A look at recent regulations on the cost of debit and credit card processing.
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If you’ve ever wondered how interchange fees are set, you’re not the only one. Back in 2011, Senator Richard Durbin proposed an amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, arguing that interchange fees had no relationship to the actual cost of the transaction.
The result was Regulation II: a law which caps the interchange fees charged to merchants accepting debit card payments in the US. An October 2023 proposal – yet to be approved – aims to bring that fee limit even lower.
Another result of the Durbin Amendment is a broadening of debit payment rail options. This aims to help merchants make savings on payment processing fees by choosing the most cost-effective rail.
While the initial Durbin Amendment only applied to debit card processing, a related bill, called the Credit Card Competition Act of 2023, aims to update credit card regulations, too.
If that was somewhat confusing, don’t worry. In this post, we’ll explain the so-called Durbin law – which actually consists of several different regulations – and what it means for merchants calculating the cost of processing payments.
The Durbin Amendment directs the Federal Reserve Board to regulate debit card interchange fees so that they are “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.”
This led to the creation of Regulation II (as in, the alphabet letter after “H”, rather than the number two) which enforces limits on the interchange fees at $0.21 per transaction and five basis points multiplied by the value of the transaction. Issuers also receive an additional $0.01 if they meet certain fraud security standards.
It’s important to note that these rules only apply to debit card transactions where the card is issued by banks with over $10 billion in assets. That means smaller issuers are not required to limit their fees in the same way as larger ones.
In addition to the cap on fees, the Durbin Amendment also placed a requirement on all issuing banks to ensure all in-person transactions made with their debit cards can be processed by at least two different networks. This was later expanded to debit card transactions online or over the phone. This is intended to encourage competition in the market by offering an alternative to processing via the large networks.
As of July 2023, the regulators tightened the requirements on debit cards issued by the larger institutions removing further barriers to choice. As a result acquirers/issuers must offer merchants at least two different networks through which to route these online domestic debit card payments.
A proposed further amendment to Regulation II would see the maximum interchange fee paid to an issuer per debit card transaction fall. The base component would decrease from 21.0 to 14.4 cents, the ad valorem (which means it depends on the value of the transaction) portion would decrease from five basis points (multiplied by the transaction amount) to four basis points (multiplied by the transaction amount).
Why now? The 2023 proposal notes that since 2011, “certain costs incurred by these issuers have declined significantly; however, the interchange fee cap has remained the same.” Hence the reason for the suggested update at this time.
In the document, the Federal Reserve Board also suggests “to update the interchange fee cap every other year going forward” based on cost data from large issuers. If implemented, that could mean that interchange fees earned by issuers would go up or down in line with their processing costs.
Consultation on this amendment proposal is ongoing at the time of writing (May 2024).
No, only debit card transactions are in the scope of the original 2011 Durbin Amendment. However, proposed regulation from Senator Richard Durbin (first introduced in 2022) seeks to expand the number of payment card networks available to merchants taking credit card payments. The proposed legislation is the Credit Card Competition Act 2023, which we’ll explain in the next section.
The Credit Card Competition Act is a proposed expansion of the Durbin Amendment, sometimes referred to as the “Durbin 2.0” submitted for consideration by the Senate. The proposed Credit Card Competition Act of 2023 would enable merchants to choose between a wider range of credit card payment rails for transactions. In a similar vein to the debit card reforms, Durbin 2.0 would require issuers with $100 billion in assets to enable their credit cards to be processed on a non-Visa or -Mastercard network.
This would reduce credit card interchange fees if more cost-effective network rails were available for relevant transactions.
Those who oppose the bill argue it would result in higher costs to consumers as well as leverage unfair infrastructure costs on banks. This could force banks to reduce their consumer credit limits.
The reform would not apply to card networks that are also issuers (such as Discover or American Express).
The Amendment has certainly reduced the interchange revenue paid to issuers. After Durbin, average domestic debit interchange fee revenue per transaction fell from approximately 44 cents to around 24 cents (Chicago Law School, 2013). That means, for the average transaction of $38.58, the interchange fee was $0.20 less per covered debit transaction.
An important aim of the Durbin law was to benefit the consumer. As Senator Durbin himself argues: “Consumers ultimately pay for all of these fees in the price of the goods and services they buy.”
However, the impact of the regulations on costs for merchants and consumers is not so clear-cut. It’s hard to argue that it’s achieved its initial aims thus far. A 2017 Congress report was ambivalent:
“Since implementation of the rule, merchants have seen a limited and unequal impact on the amount they pay in swipe fees. Likewise, the impact of Regulation II has been uneven for covered institutions. Institutions not covered by the Regulation II have reportedly observed minimal change in revenues generated by debit transactions.”
Some go further in their criticism, and claim the Durbin law only really benefited huge merchants such as Walmart and Amazon, while increasing costs for small businesses. Some analysts claim merchants are making less than half of the savings originally predicted.
The argument is that before Durbin, most issuers would apply a variable fee structure in line with the purchase size. This meant that merchants paid smaller fees on low-value purchases, like a cup of coffee. However, after the introduction of the Durbin Amendment, the schemes abandoned this pricing system. Instead, they applied the maximum interchange fee permitted no matter the size of the transaction, thus raising the fees merchants paid on transactions below a certain value.
The Durbin Amendment remains a contentious topic; while further legislation is proposed, opponents are calling for the entire project to be scrapped.
Proponents believe the regulations are limiting unfair swipe fees, and have already saved merchants billions of dollars in excess interchange charges. Detractors argue the regulation is in direct contrast with a free and fair market, and burdens the banking sector with costs so high that financial institutions are forced to recoup these losses elsewhere.
On the pro-Durbin side, many medium to large retailers, industry groups, and certain US senators say that without this amendment, interchange fees would continue to rise. This would lead to worsening costs for merchants and consumers. They also argue that the amendment addresses a perceived duopoly of certain card schemes.
However, the repeal side argues that the Durbin law represents a bad deal for consumers, because merchants do not always pass on their interchange savings. Furthermore, certain banks have stopped offering debit reward programs because of reduced revenue. Additionally, they argue, the cap actually increases costs for small businesses with low average sales.
Citing a 35% reduction in debit interchange revenue at community banks and credit unions, banking groups such as the ABA argue Durbin has done more harm than good. Interchange revenue is vital for ensuring the security and quality of the payment system, they argue, and supports customer access to low-cost financial services. They assert that no more regulation should take place until additional research on the costs to consumers and financial institutions has taken place.
Our research found that 48% of merchants do not receive a detailed breakdown of their payment costs from their payment service providers (PSP). Without this insight, there is little chance for merchants to drive down costs.
Blended pricing generally gives merchants little-to-no visibility into how their payments are priced, as numerous separate charges are combined into one lump sum.
By contrast, interchange++ our ‘pass-through’ pricing model offers greater transparency. This is the pricing model we use at Checkout.com, which ensures certain charges are itemized, to help with accurately costing your payment processing. It also allows merchants to realize the pricing benefits of any optimizations they make — and understand cost before making strategic changes.
Specifically, our Card Metadata API allows you to work out the type of payment card your customer is using, and determine whether it is Durbin regulated. This helps you understand the interchange cost of a card before accepting it. A particularly beneficial use case of this data is working out the right amount to surcharge (where applicable) and whether you want to accept certain types of cards at all.
