Reg II 2.0: It All Boils Down to PINless Transactions

In this blog, Phil Jarrell, debit card services expert at PRI, examines the new rule and how it may affect FIs. Jarrell said the key lies in whether the issuer’s network supports PINless transactions.


Thanks to the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve has required that banks and other card issuers offer merchants at least two unaffiliated network options for merchants to route debit card payments since 2011. Of course, the world has changed significantly since then, with card-not-present (CNP) activity to support online purchases rising steadily and becoming turbo-charged during the pandemic.

“A significant percentage of consumer buying has moved to remote, card-not-present (CNP) channels. The Federal Reserve estimates that in 2019, CNP activity controlled 23 percent of debit volume. That has only increased in recent years, spurred by the Covid pandemic.” – Payment Card Routing is All Politics, Digital Transactions

To address the current environment, the Fed recently issued a modification to Reg II, commonly referred to as “Reg II 2.0,” which will require issuers to enable merchants to choose from at least two unaffiliated networks for CNP debit card purchases online or by phone. The rule, which takes effect on July 1, 2023, was supported by merchant groups and PIN networks and opposed by banks and credit union associations, which contend that requiring them to support PIN networks for PINless transactions would compromise transaction security and result in increasing fraud losses.

The rule change also promises to further squeeze interchange income for financial institutions. In the PRI article, What is Interchange Income and How Do You Calculate It, Mike Holt, PRI partner, discussed interchange income and how it was initially affected by Durbin.  

“This modification does not require action on the part of issuers unless the issuer does not have a PIN network that supports PINless transactions,” Jarrell said. “If this is the case, the issuer needs to enable PINless transactions for their PIN network by July 2023.”

The result of this action is that exempt issuers – those with less than $10B in assets – that do not have PINless currently enabled will see an immediate hit to interchange income when PINless is enabled, as some online and CNP merchants take advantage of the lower cost option.

“The size of this hit depends on many factors, including which networks are on their cards and the current CNP mix of transactions,” Jarrell said.

Jarrell said if an issuer currently supports PINless transactions, the impact of this regulation may not be significant in the short-term, as merchants are already routing CNP transactions over PINless networks. However, not all CNP merchants will route transactions over PIN networks.

Large merchants have negotiated favorable interchange rates with global networks. Additionally, merchants carry liability for standard CNP transactions and will likely choose a global brand for higher risk transactions due to their enhanced fraud prevention capabilities and thus lower fraud risk compared to PINless transactions.

“Longer term, exempt issuers should expect ongoing compression of interchange rates, as merchants and acquirers likely expand use of PINless transactions, forcing global networks to reduce interchange rates to compete for volume,”  Jarrell said.

“Small financial institutions that have not already adopted a PINless network are the most impacted party. Like their large bank brethren, they will need to fund projects to make the necessary adjustments to their card portfolio. Since today they are receiving the higher global network interchange rate, they will incur a drop in non-interest fee income. This comes at a particularly painful time for community banks that are struggling under other hefty regulatory requirements and tough competition from fintechs.” – Payment Card Routing is All Politics, Digital Transactions

Issuers should evaluate their portfolio performance relative to benchmarks to identify opportunities that drive incremental revenue and in turn offset interchange impacts from this changing environment. Relatively small improvements in debit card penetration, active rate and usage can more than offset impacts from the updated regulation.

Jarrell recommends that issuers focus on the following to prepare for the new regulations:

  • Ensure PINless transactions are supported on the FI’s debit card.
  • Evaluate the PIN networks supported on the FI’s cards. There can be sizable differences in interchange, expenses and PINless volume between PIN networks. An expert consultancy can help evaluate PIN networks for the most favorable mix.
  • Understand their portfolio trends and key metrics, especially transaction mix, PIN, SIG and PINless interchange rates, transaction expenses and fraud.

Jarrell also recommends staying engaged with banking associations and local representatives and senators to ensure the negative impact of increasing government regulation, especially to community banks and credit unions, is fully understood and considered in legislative and regulatory development.

Terms to Know

  • Reg II: Federal regulation that implemented requirements on debit card routing and limits on interchange fees in 2011. Commonly referred to as “Durbin.”
  • Reg II 2.0: Modification to Reg II announced on Oct. 4, 2022 that requires that two unaffiliated networks are available on cards for all transactions, including CNP. This essentially requires that issuers support PINless transactions on their card.
  • Non-exempt issuers: Issuers with over $10B in assets that are subject to the Reg II interchange cap.
  • Exempt issuers: Issuers with less than $10B in assets that are not subject to the Reg II interchange cap but are subject to the other requirements of Reg II.
  • Dual message transactions: Payment transactions that are composed of two individual messages between merchant and issuer/processor, which are an initial authorization message to get approval for a transaction followed by a “clearing” message that communicates transaction completion and final amount. These are typically global network transactions such as Visa and Mastercard.
  • Single message transactions: Payment transactions that include both authorization and clearing in one message and typically use the PIN as a primary fraud protection. Single message network (also known as PIN networks) examples include Interlink, Maestro, STAR, PULSE and NYCE.
  • PINless transactions: Single message transactions that do not require a PIN.
  • CNP transactions: “Card Not Present” transactions. These are transactions primarily conducted online or over the phone.


What is Interchange Income and How Do You Calculate It, PRI

Payment Card Routing is All Politics, Digital Transactions

Visa, Mastercard Face Emerging Competition in Online Payments, Bloomberg Law

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