Least-cost Routing of Debit Card Transactions

Least-cost routing is an initiative aimed at promoting competition in the debit card market and helping to reduce payment costs in the economy.

Background on debit cards and payment costs

When a merchant (e.g. a shop or business) accepts payment from a customer via a debit or credit card, the merchant is charged a fee by their bank or payments provider. Higher payments costs for merchants feed through into higher prices for goods and services, so merchants are typically keen to hold down their payments costs, just as they try to reduce other costs of doing business.

Debit cards are cards issued by banks, credit unions or building societies that allow individuals to make purchases or cash withdrawals from their deposit account. In Australia, debit card transactions can be processed through one of three debit card scheme networks: eftpos, Debit Mastercard or Visa Debit. Usually, the transaction draws on the same deposit account, regardless of the scheme that processes it. But the cost the merchant faces from their financial institution for accepting a debit card transaction can vary depending on which of the three networks processes the transaction. For many merchants, payments via the eftpos network can be significantly less expensive than payments via the international Debit Mastercard or Visa Debit networks.

Most debit cards in Australia have a functionality that enables a payment to be processed via either eftpos or one of the two international networks. These are called dual-network debit cards. These cards have an international scheme logo (Mastercard or Visa) on one side and the eftpos logo on the other.

When a customer inserts their dual-network debit card into a terminal to make a payment, they are asked to select which network to use. For example, a customer may select the eftpos network by pressing the CHQ or SAV buttons, or they may select the international network by pressing the ‘Visa Debit’, ‘Debit Mastercard’ or CR button (in the latter case, it is still a debit transaction even though traditionally the button has been labelled ‘CR’ for credit). The transaction typically draws on the same deposit account regardless of which button the customer pushes – the payment message just gets to the customer's bank via a different route.

What is least-cost routing?

When a customer makes a contactless (‘tap-and-go’) payment with their dual-network debit card, the merchant may choose to send the transaction via the debit network that costs them the least to accept. This is known as ‘least-cost routing’ or ‘merchant-choice routing’. If the merchant chooses not to route, the transaction will be sent via the default network which is programmed on the card, typically the Debit Mastercard or Visa Debit network. In the past, least-cost routing has only been possible for in-person (contactless) transactions, as online payments could only be processed via the international networks (Visa Debit or Debit Mastercard). However, online payments functionality is currently being enabled for eftpos, opening up the possibility of least-cost routing for online transactions.

If a merchant uses least-cost routing, it does not affect which deposit account the funds are paid from, and the three networks offer similar protections to the cardholder from fraud and disputed transactions. A customer can always select a particular debit network by inserting their card and selecting a network rather than tapping their card when making an in-person transaction. And least-cost routing only applies to dual-network debit card transactions; it does not affect customers using credit cards.

Least-cost routing is expected to bring down payment costs by (1) giving merchants the ability to route dual-network debit card transactions to the lowest-cost network, and (2) increasing the competitive pressure between the debit card payment schemes such that there is greater incentive for all schemes to lower the fees – interchange fees and scheme fees – that they set on debit card transactions. These fees are a key component of the price that merchants pay to accept card payments.

A number of government reports have called for banks and payment providers to provide merchants with least-cost routing. This includes the House of Representatives Standing Committee on Economics Third Report on the Review of the Four Major Banks, the Productivity Commission Draft Report on Competition in the Australian Financial System, and the Black Economy Task Force Final Report.

What is the RBA doing on least-cost routing?

The Reserve Bank's Payments System Board is charged with promoting competition and efficiency in the Australian payments system. In line with this mandate, the Board supports the issuance of dual-network cards to consumers and the provision of least-cost routing functionality to merchants.

The Board has been monitoring industry progress on providing merchants with the ability to route dual-network contactless debit card transactions to their lowest-cost processing network. Following pressure from the Reserve Bank over a number of years, most banks and payment providers had introduced some form of least-cost routing functionality by the middle of 2019. However, take-up among merchants remained fairly low, which may reflect a general lack of awareness among merchants of the potential benefits of least-cost routing, along with a lack of promotion by some acquirers. The Board has also been monitoring the response of card schemes and other participants to the rollout of least-cost routing. While the competitive pressure associated with least-cost routing appears have resulted in lower interchange rates for some merchants, particularly larger ones, there is some evidence that this has been accompanied by increases in rates on some other types of debit transactions, including where least-cost routing is not an option.

A number of recent trends have posed further challenges for least-cost routing. These include the shift towards new technologies for card payments, such as mobile wallets, where least-cost routing has to date not been possible; and some card issuers moving towards issuing single-network debit cards which only allow payments to be processed through one network. The Bank has also heard concerns from some merchants that they may be penalised by higher interchange rates on their credit transactions if they adopt least-cost routing for debit transactions.

These issues were considered as part of the 2019-21 Review of Retail Payments Regulation. Following this review, the Bank decided to adopt further policy measures to promote dual-network debit card issuance and least-cost routing. Firstly, the Bank expects all large debit card issuers (with more than 1 per cent of the total value of debit card transactions) to issue dual-network debit cards. Additionally, to limit the incentive for card issuers to issue single-network debit cards, the Bank introduced an 8 cent cap on the weighted-average interchange fee for single-network debit cards (the same as for dual-network debit cards).

Further, all acquirers and payment facilitators that provide card acceptance services to merchants are expected to offer and promote least-cost routing to their merchants for in-person transactions, and for online transactions by the end of 2022. Acquirers and payment facilitators are expected to report to the Bank every six months on their least-cost routing offerings, and on merchant take-up of least-cost routing. The Bank will also seek voluntary undertakings from the international schemes that they will not penalise merchants that route transactions through eftpos with higher interchange rates on their credit transactions, as this would disincentivise the take-up of least-cost routing and limit competitive pressure in the debit card market. The Bank has also been engaging with the Australian Competition and Consumer Commission (ACCC) on some of the competition issues associated with least-cost routing. For a more detailed summary of the policy decisions relating to least-cost routing that came out of the 2019-21 Review, see the Executive Summary of the Conclusions to the Review of Retail Payments Regulation and the Conclusions Paper.

How can a merchant switch on least-cost routing?

Merchants should ask their payment services provider about the availability of least-cost routing. If merchants are unable to access least-cost routing from their current payment provider, they may choose to consider alternative providers. Least-cost routing may require an upgrade to payment terminal software, and in some cases a replacement of the terminal itself.