Wednesday, August 3, 2011
In his paper titled Race to the Bottom: Debit Card Network Routing in a Post-Durbin World, Riha describes the impact allowing merchants to make routing decisions will have on the payments industry.
"Unlike the routing provision's headline-grabbing counterpart (i.e. the interchange cap), which exempts most credit unions and community banks, the Fed's final rules on debit network routing apply to all debit card issuing FIs regardless of size," Riha wrote. "What this may mean for credit unions and community banks is that their interchange cap 'exemption' is actually a false freedom from the rules."
It used to be debit card issuers could route cards to the path of least cost and highest interchange fees, but those days are past, and problems lie ahead, Riha pointed out. Challenges ahead include determining the bottom of the network interchange rates and defining potential new PIN POS network infrastructure troubles.
Recently Visa Inc., the nation's largest issuer of debit cards, indicated it will lower processing costs for merchants in an effort to maintain customer loyalty in the new debit environment. Riha anticipated this reaction noting, "In order to maintain or gain market share, it is quite possible that … networks may actually lower their interchange rates and/or merchant fees to attract merchant routing.
"Sending transactions down the lowest-cost route for the merchant could lead to lower average interchange, as well as additional expense or fees for the issuer when transactions do not follow their preferred network path."
Riha believes the new rules make it more difficult for networks to manage their businesses. Pre-Durbin, networks could project infrastructure and capacity needs based on how many issuers were under contract, the number of cards in the network and projections of transaction volumes. Now the networks will also need to determine how many transactions will go down alternate, less preferred routes.
The CEO voiced other concerns, too. "The shift in control also leads to the risk that a network may not be prepared to handle the additional surge in volume when merchants begin to implement smart routing solutions," he wrote. "If this scenario occurs, we are likely to see processing performance begin to suffer, leading to time-outs that may result in higher-risk stand-in processing or failed transactions.
"In the post-Durbin world, it will be critical for the networks to work closely with the merchant community to understand merchants' routing preferences and forecast potential capacity," Riha wrote.
Riha also urged networks to begin working with FIs that have chosen alternate, unaffiliated networks as soon as possible. "It will be critical to review your FI's average interchange income by network, as well as understanding both network fees and processor-related fees when your transactions route through one network versus the other," he wrote.
After this review is done it is just a matter of projecting the financial impact of routing using one network or another to estimate potential loss of interchange income or cost increases, Riha added.
Riha noted that unknown factors will affect the direction of post-Durbin debit transaction processing. These include new network discounts for interchange and fee routing services, as well as the impact of the two-tier interchange system on smaller financial institutions competing for post-Durbin dollars.
"Community FIs must take action now to get a jump start on compliance, as April 2012 is just around the corner," Riha noted in his conclusion. "Even more immediate is the effective date of Oct. 1, 2011. On this date, merchants will be allowed to direct debit transactions down whichever network they prefer. Issuers who participate in multiple PIN POS networks will ultimately see a change as soon as this October." 
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