What is least-cost routing and how will it save you money?


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Whether it's tapping a phone on your commute or a physical card at the supermarket register, the act of making card payments is one of those automatic parts of life that many of us pay little attention to.

There's a cost to these transactions though, and it isn't the $5 you fork out each morning on a flat white.

what is least cost routing

Every time you pay with your debit card or credit card, the merchant (i.e. a café or retailer) is charged a fee by their bank or payments provider to process that transaction.

These fees are then generally passed on to customers, either indirectly through higher prices for goods or services, or directly via card surcharges. Reserve Bank research found that in 2022 more than 7% of card payments attracted a surcharge.

As Dominic White, chief product officer at Tyro Payments explains, not every transaction will attract the same cost though. When it comes to debit card payments, for instance, there are three payment networks in Australia which charge different fees.

"There's Eftpos, which is Australian, domestic-only and owned by a group of big retailers and banks. Then you've got Visa and Mastercard which are obviously large global companies.

"Then it gets really complicated. There are 50 to 100 different rates for transactions within the Visa and Mastercard networks which you can see by searching for interchange rates on their websites.

"For example, a fully authenticated transaction that is less risky will attract a lower cost than an online transaction. So something like an everyday supermarket transaction might be deemed less risky."

Mastercard and Visa are the cheaper options when it comes to credit cards according to merchant fee data collected by the Reserve Bank - at least, when stacked up against their competitors American Express and Diners Club.

Whereas Eftpos has consistently had lower fees for debit card transactions than Mastercard or Visa, though the average Eftpos fee has ticked up in recent years.

What is least-cost routing?

Given that debit accounts for the vast majority of card payments in Australia, there's been an ongoing move to help bring down the cost of debit payments: an initiative called least-cost routing (LCR).

"The idea that the Reserve Bank and a number of regulators around the world have had for quite a few years now is that, on debit products, the payment provider should be able to route that transaction through the least-cost network in order to drive competition in the system," White explains.

For example, if a customer goes to pay with a debit card that's enabled to work with both the Eftpos and Mastercard networks, the transaction will automatically be made via the cheaper of the two.

Simply put, the theory behind least-cost routing is that it will benefit businesses who will pay lower merchant fees, and customers who will be on the receiving end of lower costs. It will also encourage competition among payment providers who will then lower fees even more.

The transition to least-cost routing isn't moving at the speed desired by the RBA though. In a speech to the Australian Payments Network Summit in December, governor Michele Bullock noted that LCR uptake was around 54% - well below the central bank's 80% target.

"While some progress has been made to enable LCR for businesses, it has been slow. So formal regulation may be required to get acquirers and other service providers to deliver the full benefits of LCR to businesses."

Despite least-cost routing being available to all Tyro customers, White says that only 65% have taken it up so far, though he expects that to reach 80% by the end of the financial year.

Part of the issue is down to a lack of awareness about the benefits it can bring, but White also says that some businesses are simply unsure if it will be right for them.

"Why hasn't everybody in the market taken it up? A simple example is that Eftpos charges on a flat cents per transaction basis whereas the international card schemes charge on a percentage of the transaction.

"So if you run a cafe that has small transaction sizes, like $5 for a cup of coffee, Eftpos might not be the cheapest option because they will get charged that cents per transaction. Whereas with a Visa or Mastercard transaction, it might be 1-2% of that $5."

Are card surcharges really legal?

It might be a frustrating part of paying at the checkout, but businesses are well within their rights to charge their customers a surcharge for using a card to pay.

Of course, not every business will. But for those that do surcharge, there are a few important rules that they'll need to follow.

Back in 2017 the Australian Competition and Consumer Commission (ACCC) announced that all businesses would be banned from lumping their customers with excessive surcharges. Instead, surcharges can now only reflect the true cost of accepting a card payment.

The ACCC also says that if there are payment options available that won't incur a surcharge, these should be prominently displayed so that customers can make an informed choice.

What if there are no options to pay without incurring a surcharge though? Again, businesses are free to do this, but they must ensure that the minimum surcharge payable in displayed in the price of whatever goods or services they're offering.

For example, a shop selling sandwiches for $15 would need to display the price as $15.10 if the lowest surcharge available was 10 cents for anyone wanting to pay with a debit card.

For a more thorough explanation of business obligations and consumer rights check out the ACCC's article on card surcharges, or for information on service fees and weekend surcharges read our piece on the surcharges you need to look out for.

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Tom Watson is a senior journalist at Money magazine, and one of the hosts of the Friends With Money podcast. He's previously worked as a journalist covering everything from property and consumer banking to financial technology. Tom has a Bachelor of Communication (Journalism) from the University of Technology, Sydney.