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 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’ (LCR) 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 (‘tap and go’)
transactions made with a physical debit card, as online payments and mobile-wallet transactions
could only be processed via the international networks (Visa Debit or Debit Mastercard). However,
least-cost routing is now becoming available for online transactions following eftpos’ enablement
of online payments functionality. The Reserve Bank also expects least-cost routing to become
available for mobile-wallet transactions in the future; see the ‘Recent Developments’ section below
for more detail.

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 PDF , and the Black Economy Task
Force Final Report PDF .

What is the RBA doing on least-cost routing?

Background

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 strongly supports the
issuance of dual-network cards to consumers and the provision of least-cost routing functionality
to merchants.

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 for contactless debit card
transactions by the middle of 2019. However, take-up among merchants has 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. While the competitive pressure
associated with least-cost routing appears to 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 other 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.

2019-21 Review of Retail Payments Regulation

These issues were considered as part of the 2019-21 Review of Retail Payments Regulation.
Following this review, in October 2021 the Bank decided to adopt further policy measures
to promote dual-network debit card issuance and least-cost routing:

First, 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.

Recent developments

Since the conclusion of the Review, the Bank has been actively monitoring industry progress in
issuing dual-network debit cards and providing merchants with access to least-cost routing
consistent with the Board’s expectations.

LCR for card-present transactions

To provide greater transparency on the extent to which providers are supporting LCR,
the RBA publishes a table on LCR availability and take-up across the major acquirers
for card-present transactions. As at the end of 2022, providers had generally made good
progress on LCR availability, with LCR available to be turned on for the vast majority of relevant
merchants. In contrast, the take-up of LCR by merchants remained relatively low, indicating that
acquirers had more work to do to promote LCR to their merchant clients.
LCR online

For online transactions, the Bank set an expectation that all acquirers and payment facilitators will
offer LCR to merchants by the end of 2022. The Bank is actively monitoring the industry’s
compliance with this expectation. The first round of reporting from providers indicated that while a
lot of work was underway, the industry had not met this timeline. The Bank expects to see
substantial progress by June 2023 on enabling LCR for merchants online. In the interest of
transparency, the Bank will publish a table on LCR for online transactions once it has received
providers’ June 2023 reporting.

LCR for mobile wallet transactions

In August 2022 the Board announced a further policy measure relating to least-cost routing. Given
the rapid ongoing growth in mobile wallet transactions and the benefits for competition and
efficiency in the payments system, the Board also now expects the industry to develop
least-cost routing functionality for mobile-wallet transactions. This decision followed
recent indications that implementing least-cost routing for mobile-wallet transactions would be
more feasible and less costly than previously indicated. Following further consultation with the
industry, in November 2022 the Board indicated that it considers it to be both feasible and
desirable for the industry to deliver LCR functionality for mobile wallet transactions by the end of
2024 (see Payments System Board Update: November 2022 Meeting for further details).

Undertakings prohibiting tying conduct to support LCR

Mastercard and Visa have each given undertakings to the Bank that they will not engage in ‘tying
conduct’ involving their debit and credit card products, effective from 1 July 2023. The
undertakings address concerns that the international schemes could engage in conduct that would
limit competitive pressure in the debit card market, which has the potential to impose additional
costs on the payments system. This will help realise the benefits of least-cost routing by ensuring
the debit schemes compete solely on the basis of their debit card offering.

Undertaking No.1 of 2023: Mastercard Undertaking In Relation to Least-Cost Routing of Debit

Transactions by Merchants PDF

Undertaking No.2 of 2023: Visa Undertaking In Relation to Least-Cost Routing of Debit

Transactions by Merchants PDF