Blog January 8th 2020

Unregulated Debit: The Trend Silently Costing Merchants $1.3 Billion

Despite stores reopening and many states coming out of lockdown restrictions, merchants are continuing to feel the impact of the COVID-19 pandemic on the retail industry – and will do for a long time

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Dan Luehm

Director, Transaction Routing Optimization

One growing trend, as a result of the crisis, is the increasing proportion of unregulated debit transactions in the U.S., from cards issued by smaller banks who are exempt from the Durbin amendment. As a result, costs are increasing and the disparity between efficient and inefficient merchants is widening. If merchants don’t optimize their debit arrangements now, they could foot part of a $1.3 billion bill of annual fees set to arrive as the volume of expensive unregulated debit transactions rises.


The Durbin amendment, which was part of the Dodd-Frank Wall Street Reform Act, entered into force on October 1st 2011. The regulation covered debit card payments within the U.S. and had two key components: debit card interchange fees were capped at $0.21/0.22 + 0.05%; and a No Network Exclusivity (NNE) clause meant each debit card issued in the U.S. must contain at least two unaffiliated network options for merchants to route down.

Before the Durbin text was signed off, there were concerns the interchange caps may threaten the financial viability of many of America’s thousands of small local credit unions, many of whom don’t have credit card programs and have become reliant on debit card interchange income to survive. As a result, the final Durbin text contained an exemption from the caps component of the regulation for issuers with less than $10 billion in assets.

The Cost Impact of the Small Issuer Exemption

Dual Message Debit

Overall, the small issuer exemption has had a negative cost impact for merchants. Although unregulated dual message interchange fees tend to have lower per item (or cent per transaction) fee components, the Average Transaction Value (ATVs) needs to be very low to benefit from this and be cheaper than a regulated fee. For example, a $10 transaction (Fig 1 ) would incur a $0.23 interchange fee on Visa’s unregulated Custom Payment Service (CPS) Retail/Debit interchange category, higher than the corresponding regulated fee of $0.225. At larger transaction values the difference is even more stark: a $100 Visa CPS Retail/Debit transaction would have $0.95 unregulated interchange fees and just $0.27 regulated fees.

On average (Fig 2), unregulated dual message interchange fees are $0.52 per transaction and they constitute 24% of all U.S. debit transactions, according to the Federal Reserve. By contrast, regulated dual message interchange fees average $0.22 per transaction and represent 41% of all U.S. debit.

“What is single vs dual message debit? Single message debit is when a transaction is authorized and settled within a single message – most commonly used for transactions with PIN confirmation. Dual message debit will send an authorization request with the first message and requests a settlement with the second – more commonly used for transactions requiring a signature confirmation.”

Single Message Debit

There are potential cost impacts for single message debit as well. Single message regulated and unregulated interchange fees tend to be similar, averaging $0.24 for regulated transactions and $0.25 for unregulated (Fig 2 – Federal Reserve). However, this doesn’t tell the full story. Because single message transactions are routable, in this context, merchants should view unregulated transactions positively. Since unregulated transactions are not capped, they are negotiable and, in many cases, it is possible to achieve significantly lower net unregulated interchange for single message transactions. Ultimately, unregulated fees highlight the stark difference between merchants with efficient debit routing arrangements and those with inefficiencies – therefore, an increase in unregulated volumes can be a competitive advantage for the most optimized merchants.

Fig 1

Regional Trends

Federal Reserve numbers suggest 64% of transactions were regulated as of 2017. However, there are clear regional trends, with the exemption having had very different impacts in various areas throughout the U.S. In urban areas, large banks such as Chase, Bank of America and Wells Fargo tend to dominate. Whereas, rural areas – particularly in the Midwest – have a far higher rate of small, local credit unions. For example, New York state has a more than 95% rate of regulated cards while Mississippi only has 29.25% regulated.

What Impact is the Pandemic Having?

We are seeing far higher unregulated volumes during the pandemic due to rural areas seeing lower levels of COVID-19 cases than urban areas and, as a result, tend to be emerging from lockdowns sooner. Texas, for example, was one of the first states to pull out of their stay at home order on April 30th.

The cost impact of this is significant for some merchants, particularly those with broad footprints such as Convenience and Fuel retailers. In the case of a merchant incurring average regulated and unregulated interchange fees, according to the Federal Reserve’s schedule, total weighted average debit interchange fees prior to the pandemic would be $0.301 per transaction. If this merchant then saw a 20% increase in the number of unregulated transactions during the pandemic, from 36% exempt to 45% exempt, then their weighted average interchange fees would increase to $0.319 per transaction.

Fig 2

This may not seem like a lot, but for a $1 billion debit card revenue merchant, with an ATV of $40, annual debit card interchange fees would rise from $7.51 million to $7.97 million: an increase of $460,000.

If this were to be applied across the U.S., it would result in $1.3 billion in additional annual costs for U.S. merchants. Coupled with $168 billion of lost retail revenue during the pandemic and other cost increase trends, such as the shift to online and contactless spending, this should be another cause of alarm for merchants.

How Long Will This Last?

It’s likely any trend towards unregulated cards will last for at least the next few months. Although it is hard to see the global economy being able to sustain social distancing forever, it could be a while until urban areas with regulated cards fully recover. Even a 90% economy like we’re seeing now would lead to devastating levels of wealth deprivation, if it continues indefinitely.

In heavily populated urban areas such as New York City, it seems unlikely we will see an end to social distancing measures any time soon. As covered in our Retail Payments Review, industries such as restaurants will struggle to see revenue levels return to normality during social distancing.

The effect of increasing unregulated debit transactions will last long enough for merchants to need to consider its potential impact when budgeting over the next 12 months. When combined with the many other trends we’re seeing at the moment – higher online sales, a decline in cash, a shift to contactless, reduced international volumes and an increase in credit card usage – it paints an increasingly complex and confusing picture for merchants.

The Silver Lining

The pandemic is increasing the volume of unregulated debit card transactions we’re seeing, with some CMSPI clients seeing unregulated volumes increase by more than 30%. Unregulated dual message interchange fees are more than double the size of regulated fees, and if unregulated volumes increase by 20%, this could cost U.S. merchants $1.3 billion in additional annual card fees. Although regulated card volumes are expected to return to normality eventually, this could still take many months or even years, and this trend is particularly concerning given the strain the retail industry is currently under.

The silver lining for merchants is unregulated single message interchange and network fees are negotiable and CMSPI has observed significant efficiency savings for merchants who overcome complexities and optimize their debit arrangements.

At CMSPI, we can analyze your current debit routing arrangements and, using our in-house proprietary Debit Optimization Tool (DOT), we can create custom routing arrangements to benefit your bottom line. DOT delivers essential insights into a merchant’s routing profile and financial incentives, allowing our dedicated payments experts to track key debit metrics to ensure your routing arrangements, and your rates, are truly optimal.

See what Smarter Payments Intelligence can do for you.

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