Fed To Examine Debit CNP Routing — Pressure Looms For Interchange Fees

The great digital shift, especially toward debit transactions, is sparking examination of how those transactions are processed.

To that end, the Federal Reserve published a Notice of Proposed Rulemaking May 7 (with a commentary period to follow) that would require merchants have a choice in how those online transactions are routed and might ultimately reduce interchange revenue streams for banks and the payment networks.

In terms of the mechanics, the revamp of what is known as Regulation II, would mandate that issuers adopt what is known as a “dual-message debit” option, which is also known as a PINless debit.

That optionality would ensure that merchants can access at least two unaffiliated networks for eCommerce, where that functionality had been in place for in-store transactions.

At a high level, putting at least two unaffiliated networks on debit cards issued by the banks means that merchants can choose which network they want to use to facilitate those transactions.

Adding card-not-present (CNP) transactions, and specifically, debit CNP transactions to the mix is a nod to just how pervasive that payment choice has become in just the past few years

As the Fed said in its proposed rules, “Over the last decade, card-not-present transactions have become an increasingly significant type of debit card transaction. Spurred by the growth of online commerce, the number of card-not-present debit card transactions has increased rapidly in recent years, growing approximately 17 percent per year, on average, from 2009 to 2019, in contrast to the 6 percent average annual growth in card-present transactions over the same period. As a result of this differential growth, card-not-present transactions comprised almost 23 percent of all debit card transactions in 2019, up from slightly less than 10 percent in 2009.”

Those stats do not take into account the pandemic and the great digital shift. As we’ve seen in earnings results from banks and the payment networks, debit transactions have been growing double-digit percentages year over year as consumers want to spend the cash they have on hand, while they’ve been paying down credit card debt (as witnessed in the latest data from the Federal Reserve Bank of New York). Visa has said, for example, that debit payment volume totaled $2.23 trillion in 2020, up more than 15 percent from the year before.

The Networks

The Fed said in its bulletin, too, that two types of payment card networks currently exist to process debit card transactions: single-message networks and dual-message networks.

Single-message networks, which developed from ATM networks, typically authorize and clear a transaction through a single message and have traditionally processed transactions authenticated using a cardholder’s personal identification number (PIN).

Dual-message networks, which developed from credit card systems, “typically authorize and clear a transaction through two separate messages and have traditionally processed signature-authenticated transactions,” the Fed said.

Over time, technological advances have made it so that transactions over dual-message networks may be done without signatures or PINs, which make it possible to have combinations, or approaches to messaging.

“In the decade since Regulation II was adopted, various innovations have emerged, and most single-message networks are now capable of processing card-not-present transactions,” the Fed said.

Despite the widespread adoption of these innovations, the bulletin noted, the volume of CNP transactions processed over single-message networks remains low. Single-message networks processed only 6 percent of all CNP debit card transactions in 2019 versus over 40 percent of card-present transactions.

With the ostensible move toward routing choice, merchants would be able to choose to route their transactions across Visa or Mastercard, yes, but also smaller debit networks that might charge lower fees.

Consultancy firm CMSPI has estimated that debit routing has saved merchants $1 billion annually since the no-network-exclusivity provision was enacted in 2011.

The spotlight being trained on debit card transactions, related fees and networks’ revenue streams may get a bit brighter.

Late last month, for example, merchants (the North Dakota Retail Association and the North Dakota Petroleum Marketers Association) filed suit in U.S. District Court in North Dakota against the Fed, alleging that the debit card fee cap, at about 21 cents, is too high. Merchants, according to the suit, have paid billions of dollars more than they would have had the Fed followed a policy in accordance with a Congressional mandate that “regulations … set a standard for assessing whether an interchange fee is ‘reasonable and proportional to the cost incurred by the issuer with respect to the transaction.’”

Yet, according to the suit, the average-per-transaction cost for issuers has been just a few pennies — so profits have been in the hundreds of percentage points.

There are other indications that merchants may seek ways to sidestep interchange fees. As PYMNTS reported, U.S. merchants pay credit card interchange fees of up to 3.5 percent on average of each transaction’s value, but open banking-enabled services that facilitate account-to-account (A2A) transactions may levy fees that are much lower.

Of course, that all hinges on consumers wanting to pay merchants directly from their bank accounts, without the current fraud, chargeback and dispute protections that debit cards currently provide.

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