The caps on debit interchange implemented in 2011 benefited merchants to different degrees, largely dependent on merchant size. Large merchants generally benefited; smaller merchants, much less so.
This article, based on a study by Fumiko Hayashi of the Kansas City Federal Reserve Bank , suggests why.
Debit card interchange fees charged to merchants in the United States climbed sharply during the 2000s. Merchants’ capacity to route transactions to preferred (and less expensive) debit card networks was limited.
In 2010, Congress passed the Dodd-Frank Act, which included measures to address escalating fees and restrictions on routing. These measures were implemented in July 2011 by the Federal Reserve Board as Regulation II.
Regulation II introduced three critical provisions:
- a cap on debit card interchange fees for large (“regulated”) issuers
- a ban on network exclusivity arrangements between networks and issuers, and
- a ban on limitations preventing merchants from routing transactions over any enabled network.
The cap applied only to card-issuing banks (“issuers”) with $ 10 billion or more in assets, leaving smaller (“exempt”) issuers unaffected by the cap. Exempt issuers collectively accounted for about 35% of all debit card transactions.
Fumiko Hayashi (of the Kansas City Federal Reserve Bank) researched the results of Reg 11 and found that since it was enacted, the average exempt debit card interchange fee for networks such as, Interlink, Maestro, STAR, NYCE, PULSE declined slightly, while it increased for networks such as Visa, Mastercard, and Discover.
Fee increases were often much larger than decreases.
Hayashi’s research emphasizes that these network-wide averages do not sufficiently capture what small merchants saw. Unlike their large counterparts, small merchants struggle to identify the lowest-cost networks and lack the bargaining power to negotiate lower fees. Even where Regulation II increased routing options, many small merchants remain unable to exercise these choices effectively.
A detailed review of interchange fee schedules for 13 networks) shows a pattern in fees charged to small merchants between October 2011 and August 2024. Some networks decreased their fees for at least one of four major merchant categories (grocery, general retail, gas station, quick-service restaurant), but others either increased or left them unchanged.
Out of 13 networks, nine decreased interchange fees for at least one category. Five of these networks also raised fees for at least one other category. Two networks raised fees in all categories, and two made no changes.
Critically, the magnitude of fee increases—often associated with newly introduced premium fees for issuers in preferred-issuer programs—was much larger than the magnitude of reductions.
The underlying market dynamics temper the ability of Regulation II to drive widespread fee reductions for small merchants.
Why aren’t small merchants getting the full savings?
- Flat-rate pricing: Most small businesses use simple, all-in-one pricing from their payment providers (for example, a flat 3% on every card sale). This helps with budgeting but hides the real costs, so merchants can’t spot fee differences or choose the cheapest route for each transaction.
- No negotiating power or options: Big businesses have the time, money, and knowledge to negotiate better deals and pick the lowest-cost way to process every card sale. Small merchants don’t usually have that ability, so most stick with the default arrangement—even when it costs more.
- Network incentives: The system is designed to give banks and payment networks reasons to keep fees higher for small merchants. They may actually offer lower fees to big merchants who can bring in bigger sales volumes..
Because most small merchants do not pursue the lowest-cost routing options, networks lack a competitive incentive to lower fees specifically for them. Instead, some networks strategically set higher fees for small merchants to entice exempt issuers into preferred programs, while offering lower fees to large merchants to win more transactions.
The research reveals that, despite the increased routing choices intended by Regulation II, overall exempt interchange fees for small merchants saw little broad decline and were frequently subject to larger increases than decreases.
As a result, policy measures focused on routing options may not be sufficient to manage fees for small merchants.
If you’d like to know more about managing your payment acceptance cost, please contact David True at dtrue@paygility.com or Dean Sheaffer deanshea@ptd.net