Regulation II impacts every financial institution in the United States. While it was enacted to prevent debit transaction interchange fees from being unreasonable, it has had a significant impact on those who rely on interchange income as part of their revenue. On July 1, changes will go into effect that require issuers to use two unaffiliated networks across all geographies, merchants, and transaction types. Credit unions utilizing Synergent have previously met the two unaffiliated network requirement. However, it’s important to recognize that as more merchants—specifically those participating in Card Not Present (CNP) transactions—choose to route transactions across a non-Visa or MasterCard affiliated network, it is expected to have further negative impacts on interchange income.
History of Regulation II
Regulation II (Debit Card Interchange Fees and Routing) has been part of our regulatory library for over a decade. Back in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in response to the effects of the Great Recession. This complex piece of reform legislation created new regulations for lenders and banks to protect consumers and prevent a future economic recession.
One component of the Dodd-Frank Act was the Durbin Amendment (also known as Reg II), which directed the Federal Reserve Board to set rules to control costs associated with PIN/debit transactions. The intention of the Durbin Amendment was to cap the debit fees that retailers had to pay to financial institutions, in turn passing along the savings to consumers.
As the payments landscape continues to evolve, so does Regulation II.
Upcoming Changes to Regulation II
This past fall, the Federal Reserve Board finalized updates to Regulation II. The updates include the following:
- The final rule specifies that at least two unaffiliated payment networks must be enabled (which are networks other than Visa and Mastercard). While this has applied to debit card purchases since 2011, card-not-present transactions—which are conducted online through a connected device as opposed to at a physical point-of-sale—are now explicitly defined.
- Interchange fees remain as-is.
- Financial institutions with less than $10 billion in assets remain exempt from interchange fee limits.
- If debit card issuers have enabled a combination of payment networks and taken reasonable steps to process card-not-present transactions, the final rule considers the requirement satisfied.
Impact of Reg II Modification on Credit Unions
Unfortunately, this modification is predicted to have a negative impact on credit unions. The National Association of Federally-Insured Credit Unions (NAFCU) wrote a letter to the Federal Reserve requesting the modification be withdrawn. When the Federal Reserve issued the final rule, NAFCU President/CEO Dan Berger stated that it, “will force small issuers to allow transactions over riskier networks, increasing fraud costs for our nation’s community financial institutions.”
The biggest impacts will be in three areas:
- Fraud Losses
- Branding Agreements (if you have one)
With card-not-present transactions potentially being conducted over secondary single message networks, the higher transaction volume means fewer transactions will be happening on Visa and Mastercard networks. These secondary networks typically provide about half the interchange as Visa and MasterCard do. This means at least some of your interchange transactions will be reduced by as much as 50%.
There is a slight benefit to these changes when looking at interchange rates. Visa and Mastercard transactions typically are a bit more expensive to process than those on secondary networks. With more transactions crossing the secondary networks, the actual transaction cost may be less.
Security is always a top concern. Unfortunately, secondary networks don’t always have the same chargeback options. This increases your exposure to fraud because you may not get to chargeback on card-not-present transactions, which is a leading channel for fraud.
For financial institutions that have commitments based on volume and interchange income, this could be impacted because there will be less volume than initially anticipated. This could result in extensions to your agreement and a decrease in compensation from Visa and Mastercard.
How To Prepare for the Reg II Changes
It is important to know about the Reg II changes, but for most credit unions, no action needs to be taken at this time other than setting strategy and being aware of the changes. Synergent credit unions that have a secondary unaffiliated network that can accept card-not-present transactions (like Accel or NYCE) have met the primary requirements. Additionally, while July 1 is the compliance date, these changes have already begun and will continue to happen gradually.
In terms of compliance with the new changes, no action is needed to change technology.
This is the time to strategize. Take time to calculate current interchange income, estimate what the impact will be, and how to reduce the impact to your credit union’s bottom line.
Regardless of where the merchant chooses to route a transaction, it’s important that the credit union be a part of it. This is the perfect time to focus on making a credit union card the preferred payment method for your members. Once a preferred card is loaded into an online shopping channel, many members take the set-it-and-forget-it approach. Getting the credit union’s card as the preferred method of payment in all channels will help preserve your interchange income.
Synergent Can Help
Synergent is monitoring the impacts of the regulation through advocacy with our League, through national partnerships, and by working with established partners like Fiserv.
Corinne Sherman, Vice President of Payment Sales & Consulting, is available to answer any questions and to work with your credit union through a scheduled consultation.
Our Marketing Services team can work with your credit union on creating a marketing campaign that communicates your card offerings and helps bring your credit union top-of-wallet and top-of-app.