Debit is the workforce of payments: simple for consumers, relatively inexpensive for merchants, and ubiquitous in everyday transactions. But beneath that no-frills experience lies a surprisingly complex ecosystem of issuers, acquirers, merchants, processors, and card networks.
For years, that complexity was largely invisible to consumers—and often secondary for financial institutions. But as more debit transactions move online, into apps, and through digital wallets, the economics of debit are chanting. As Ben Danner, Senior Debit Analyst at Javelin Strategy & Research, detailed in the Debit Network Control: The Battleground Is No Longer Just Rates report, this transformation is prompting banks to rethink their debit strategies—and, in some cases, the networks and rails that underpin them.
Instead of focusing solely on interchange revenue, institutions now need to consider factors like routing optimization, fraud prevention, and merchant acceptance performance—all while preparing for dynamic changes in regulation and technology.
Routing for Least Cost
In the conventional in-store model, merchants can route transactions to either single-message or dual-message networks.
Dual-message networks, sometimes called signature networks, are operated by major credit card companies like Visa and Mastercard. These rails allow a delay between payment authorization and settlement—a buffer that serves multiple functions. In a restaurant, for example, it can give the merchant time to add a tip to the check. It also gives merchants an opportunity to perform valuable fraud checks before the payment settles.
Single-message debit transactions work differently, combining authorization and settlement into a single action. Customer authentication in these transactions often hinges on the consumer entering a PIN to verify that they are the cardholder.
The networks that facilitate single-message debit transactions have sometimes been called back-of-card networks because their brands are often printed on the back of physical debit cards.
For consumers, single-message debit transactions are often associated with ATM withdrawals and low-value purchases. For merchants, PIN debit transactions can offer a lower-cost alternative to routing transactions through the massive global networks of the major card networks.
“If I’m a merchant, the competitive differentiator that has been around for a while now is least-cost routing,” Danner said. “What that means is when I go to Barnes & Noble and I swipe my debit card, there’s a decision that gets made automatically on the back end. Should I route it through Discover, Mastercard, or Visa, or should I route it through Accel, Pulse or STAR?”
“If the book is under $25 or something, whatever the merchant’s processor sets, they’re probably going to route it as a single-message debit network transaction, because it’s a lot cheaper for the merchant to route it through those networks,” he said.
The Drive to Dual-Messaging
That incentive has led merchants to develop increasingly sophisticated systems for optimizing transactions around least-cost routing. The model made particular sense in the brick-and-mortar environment, where PIN-based transactions were common and merchants had considerable control over how payments were routed.
But the payment landscape is no longer confined to the checkout counter. More transactions are happening online, within apps, and through digital wallets, creating new challenges for a model build around the physical point of sale.
Consumers are also storing their debit cards in these wallets and using them not only for e-commerce purchases, but also to send peer-to-peer payments and perform transactions where entering a PIN is not relevant or possible. Additionally, single-message debit transactions don’t provide the same level of authentication online as they do in-store.
As a result, the calculus around debit routing is changing. A transaction that is cheaper to process isn’t necessarily the better transaction if the routing choice increases fraud risk or leads to higher payment declines.
“There is around $4 trillion of debit volume, and about three-quarters of it—or about $3 trillion of that—runs on dual-message,” Danner said. “There are a lot of reasons for that. Part of it has to do with there are not as many people using ATMs anymore, but also single-message routing is a little bit hairier fraud-wise to run.”
“Dual-message has generally stronger fraud authentication and so a lot of merchants will still route through the dual-message networks, just from a fraud perspective,” he said.
Modeling the Scenarios
Despite the complexities of debit, many financial institutions have viewed it as a firmly established product and focused their attention elsewhere. Today, that approach may be harder to sustain. Changes in the competitive landscape, technology, consumer behavior, and regulation could all have implications for how debit transactions are processed.
The industry itself is already seeing meaningful shifts. Capital One’s acquisition of Discover, for example, could give Capital One the opportunity to migrate its debit transactions to the Discover-owned Pulse network and phase out its previous relationship with Mastercard.
Meanwhile, the evolution of payment technology continues to change what consumers expect from their payment expectations. As digital wallets, e-commerce, and other digital payment channels become more embedded in everyday commerce, the infrastructure supporting debit must adapt alongside them.
“Make sure your network is prepared for and optimized for the card-not-present environment, e-commerce, and digital wallets,” Danner said. “Certainly, know that especially younger folks are putting their debit cards—they tend to be strong debit card users—into digital wallets. They’re using them online to make transactions and to send money to friends and family.”
Regulation may ultimately prove to be the most consequential variable of all. Interchange fees on debit transactions have been capped by the Durbin Amendment and Regulation II, but there has been significant discussion about potential future adjustments to the rules. Any changes could alter the economics of debit and, in turn, the incentives facing banks, merchants, processors, and networks.
Taken together, these forces make the future of debit less predictable than its familiar, no-frills reputation might suggest. Given the complexity of the ecosystem, and the competing priorities of the participants involved, institutions should prepare for a range of possible outcomes rather than assume that today’s debit model will remain unchanged.
“If I was on a debit team for a large bank, I would want to be running a bunch of different modeled scenarios for if the interchange cap is lowered or if it goes away or if it’s raised, because it does affect profitability,” Danner said. “Interchange is one of the main ways that they’re making money in a debit portfolio. If there is potential regulation out there that’s going to change that, you want to make sure that you’re prepared.”