Inefficiencies in Debit Network Economics

Navigator Edition: March 2015
By: Myron Schwarcz and Ryan Allen

Recent data have exposed inefficiencies in the fees issuers pay for single-message and dual-message debit network participation. For covered issuers post-Durbin, the interchange revenue received for single-message and dual-message transactions is virtually equal, but a difference in network fees persists. This gap cannot be justified by differences in capabilities or economic factors, given the near identical interchange and the functional parity (international acceptance aside) between dual-message and single-message networks.

The Federal Reserve Board (the “Board”) biennially publishes data on the network costs incurred and interchange revenue received by debit card issuers. The Board’s most recent report indicates that in 2013, covered issuers received an average interchange fee of $0.24 per transaction for both dual and single-message networks (see Figure 1). However, network fees (net of incentives and discounts) for single-message transactions continue to be considerably lower than those of dual-message networks. As a result, issuers earn a net $0.226 per dual-message debit transaction, and $0.233 per single-message debit transaction (see Figure 1). This $0.007 difference in transaction economics can add up—and the incremental revenue is low hanging fruit that comes at no inconvenience to cardholders.

Figure 1: 2013 Covered Issuer Net Debit Income
(per transaction)
Fig-1_--2013-Covered-Issuer-Net-Debit-IncomeSource: Federal Reserve System, 2013 Debit Fee Study.

For many single-message transactions, the gap is much greater. Many large retailers have taken advantage of single-message network competition and negotiated acceptance costs below the statutory maximum. These merchants aggressively steer debit transactions to the lowest cost provider, which is most often a single-message network. Because large merchants disproportionately route debit card transactions to lower-cost single message networks, average single-message interchange is lower than it would otherwise be if large merchant transaction routing was distributed evenly between single-message and dual-message networks.

In addition, the Board’s study notes that while covered issuers in aggregate pay an average of $0.003 per single-message transaction, most larger issuers are paying zero fees for these transactions. Competition among single-message networks has led to price compression, but the absence of dual-message network competition appears to result in higher issuer fees.

Given the difference in net revenue between single-message and dual-message transactions (not to mention the differences in fraud levels), most debit issuers would benefit from a shift in portfolio activity toward single-message transactions, and it is unclear why issuers have not developed strategies to encourage such a shift. In some cases, issuers focus on the participation incentives received from the dual-message debit networks to supplement internal budgets. Were dual-message volume to shift to single-message, many of these incentives would be at risk. These cash flows should not be viewed as an independent revenue stream, but rather should be incorporated into the comparison of transaction economics. It is in the issuer’s best interest to compare the net revenue (net of gross fees less discounts and incentives) of a dual-message transaction versus that of a single-message transaction when deciding its routing preferences and develop strategies to influence cardholder behavior accordingly.

While single-message networks currently offer more favorable issuer economics, recent industry trends inject uncertainty into the future outlook. Emerging market forces (e.g., “Chip-and-PIN”, STAR Access, etc.) are expected to have an impact on merchant transaction routing and ultimately, issuer economics. Issuers will need to be prepared to adjust their network participation strategies accordingly.

For more information, please contact Myron Schwarcz, Senior Manager,; or Ryan Allen, Associate, Both are members of the Deposit Access Practice, specializing in Debit and Prepaid.

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