Backgrounder on Least-cost Routing

Debit card transactions in Australia

Debit cards are used in around half of all payments made by consumers in Australia. When a merchant (e.g. a shop or business) accepts a payment from a customer using a debit card, the merchant is charged a fee by their card issuer or payments provider. Higher payments costs for merchants feed through into higher prices for goods and services.

In Australia, around 85 per cent of debit cards are ‘dual-network’ debit cards (DNDCs), which allow domestic payments to be processed by either eftpos (the domestic card network) or one of the international debit networks (Debit Mastercard or Visa Debit). These cards have an international scheme logo (Mastercard or Visa) on one side and the eftpos logo on the other. A payment made with a DNDC draws on the same deposit account, regardless of which card network processes it. But the cost the merchant faces from their payment service provider (PSP) for accepting a debit card payment can vary depending on which of the card networks processes the transaction.

When a customer makes a contactless payment by tapping their DNDC on a terminal, the transaction would be automatically routed to the default network programmed on the card, which is typically the Debit Mastercard or Visa Debit network. However, for many merchants, payments via the eftpos network can be less expensive than payments via the Debit Mastercard or Visa Debit networks because the eftpos network has lower wholesale costs. The increasing use of contactless functionality by consumers has put upward pressure on the costs to merchants for accepting debit transactions. As a result, the RBA has strongly supported the introduction of functionality known as least-cost routing (LCR).

This Backgrounder describes LCR and its impact on payment costs.

What is least-cost routing?

LCR provides merchants the ability to override the default network and route contactless DNDC transactions via whichever of the two networks on the card costs them less to accept. Routing transactions via the international networks may be cheaper for some merchants, particularly those with low average transaction values, because PSPs typically charge a percentage rate for the international networks and a cents-based fee for eftpos. But having LCR enabled does not necessarily mean that transactions are always routed to eftpos.

In practice, LCR is implemented in the following ways:

  • Binary LCR – all eligible transactions are routed to one network, chosen by the merchant (or PSP).
  • Threshold LCR – the merchant (or PSP) chooses a threshold transaction value so that transactions with a value below the threshold are routed to one network, while transactions with a value above the threshold are routed to the other network. This reflects the fact that the lowest cost network may vary across transactions of different sizes.
  • Dynamic LCR – the lowest cost network is assessed and chosen for each individual transaction. This reflects the fact that the lowest cost network may vary across transactions, due to factors such as transaction value. Dynamic LCR is not yet widely available because it is more complex and so the technology is harder for PSPs to implement.[1]

What is the availability and take-up of least-cost routing?

LCR is widely available for in-person contactless (‘tap and go’) transactions made with a physical debit card. LCR also started to become available for online transactions following eftpos launching online payments functionality in 2022. Previously, online debit card payments could only be processed via the international networks (Visa Debit or Debit Mastercard). The RBA expects LCR to become available for mobile wallet transactions by the end of 2024.

Merchants that do not have LCR enabled can either ask their PSP about the availability of LCR and how to enable it, or switch to a pricing plan with LCR enabled. To provide greater transparency on the extent to which providers are supporting LCR, the RBA publishes tables on LCR availability and take-up across the major acquirers.[2]

How can least-cost routing reduce payment costs?

LCR helps to reduce payment costs in the following ways:

  • It gives merchants and PSPs the ability to route DNDC transactions to the lowest cost network, which directly reduces their payment costs. For merchants on plans with blended pricing across debit and credit (or across debit schemes), LCR serves to lower wholesale costs for PSPs. The extent to which any savings are passed on to merchants will depend on the pricing strategies of PSPs and the degree of competition in the market.
  • It increases the competitive pressure on the debit card networks to lower the wholesale fees – known as interchange fees and scheme fees – that they set on debit card transactions.[3] These fees are a key component of the price that merchants pay to accept card payments.

The RBA has estimated that the cost of accepting debit card transactions is nearly 20 per cent lower for merchants with LCR, although the results differ across merchant size and type of pricing plan. Once LCR for online and mobile wallet payments is widely available and taken up by merchants, the potential cost savings are likely to be even larger.[4]

What is the RBA doing to support least-cost routing?

The RBA has a mandate to promote competition, efficiency and safety in the Australian payments system. As such, the RBA has strongly encouraged availability of LCR since 2017:

  • In 2021, in response to slow industry progress, the RBA set an explicit expectation that PSPs offer and promote LCR in both the in-person and online environments.[5]
  • In 2022, the RBA set a further expectation that the industry make LCR functionality available for mobile wallet transactions by the end of 2024.[6]
  • To provide greater transparency on industry progress, the RBA started to publish in 2023 a table on LCR availability and take-up across the major acquirers.[7]
  • By June 2023, LCR was widely available to merchants for in-person transactions, but the functionality had only been enabled for just over half of merchants. In addition, only a few acquirers and other PSPs had made LCR available to their merchants for online transactions. As a result, the RBA communicated that if ‘substantial progress’ was not made by June 2024, it would explore a formal regulatory requirement for PSPs to enable LCR for merchants by default.[8]

By June 2024, the share of merchants with LCR enabled for in-person transactions had increased to around 70 per cent, with PSPs indicating that they would make further progress by the end of 2024. However, LCR for online transactions is at an earlier stage of progress as the industry is still adjusting to the rollout of eftpos’s online functionality. Only six of 12 large PSPs had made LCR available to all their merchants by June 2024, and two providers had LCR enabled for a significant share of their merchants.[9]

The RBA is also exploring if further regulatory action may be needed to realise the full benefits of LCR for in-person transactions.[10] For example, the RBA is considering whether PSPs should be required to enable LCR for all merchants by default, with merchants able to opt out if they wish. The RBA is also planning to seek stakeholder feedback on LCR for online transactions and mobile wallet transactions at a later time. Online and mobile LCR are at an earlier stage of progress and any formal intervention in these areas would benefit from the passage of proposed reforms to the Payment Systems (Regulation) Act 1998 that would broaden the definition of ‘participants’ in payment systems to include service providers such as mobile wallets and payment gateways.

Endnotes

Gill T, C Holland and G Wiley (2022), ‘The Cost of Card Payments for Merchants’, RBA Bulletin, September. [1]

See RBA (2024), ‘Update on Availability and Enablement of Least-cost Routing for Merchants’, August. [2]

For further information on these fees, see RBA (2024), ‘Backgrounder on Interchange and Scheme Fees’, October. [3]

Dobie B and B Watson (2024), ‘The Effect of Least-cost Routing on Merchant Payment Costs’, RBA Bulletin, April. [4]

See RBA (undated), ‘Least-cost Routing of Debit Card Transactions’. [5]

See RBA, n 5. [6]

See RBA, n 2. [7]

Payments System Board (2023), ‘Payments System Board Update: August 2023 Meeting’, Media Release No 2023-20, 17 August. [8]

Payments System Board (2024), ‘Payments System Board Update: August 2024 Meeting’, Media Release No 2024-16, 15 August. [9]

The RBA commenced a review of merchant card payment costs and surcharging in October 2024. [10]