idea that the MARKET determines pricing and not the government? This appears to be a potentially precendence setting amendment that opens the doors to the government to set prices for everything. Senator Durbin was clearly pandering to the retailers associations who he receives large contributions from, to continue to get their votes. This bill will have the unfortunate consequence of forcing banks to charge additional fees to all who have bank accounts, to please a few retailers who are very unlikely to pass any of the savings they receive on to consumers. This bill should be vehemently opposed by anyone who believes in the concept of free markets and the free enterprise system. If you want the government to determine the price that any business charges, you should be willing to pay the consequences. Retailers will be the next victim of the government pricing controls, so they should expect the government to tell them how much profit they are allowed to make on their sales.

  2. Anand Goel says:


    The Durbin amendment was introduced in May 2010 and was hotly debated for two months before the financial reform bill was signed into law in July 2010. In fact, here’s an article from June that talks about some of the compromises that were made –

    I respect and agree with the general premise that the markets and free enterprise are best in setting prices. However, the markets have failed in managing the cost of interchange over the last 20 years.

    There is no free market competition in the setting of interchange rates (credit or debit). Essentially, the issuing banks work with card networks (Visa/MC and the PIN debit networks) to set interchange fees. The networks want to set the highest interchange rates possible so that more issuing banks will gravitate to their network. And the issuing banks want the highest interchange fees possible for their cards to maximize profitability. So where are the competitive pressures in this market? The merchants never had a seat at the table.

    If interchange fees were governed by truly free and competitive markets, then the effective cost of interchange in the U.S. should NOT have increased by 23% over the last decade while transactional value has nearly doubled.

    It is unfortunate that the card networks and issuing banks got too greedy in the past and are now paying a price in form of regulation.

    • jbusiness says:

      I am also deeply concerned. The merchant should not be paying any interchange fees. Just like the merchant pays nothing to accept a check or cash. The merchant is just the middleman that makes it possible for the credit card companies, processors and the banks to make more money off of the consumer by offering an alternate payment process. Because of the lack of regulation when credit cards first came out, it became an acceptable practice to charge the merchant a user fee since the holder would not be inticed to use the cc if they had to pay a per unit usage fee. I would love to turn back the clock and take only cash but the cc companies have enticed the consumer with gifts, etc. to use only cards. The cc companies should pay 100% as part of their cost/marketing structure.
      The only free market participant in this wholeprocess is the merchant that has to keep their goods competitively priced in spite of costs out of their control!

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