While most of the focus so far has been on the twelve-cent cap on interchange, and what that might mean for financial institutions and consumers, several comments bring up a potentially more far-reaching concern about the debit card routing rules. Briefly, the original law grants merchants the power to "steer" transactions over whichever debit network they prefer, and attempts to make this meaningful by requiring debit card issuers to support more than one debit network. The idea is to reverse the current market dynamic where networks compete for issuer business to one where networks compete for merchant business, by giving merchants market power to negotiate volume discounts. Most of the commentary to date (see, for example , p.30) has focused on the potential of this provision to lower network pricing.

However, as several comments highlight, this rule has many unintended consequences:

So we have a conflict, which the Fed has to resolve somehow: the merchant right to route transactions over the lowest cost network vs. the issuer's right to control how their cards are used. If the Fed has a public policy goal of promoting innovation in the payments system, then it logically ought to prioritize issuers' and networks' rights over merchants' rights (remember that merchants can also be issuers, so it is not a zero-sum game). On the other hand, the Fed's strict interpretation of the pricing rules suggests that they favor merchants' rights under the law, and they might decide that the industry will find a way to deal with whatever disruptions occur as a result of unrestricted routing. For example, many value-added services could be provided separately from the payment transaction, as is the case with check validation and remittance data exchange. However, as previously mentioned, this would make debit networks much less profitable, so it is likely that we would see large-scale consolidation, resulting in just one or two PIN debit networks for the whole country. That makes the idea of unrestricted routing seem rather pointless in the long run, so I hope the Fed will not choose to go that route. What do you think?

Join me next time as I try to figure out why small issuers don't like the exemption from the caps that was put in especially for them.