The shift to ecommerce has given merchants access to far more consumers and potential revenue than traditional brick-and-mortar retailers. It does come with its pitfalls, however. There are much wider cost implications and risks associated with online transactions.
Not only do U.S. merchants pay far higher card fees for online channels, but it’s also more difficult to process online transactions through cheaper avenues by debit routing.
That’s where the Durbin Amendment comes in: a clause that allows merchants to route PIN debit transactions (in-store) and PINless transactions (online) to the lowest-cost network, resulting in lower costs and increased competition between card networks.
The Durbin Amendment: No Network Exclusivity (NNE), and What Debit Routing Is
In 2011, the U.S. Government brought in the Durbin amendment (as part of the Dodd-Frank Wall Street Reform Act) to offer merchants some relief on processing fees for debit transactions.
This clause mandated all debit cards in the U.S. to be badged with at least two unaffiliated networks. This gave card-accepting merchants in the U.S. the right to choose which network on the card would be used for an individual transaction. The process of choosing a network for a transaction is known as debit routing.
Prior to this, Visa dominated the debit network market. They achieved this by entering into incentive agreements with a large proportion of issuers (banks) that left merchants no choice but to route their transactions through Visa, which is why many are paying exorbitant costs.
Durbin’s No Network Exclusivity (NNE) clause enabled merchants to route more debit transactions to local networks, using transaction volume and value in exchange for preferential deals. Merchants were now benefiting from increased competition in the market, as card networks were forced to compete amongst themselves for merchant transaction volume.
It should be noted, however, that cards issued from banks with under $10bn in assets are exempt from this regulation.
The Cost of Network Fees
Prior to the Durbin amendment, merchants were essentially forced to pay fees related to the card network they were on, costing them a significant amount. With the Durbin amendment, merchants can now use debit routing to process transactions on the least-cost network.
These network fees are a transaction-processing cost that merchants pay when a purchase is made by customers. These costs are paid to the networks (i.e. Visa, Mastercard, or other local networks), and are dependent upon:
- Which network the purchase is routed through
- What type of card the customer is using (debit or credit)
- Whether it’s a:
- Card Present Transaction (CP; in-store purchase); or,
- Card Not Present transaction (CNP; online purchase)
- How the card is processed (i.e. in-store, online, over the phone)
There are also other factors that determine the cost, including the ‘risk level’ of the transaction. On average, merchants pay $0.92 per transaction for Durbin-exempt online transactions in PINless debit transactions.
With the Durbin amendment's "no-network exclusivity" clause, merchants can route PIN debit transactions and PINless transactions to the lowest-cost network, changing the payments ecosystem and saving them an average of 20-30% on interchange & assessment fees.
Debit Routing: PIN vs PINless Debit Transactions
Routing a single-message debit transaction can typically be achieved through two types of transaction authentication: PIN and PINless.
PIN is prevalent in-store, with customer verification easily achieved. However, as transactions shift online and the use of contactless payment methods increase, using PIN to authenticate a transaction becomes increasingly difficult.
What is a PIN Debit Transaction?
A PIN-based transaction is authorized and settled within a single message from the processor to the consumer’s bank. It is most commonly used for transactions with PIN confirmation, such as Card Present and ATM transactions.
PIN is prevalent for in-store transactions, providing competition between debit networks that helps drive costs for merchants downwards. However, the practical application of the NNE clause has meant that merchants only tend to have routing choice when a debit card network transaction is authenticated via PIN.
In response, many domestic debit networks have developed PINless functionality, which allows merchants to route transactions down these networks without the need for a PIN entry.
What is a PINless Debit Transaction?
PINless is a debit transaction processed through a debit network without the need for a PIN entry.
Historically, domestic debit networks – such as Star, Pulse, and NYCE – have been characterized by PIN verification. This has naturally limited their growth, as PIN verification is not desirable in all situations, such as online transactions and small-ticket transactions like fast-food restaurants, where speed at the point of sale is vital.
