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Mandating dual routing is one of the many tools regulators have as they try to keep card acceptance costs at bay. With several countries pushing for dual routing, one merchant advisory firm tells VIXIO the merits of this regulatory method compared with capping interchange fees.
Regulators across the world are taking different approaches to intervene and challenge high card fees and the perceived dominance of Visa and Mastercard. Reforms range from banning the international networks for domestic use on locally issued cards to dual routing mandates and interchange fee caps.
In 2022 alone, new interchange fee caps have either been proposed or amended in Brazil, Chile, Canada, Malaysia and New Zealand.
In Australia, which was one of the first countries to impose interchange caps back in 2003, regulators have more recently focused on least-cost routing (LCR). Initially targeting in-person contactless debit card payments, the requirement is in the process of being expanded to online and mobile wallet payments.
This means merchants now have the choice of whether to route card transactions over the low-cost domestic system, eftpos, or via Visa and Mastercard.
A similar requirement was introduced in the US via Senator Richard Durbin’s amendment to the Dodd-Frank Act in 2010, which placed interchange fee caps on debit cards and ordered large card issuers to allow dual routing on cards. In July, Durbin went further, introducing the bipartisan Credit Card Competition Act, which, if passed, would introduce dual routing on credit cards for the first time.
Similar to LCR, dual-routing in the US requires cards to be co-badged on at least two unaffiliated payment card networks, one of either Visa or Mastercard, plus one other. Merchants can then choose which network they wish to process the card on.
According to merchant advisory firm CMSPI, the combination of an interchange fee cap and dual routing as part of US debit card regulations saved merchants an estimated $9.4bn a year, with some studies suggesting 70 percent of such savings are passed on to consumers.
However, the consultancy estimates that since the passage of the law, the savings from caps have been largely eroded but merchants continue to benefit from the requirement to co-badge cards, Martha Southall, CMSPI senior economist, told VIXIO.
Dual routing and interchange fee cap
Despite the argument that dual routing and the interchange fee cap may save merchants billions of dollars, regulators in the UK and Australia have recently started to voice concerns that acquirers may not fully pass on savings from the interchange fee regulations to merchants. They have also complained that the fall in interchange rates has been counterbalanced by a rise in scheme and other processing fees.
It is not unusual that as one part of the merchant discount rate goes down as a result of the cap, other unregulated fees increase, creating a whack-a-mole type situation, Callum Godwin, CMSPI’s chief economist said.
Such a situation is unlikely to happen in the case of dual routing, which is fundamentally based on the idea that greater competition leads to lower prices.
“We have observed that dual routing requirements have positive impacts in terms of competition. That competition naturally puts downwards pressure on pricing and leads to a more economically efficient outcome,” Godwin said.
By contrast, interchange caps do not challenge the market power of dominant networks and they can continue to set unregulated prices at their will.
“In our experience, this whack-a-mole situation only happens in mono-badged cards. If you address the fundamental issue by introducing co-badging and having competition on each bank card, it is very difficult for the networks to increase prices because if they do, the merchants can choose to use the other network on the card,” he explained.
Different countries, different approaches
Although some countries have explicit legislation to mandate dual routing, in many countries it is either not regulated or regulations are not yet strong enough to achieve the desired impact.
For instance, in Australia, LCR was encouraged by the Reserve Bank of Australia (RBA) for contactless in-store payments.
However, take-up among merchants has remained fairly low and research suggests that savings gained on contactless in-store transactions have been eaten up by increases in rates on other types of debit transactions.
Last year, the RBA decided to expand the LCR “expectation” to apply to all in-person and online transactions by the end of 2022 and all mobile wallet transactions by the end of 2024.
By setting an “expectation” rather than a “mandate”, it is unclear to what extent the RBA will be able to monitor compliance and enforce LCR.
As of mid-2022, the RBA found that LCR for in-store transactions was enabled only at half of merchants.
Meanwhile, in other jurisdictions, where there is no explicit regulation requiring dual routing, such as in the EU, mono-badging is gaining ground.
CMSPI has found increasing instances of exclusivity arrangements in markets such as Germany and Denmark, where global networks appear to be pushing for mono-badged cards and cutting out domestic rivals, Southall said.
At the moment, only very few countries have adopted regulations or legislation to mandate dual routing.
However, Godwin expects there will be a wider movement to address high card acceptance fees in the coming years.
“Legislators and regulators across the world appear to be acknowledging that there are often competition issues within card payment markets and co-badging is often seen as an excellent free market solution to those competition issues,” he added.
