Debit Interchange Limit Will Raise Fees on Small-ticket Sales

The effects of the Federal Reserve’s new interchange limit rules on the cost of accepting debit card payments will be much more complex than many observers realize. I wrote last week about the strong probability that one consequence of the new fee structure will be the rising cost of accepting PIN-based debit. The same fate will befall merchants accepting small-ticket transactions and this will surely not go unnoticed. One consequence you can be certain of is that issuers will do their best to steer consumers into using the “right” card at the “right” place. Let’s take a look at the dynamics.

The Current State of Debit

The Federal Reserve gives us detailed data on debit and credit card use by card type and amount. Here is the breakdown:

The report notes that:

General purpose credit cards and, particularly, signature debit use were the preferred methods for transactions below $5. Their high share of these low value transactions may indicate the success of card network rules (and promotional campaigns) to allow merchants and cardholders to forego a signature authorization for low value transactions.

Once the Fed’s interchange fee cap takes effect later this year, the card networks will have a much bigger incentive to increase the share of small-ticket transactions paid with a debit card. Here is why.

Why the Interchange Fee Structure Matters

The new rule states that issuers can charge no more than $0.21 per transaction plus 0.05% of the sale’s amount and can charge an additional $0.01 per transaction for fraud prevention measures they have implemented.

In order to make sense of what the new pricing means, we will have to look at how it compares to the (still) current fee structure. As there are many different debit interchange rates, I will only take one that applies to small-ticket Visa debit transactions (and the one that incidentally is of interest here) — the Visa CPS / Small Ticket, Debit — which right now is at 1.55% + $0.04. The table below shows how the two pricing structures compare for amounts of $5, $10, $15, $20 and $25.

As you see, under the new structure the interchange fee amount grows very slowly as the sales amount increases, which makes small-ticket transactions much more profitable for issuers on a per-dollar basis. This is due to the much higher weight the per-transaction fee carries in the new interchange arrangement. Crucially, it also means that the new pricing structure will allow issuers to make more money from debit transactions in amounts of up to $11 or so than they currently do. Moreover, as the credit card interchange fees are unaffected by the new rules, bigger-ticket transactions will be much more profitable for issuers if made with a credit card than with a debit card and the difference will only grow with the sales amount.

The Takeaway

So issuers will have a very strong incentive to steer consumers into using debit cards for small-ticket transactions and credit cards – for everything above $11 or so. Exactly how they will do that I don’t know but that they will try I have no doubt.

The other side of the coin is that merchants selling small-ticket items will end up paying higher fees for debit transactions than they currently do.

Image credit: Vleto29.ru.