To counter that, local debit networks (apart from Visa’s own local network, Interlink) have developed the technical ability to process transactions without a PIN. This has allowed for the same competition between debit networks (which we see in the PIN-authenticated in-store environment) to occur online.
The shift to PINless is not without its challenges, however.
Barriers to PINless Transactions & Debit Routing
In order for PINless to reach ubiquity in the online space, all stakeholders in the payment supply chain are required to participate. Unfortunately, this doesn’t seem to be the case.
Among many barriers to PINless growth, Bank Identification Number (BIN) enablement represents a challenge at the issuer level; individual issuers may not be enabling PINless functionality when providing debit cards, which is widely seen as a violation of the Durbin amendment by the merchant community.
It’s reported that merchants cannot use PINless more than 50% of the time, despite having the technology to enable a PINless transaction and route debit transactions. This means the great majority of Card Not Present transactions have been routed to Visa or Mastercard networks, which are typically more expensive.
In fact, we estimate that if U.S. merchants were able to use PINless for Card Not Present transactions, it could drive an astounding $2.1 billion of savings during the trading year of 2020 (Fig 1).
However, with the dramatic shift to online accelerated by the COVID-19 pandemic, we estimate that number could rise to an estimate of $3.1 billion dollars, if not more – further highlighting the impact on merchants of not being able to route online debit transactions via PINless.
Fig 1. | Sources: CMSPI Estimates & Federal Reserve Reports (This image currently not working on site, new file should be uploaded!)
With a large piece of the puzzle falling on card issuers, merchants and merchant advocates (including CMSPI) would like to see the Federal Trade Commission add clarification to the Durbin Amendment, stating, ‘all single-message debit cards, no matter the channel, should be routable by law.’
What’s Changed Recently?
In November 2019, the Federal Trade Commission (FTC) launched an inquiry into Visa and Mastercard’s debit transaction routing processes. It was found that just 6% of CNP transactions were single-message networks.
John Drechny, CEO of the Merchant Advisory Group, recently highlighted the issue and importance of the FTC inquiry for merchants:
“As merchants spent time and money to implement these new transaction types, it became clear they were not enabled by all issuers who have those domestic networks on their cards… Merchants believe this is against the routing provision of Reg II and would be happy to see the FTC and Federal Reserve clarify this point and enforce regulation.”
(Note: Durbin amendment is also known as Reg II)
In May 2021, the Federal Reserve released a statement echoing the calls of merchants and merchant advocates to ensure PINless capabilities are not limited in the Card Not Present environment.
The Federal Reserve notes:
“The absence of at least two unaffiliated networks for card-not-present transactions forecloses the ability of merchants to choose between competing networks when routing such transactions, an issue that has become increasingly pronounced because of continued growth in online transactions, particularly in the COVID-19 environment.” (Source)
This is an important position which could ultimately lead to the proper implementation of Durbin, enabling all debit transactions to be routed by the merchant.
What Should Merchants Do?
Given the challenges in PINless enablement, many merchants are not fully considering the benefits of PINless debit routing. While PINless issuance and enablement continue to pose challenges and opportunities for merchants accepting online payments, it’s important for merchants to assess the business case and ROI for PINless routing.
Merchants should be aware of the trends in issuer and network enablement rates and understand how those trends may be affected by regulatory response & intervention. It’s also important to optimize your debit arrangements, especially while we await a major shift in PINless debit networks.
These trends also change over time, making monitoring and surveillance of PINless growth an important consideration. Depending on the debit card profile of each merchant, the benefits and challenges of PINless enablement will vary.
The Role of CMSPI in Debit Routing
As merchant advocates, CMSPI wants to help you reduce the costs of your payment arrangement.the costs of your payment arrangement.
Learn more about what we can do for you and your business, and let’s get that well-earned money back into your pocket. Contact us today.