In early October, the Federal Reserve finalized a rule, known as Regulation II (Debit Card Interchange Fees and Routing), that requires every debit card transaction to have access to two unaffiliated payment card networks. This rule extends the existing regulation from PIN debit transactions to card-not-preset (CNP) transactions and enables merchants and acquirers to choose from competing networks with the intent to lower their debit card processing costs.
With this new rule, a large proportion of CNP transactions, including ecommerce purchases and recurring payments, could (and likely will) end up on networks other than Visa or Mastercard, where interchange fees are lower.
Why change the regulation? The Fed’s rationale is that technology has advanced to properly support CNP with multiple networks.
While there is no modification to requirements related to interchange fees, this change will negatively impact banks’ and credit unions’ payments revenue and, likely, increase their fraud-related costs.
The pandemic helped accelerate consumers’ digital activity, and, as a result, CNP transaction volume has soared in the past two years. Historically, 50% of CNP transactions were on the signature debit rails. With the rule change, a percentage of financial institutions’ revenue from related debit/CNP transactions will be cut in half.
Although the regulatory change doesn’t require banks and credit unions to make any technology changes, they shouldn’t idly sit by waiting for the new rule to take effect. In “New Durbin Regulation, Now What,” a recent Cornerstone Advisors webcast, Brandi Gregory, managing director, and Tony DeSanctis, senior director, in Cornerstone’s Payments Practice, outlined three things financial institutions should do:
The Federal Reserve’s goal for the revised debit rule is to promote competition, thus reducing costs for merchants and, ultimately, prices for consumers.
It’s reminiscent of how the 2010 Durbin Amendment was supposed to save money for consumers. Not surprisingly, merchants did not pass the savings on to customers. In 2015, the Fed found that because of the 2010 regulatory changes, only 1.2% of merchants reduced prices. Consumers lost in 2010 and they will lose again in 2023.
This regulatory proposal coincides with a broader industry trend. A structural shift in the economics of a checking account has occurred over the past two years. Revenue from overdraft to interchange has been squeezed, and smaller debit card issuers are feeling it far more than large retail banks.
Small and mid-size institutions need to innovate and redesign the checking account to increase the value the product delivers. Doing so will involve some combination of three strategies:
Banks and credit unions seeking to redefine the checking account value exchange will have a longer list than those suggested here. To win this war, institutions need to act with speed and agility, and those that deliver on this premise will also provide victories for customers.