The Merchants Payments Coalition (MPC) is pushing the U.S. Federal Reserve’s renominated chair Jerome Powell to iron out overdue debit card routing and swipe fee regulations.
U.S. merchants urged Powell to finalize a rulemaking on debit card routing and interchange fees as the Senate hearing on his nomination to serve a second term as chairman of the Fed kicked off on January 11.
“We’re quickly coming up on a year since the Fed acknowledged that big banks and the big payment networks are standing in the way of competition over online debit card processing that could save retailers and their customers billions of dollars,” MPC executive committee member Doug Kantor said in an email statement.
“During that time, the number of transactions that the banks won’t allow competition on has continued to increase and merchants and consumers have continued to suffer. It’s time for the Fed to act.”
Tardy debit card routing regulations
The Fed launched a consultation on card-not-present transaction routing last May aimed at opening up competition in debit card routing for online transactions.
The proposed changes are intended to clarify that the Durbin Amendment regulations, which allow merchants to choose from at least two unaffiliated networks when processing debit card transactions, apply not only to card-present payments but also to card-not-present ones, such as online purchases.
Named after its sponsor Senator Richard Durbin, the amendment was part of the post-financial crisis Dodd-Frank Wall Street Reform 2010. It established a cap on large issuers’ debit card interchange fees and laid down provisions to restore competition between issuers.
However, in 2011, at the time the Fed issued regulations mandating the routing option, the market had not yet developed solutions to broadly support multiple networks in card-not-present transactions.
Consequently, some of the largest banks still do not enable routing for online transactions.
Meanwhile, the use of debit cards in card-not-present transactions has gained traction over the last decade.
According to the latest Fed payments study, online debit and credit card payments surged 24 percent in 2020, while card-present payments fell 13 percent. This is partly the result of the rapid growth of e-commerce, which was further accelerated by measures taken during the COVID-19 pandemic.
Despite the significant growth in online payments, only about 6 percent of these transactions are processed over competing networks, according to the Fed.
The MPC stressed that routing is “a more pressing issue than ever,” which was reflected in the fact that the Fed received a record amount of submissions in response to the consultation.
Enabling merchants to choose between various routing options is an important tool in the hands of regulators to promote competition.
Earlier in October, the Reserve Bank of Australia (RBA) mandated all acquirers and payment facilitators that provide card acceptance services to merchants to offer “least-cost routing” functionality to merchants in the card-present environment and enable the same in card-not-present transactions by the end of 2022.
Time is ripe for further interchange fee regulation
The routing option was, however, not the only gap in the Durbin regulations that received further attention.
The Durbin regulations required the Fed to establish a cap on large banks’ debit card interchange fees that is “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.”
In 2011, when the Fed adopted the regulations, it took a “one-size-fits-all fee” approach, setting the interchange fee cap at 21 cents. The 21 cent fee was already significantly higher than the average processing cost of 8 cents in 2009 but, since then, these costs have more than halved, falling to 3.9 cents.
This means that the margin made by issuers that charge the maximum interchange fee has significantly improved compared to when the caps were first introduced. The 21 cent cap “is now about 5.4 times the average cost — more than double the 2.6 times when the regulation was adopted,” the MPC said.
It also stressed that banks are allowed to charge a different amount if they set the fees themselves rather than following fees set centrally by Visa and Mastercard, but no major banks have done so.
Credit card interchange fees
Interchange fee is only one element of the overall swipe fee, also known as the merchant discount rate, that merchants pay. In addition to the interchange fee paid to the issuer, merchants also pay a scheme fee to the card network and an acquirer fee to the acquiring bank.
Criticism has recently been revived that the existing regulation only addresses debit card interchange fees, but scheme fees paid to card networks and interchange fees of credit cards fall outside the current U.S. regulations.
This partly resurfaced following Visa’s failed attempt to acquire Plaid in January 2021. Gaps in the Durbin regulations were one of the key concerns that drove the Department of Justice (DOJ) to block Visa’s acquisition.
For example, U.S. credit card fees have been historically among the highest among developed countries.
A previous Nilson report estimates that the industry-wide average rate for Visa and Mastercard credit card transactions is 2.25 percent of the price of the purchase, which is more than seven times the 0.3 percent for credit cards allowed in Europe.
Evidence from other markets show that even if the interchange fee is reduced, it might not necessarily be reflected in the overall swipe fee that merchants pay.
For instance, a recent report in the UK highlighted, acquirers may not pass on savings from interchange fee caps to merchants, meaning they do not benefit from the savings that was supposed to reduce merchant costs by the UK Interchange Fee Regulation (IFR).
According to the UK Payment Systems Regulator (PSR), “some acquirers had told us that the explanation for lack of IFR [Interchange Fee Regulation] pass-through could be that they invested the savings in providing higher quality of service to their customers rather than lower prices.”
PSR chief Chris Hemsley warned the UK might intervene should scheme fees and interchange fees “continue to rise unchecked”.
In addition to the UK, Australia has been looking at its interchange fee regulations. Following its retail payments regulation review, the RBA reduced the cap on debit and prepaid interchange fees from 15 cents to 10 cents.
Although the RBA has decided not to introduce scheme fee regulations yet, the central bank has alluded to “the opacity” of these arrangements.