Fed Announces Final Debit Card Routing Rules

The Federal Reserve Board intervened in October 2022 to encourage competition between card payment networks by clarifying rules around the routing of debit card transactions. 

This article will shed light on the new rules for routing debit card transactions, the background context of their implementation, and what relevant stakeholders are saying about the changes.

What is the Fed's new rule for debit card transactions?

The Fed's revised rule concerning debit card transactions explicitly specifies that card issuers now need to offer at least two unaffiliated networks for processing all debit card transactions. Specifically, the provision requires that:

• Debit card issuers must enable at least two unaffiliated networks to process a debit card transaction.
• Every debit card transaction should be processable on at least two unaffiliated payment card networks. The rule clarifies that this also applies to online and other card-not-present transactions.

The final deadline to implement the above is July 1, 2023. 

This intervention does not modify the Federal Reserve Board's requirements concerning interchange fees. However, they shall continue reviewing the interchange fee requirements in light of the recent debit card industry cost data that they've collected. 

This update is a move to better clarify Regulation II of the Durbin amendment, which had previously set forth the rule about providing alternative routing options for debit cards. 

What is the Durbin amendment?

The Durbin Amendment is a debit card legislation passed in 2011, in the aftermath of the financial crisis.  Under the law,  a cap was placed on merchants' interchange fees each time they processed a debit card payment from an issuing bank with over $10 billion in assets. They also required networks to allow alternate routing options for debit card payments. 

The amendment lowered debit fees from an average of $0.44 per transaction to a maximum of $0.21 + 0.05 percent of the transaction, plus an additional $0.01 for anti-fraud protection. 

The rule was primarily enacted with a view to increasing market competition with the idea that the benefits would be passed on to consumers.  Estimates suggest that this move had helped retailers and their customers save $9 billion annually. Although the evidence for how much of these savings actually ended up with the end consumer is mixed. 

Why were Durbin amendment rules not implemented by the Feds earlier?

When the Durbin amendment was passed, the available technology needed was not mature enough to support full-scale alternate routing implementation for multiple networks online using PIN-less transactions.

Thus, for the alternate routing of debit card transactions, the implementation of Reg II was restricted to in-store transactions where users could enter a PIN to access the independent debit networks. 

Furthermore, a combination of Visa/Mastercard rules and financial incentives seemingly pressured banks not to enable the "PIN-less" capability required for the cards to be processed over independent networks online, where users cannot enter a PIN. As a result, all but about 6 percent of online debit transactions continued to be processed over Visa and Mastercard. 

Data estimates suggest that the lack of alternate online routing options cost merchants between $2 billion and $3 billion since the beginning of the COVID-19 pandemic. 

Debit and credit card fees, which totaled $137.8 billion in 2021 according to the Nilson Report, are among merchants' highest costs and drive up prices paid by consumers by hundreds of dollars a year for the average family. 

Moreover, debit card fees in 2021 totaled $32.6 billion, with payments processed over Visa and Mastercard accounting for $28.1 billion.

Today, as online payments have grown remarkably, this issue is more pronounced. At the same time, as technology has also evolved over the last decade, implementing end-to-end alternate routing is a practical possibility now. However, some debit card issuers still have yet to enable at least two unaffiliated networks for merchants to choose between when routing such transactions. Thus, the decision by the Fed to intervene.  

What is the sentiment of different stakeholders around the new rules?

This updated rule is seemingly a blow to the major networks that issue the cards and will possibly reduce their market share. Neither Visa nor Mastercard have provided official comments yet on the new regulation. . However, Visa’s opposition to the new regulation is apparent from their response to the Fed's request for comments on the proposal last year in July 2021. 

At that time, Visa stated, "Technologies for supporting such transactions on historically PIN-based debit networks are, relatively speaking, new and unproven, and therefore have not been widely deployed or supported by issuers, PIN networks, merchants, or other participants in a debit transact. For this reason, we believe that those aspects of the proposal that would deem card-not-present transactions to be a 'specific type of transaction' for purposes of the two network requirements are premature and would introduce confusion and uncertainty about issuer obligations rather than clarity.”

Conversely, the merchant community appears to be welcoming the new rule. "This ruling is particularly important given the dramatic shift to e-commerce during the pandemic and the increased use of mobile apps and digital wallets for in-store purchases," said Doug Kantor, an executive committee member at the Merchants Payments Coalition, in a release. The MPC is a trade organization that represents about 2.7 million retail stores in the U.S. "These transactions account for a rapidly increasing share of our nation's economy, and the Fed has closed a major loophole that allowed them to escape the competition intended by Congress," said Kantor.

While many merchants are positive about the impact the implementation of the rule will have, some analysts wonder if the intended impact will actually be achieved. 

"Under the final rule, issuers must only ensure that each debit card can be processed on at least two unaffiliated networks—though two networks may ultimately not be available to a merchant if, for instance, one of the two networks enabled on the card is not accepted by the merchant (likely, given the smaller acceptance footprints for STAR, NYCE, Pulse, etc.)," said Jefferies analyst Trevor Williams in a note to investor clients. 

Some others feel that this rule could be circumvented on several technical grounds, preventing transactions from being routed to Visa or Mastercard competitors even if banks end up enabling PIN-less.

Interesting times lie ahead

The recent measures by the Fed are a significant step forward in tackling the duopoly status enjoyed by payment giants Visa and Mastercard. With strict enforcement coming on debit card routing, after a delay of over a decade, further steps like legislating Durbin 2.0 concerning credit card routing will likely also gain momentum. 

Only time will tell what impact these changes have on consumers, merchants, and the payment industry as a whole. 

For more information on this topic and other payment topics, contact us or check out the Justt blog.