Where Is My Debit Discount?

Where Is My Debit Discount?


The proponents of the legislation that reduced the fees retailers pay for accepting debit cards promised that such a reform would lead to lower retail prices. The reform, known as the Durbin Amendment, went into effect on 1 October 2011, but Martha C. White of Time Magazine can’t see the savings. What she does see instead are higher bank fees.


White is not the first one to make this observation. We have written about the Durbin Amendment’s negative side effects on this blog many, many times before. But if the reform didn’t result in lower retail prices, where did the money go? After all, the lowering of the debit interchange fees from an average of $0.43 to $0.24 per transaction has reduced the card issuers’ aggregate annual revenue by billions of dollars ($8 billion, according to a CardHub.com estimate cited by White). However, locating the whereabouts of the missing billions proves to be a daunting task and White eventually gives up on it, concluding that “about the only thing everyone agrees on is that customers are losing out while these respective industries [retail and banking] battle over swipe fees.”


Well, I think that White may have given up a bit too easily on this one. There are only two places where the missing billions may be hiding: the merchants and their processors. Let me elaborate.

What Is Interchange?


In order for us to locate our elusive target, we first need to understand exactly what interchange is. So interchange is the fee which a card issuer collects for every transaction that involves one of its payment cards (credit, debit or prepaid). The interchange fee is paid by the processor of the transaction, which then collects it from the merchant which accepted the card for payment. The whole process is facilitated by the credit card network (Visa or MasterCard) whose logo is imprinted on the card. Here is a visual representation of the process:


Where Is My Debit Discount?


By the way, the “swipe fee” label that is frequently applied to the interchange fees is really unhelpful. These fees are charged for both swiped (face-to-face) and non-swiped (telephone or e-commerce) transactions.

How Merchants Pay Their Transaction Fees


Now that we know what interchange is, let’s take a look at how it is collected from the merchants. As illustrated in the diagram above, the merchant does not transact directly with the issuer. The processing bank (or merchant bank) is the merchant’s link to the payment card system and is the entity responsible for the settlement and funding of the merchant’s transactions. It is also the entity that collects the interchange fees from the merchant. However, the interchange makes up only a portion of the total amount of the fees collected by the processor. The rest is comprised of the fees which the processor itself charges for its services. And here is where it gets tricky.


The only way that a merchant would have directly benefited from the lowering of the debit interchange fees would be if it had signed up for an interchange-plus pricing model with its processor. In this pricing structure, the processor’s fees are charged independently from the interchange fees, so any lowering of the latter by any amount would result in a saving for the merchant by the same amount. Let me give you an example. Suppose that a merchant is charged a transaction rate of 0.50 percent above the interchange. Here is what this merchant would be charged for a debit transaction in the amount of $100 before and after the Durbin reform.

Transaction Amount: $100

Merchant Fees if Pricing

Structure is Interchange + 0.50%

Pre-Durbin Interchange: 0.95% + $0.20

$1.65

Post-Durbin Interchange: 0.05% + $0.22

$0.77


So in our hypothetical example (I’ve used the pre-Durbin rate of Visa’s “CPS/Retail Debit — All Other” interchange category), the merchant pockets the entire saving (all $0.88 of it) afforded by the interchange reform.


However, in any other type of merchant pricing, the interchange rate is incorporated into the aggregate processing rate, which is unaffected by the Durbin Amendment and in this case the saving would be pocketed by the merchant. Here is the same example, but this time the transaction rate is a flat 1.45 percent plus $0.25:

Transaction Amount: $100

Merchant Fees if Pricing

Structure is 1.45% + $0.20

Pre-Durbin Interchange: 0.95% + $0.20

$1.65

Post-Durbin Interchange: 0.05% + $0.22

$1.65


As you see, in this scenario the lowering of the interchange rate has absolutely no impact on the merchant’s processing cost, but it increases the processor’s profit.

The Takeaway


So the different pricing structures used by the payment processors are the main reason why Martha White and others are having difficulties tracking down the billions lost by the card issuers in the wake of the interchange reform. And yet, there are only two participants in the transaction process that may have collected the elusive fees: the processors themselves and the merchants.


But keep in mind that all of the big retailers’ payment processing accounts are set up using interchange-plus pricing. Big-box retailers employ armies of accountants who have long ago figured out that interchange-plus is by far the best pricing model, even as their smaller competitors are having a huge problem wrapping their minds around it (trust me, I’ve tried explaining what interchange is and how it works many, many times with astonishingly little success). The bottom line is that the big retail guys are paying much less in debit transaction fees than they used to. So where is my promised discount?


Image credit: Etsystatic.com.

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