Debit card routing requirements have become increasingly important as consumers shift more of their spending to e-commerce and other card-not-present channels. A proposed clarification to Regulation II would require financial institutions to ensure merchants have a choice of at least two unaffiliated networks for processing debit transactions, whether purchases occur at a physical point of sale or remotely. While issuers have long supported multiple networks for in-store transactions, the growth of PINless debit capabilities has made greater routing choice technically possible for online payments as well.
The change could have significant implications for issuers, merchants, and debit networks. Merchants could gain additional opportunities to optimize transaction routing and potentially lower acceptance costs, while financial institutions could face changes in debit interchange revenue as more transactions become eligible for routing over domestic EFT networks.
The Federal Reserve Board made an announcement today that it is seeking input on a clarification to Regulation II requiring that all financial institutions, regardless of asset size, offer two unaffiliated debit networks on cards that will function for purchases made both in-store and in remote channels. Here’s a link to the Fed’s announcement.
While all financial institutions offer two unaffiliated debit networks today, some issuers do not offer a version of a domestic EFT debit network (aka PIN debit network) that will work for all ecommerce purchases. The Fed correctly points out that when Reg II first rolled out, this capability wasn’t available.
Since then, networks like Shazam, STAR, PULSE and Accel among others have rolled out their PINless debit products that allow purchases made online to be routed through their networks instead of the global networks. Here’s what the Fed said in its announcement:
“…the regulation requires that there be at least two unaffiliated payment card networks enabled on a debit card to process debit card transactions. At the time the Board promulgated Regulation II, the market had not developed solutions to broadly support multiple networks over which merchants could choose to route card-not-present transactions. Although technology has subsequently evolved to address these barriers, data collected by the Board and information from industry participants indicate that two unaffiliated networks are often not available to process card-not-present debit card transactions because some issuers do not enable two networks for those transactions. 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.”
This change or clarification to the regulation under consideration was sparked by a letter written to the Fed last October by Senator Durbin. More on that here.
So what does this mean? I suspect that the clarification will be made and those financial institutions that don’t already offer PINless will need to change their issuance strategy going forward. Also, merchants who optimize their routing will have another option for ecommerce transactions when a debit card is used.
If merchants select the EFT debit network, they will likely be charged less interchange meaning financial institutions will see less interchange revenue.
The Federal Reserve’s proposed Regulation II clarification reflects how substantially the debit payments environment has changed since the original routing requirements were introduced. At that time, providing multiple unaffiliated routing options for card-not-present transactions was constrained by technology. As domestic EFT networks expanded their PINless debit capabilities, however, those technical limitations became less significant.
Requiring two unaffiliated networks for both in-store and remote transactions could consequently increase competition for debit card routing. Merchants that actively optimize routing would have more opportunities to determine which eligible network should process an e-commerce debit transaction rather than having those transactions predominantly routed over global card networks.
For financial institutions, the implications could be more complicated. Issuers that do not already enable a domestic network capable of processing card-not-present transactions could need to adjust their debit card issuance and network strategies. If merchants increasingly route eligible purchases over lower-cost EFT debit networks, issuers could also experience pressure on interchange revenue.
The broader impact extends beyond compliance. E-commerce growth has made card-not-present debit transactions a much more important component of the payments landscape, increasing the significance of routing competition in remote channels. Expanding debit card routing requirements to reflect these changes could alter the economics of online debit transactions for merchants, networks, and issuers alike.
Ultimately, the Regulation II clarification could bring the original principle of merchant routing choice more fully into the digital commerce environment. As PINless debit technology continues to mature, financial institutions will need to evaluate their network configurations while merchants determine how expanded routing options fit into their payment acceptance strategies.
Overview by Sarah Grotta, Director, Debit and Alternative Products Advisory Service at Mercator Advisory Group