Think Tank: Widespread Move to Open-Loop Payments in U.S. Remains ‘Elusive;’ High Interchange Partly to Blame

Vladimir Timofeev

Open-loop payments can improve the customer experience, helping transit agencies win back customers in a post-pandemic world while also reducing cash-handling costs and speeding up boarding times, according to a new report from the Brookings Institution, a major think tank in the U.S.

But widespread adoption of open payments has “remained elusive” for U.S. transit agencies, with only a handful of agencies having rolled out the technology to date. Among the reasons are high interchange rates when customers tap their credit and especially their debit cards to pay for rides.

“Bus costs $2 but swiping debit card can cost 25 cents or more for transit agency to process. Our payment system doesn’t work well for micro-digital payments,” wrote the report’s author, Aaron Klein, on Twitter today.

In the report, Klein, a former U.S. Treasury Department official, now a senior fellow at Brookings, also pointed to costs for agencies to buy and install new hardware to introduce open loop, as well as challenges they face in ensuring equity for unbanked and underbanked customers. That’s in addition to the need to accommodate such riders as seniors and disabled persons, who are eligible for concessionary discounts.

This, plus the high bank-card fees and other challenges–such as “limited competition in the U.S. fare equipment market”–help explain why U.S. transit agencies appear to be lagging behind other categories of merchants in the move to digital payments, said the report.

“These problems form a perfect storm when it comes to transit agencies,” wrote Klein in the report, “How Better Payment Systems Can Improve Public Transportation.”

 “Public transit has a large share of low-dollar, high-volume payments,” he said. “Transit agencies face unique challenges in adapting their fare payment systems to best meet the needs of riders while simultaneously solving concerns regarding user ease, speed, interoperability and costs.”

Fixed Interchange Costs Cause Problem for Agencies
Klein, whose bio says he helped write and secure passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, while serving as deputy assistant secretary for economic policy for the Treasury Department, devoted a significant portion of the report to the problems transit agencies face in accepting debit cards regulated by the Durbin Amendment, which is part of the act.

Durbin resulted in a “two-tier pricing” model for debit cards, based on the size of the issuing bank, he noted. Debit cards issued by smaller banks, those with less than $10 billion in assets, are not regulated by the law. But the vast majority of debit cards are issued by banks that do fall under the act. The law effectively capped interchange at a fixed $0.22 per transaction plus 0.05% of the transaction amount.  

As a result of the legislation, average debit transaction costs fell by around 50%, but the decline is highly dependent on the size of the transaction, said Klein.

Research by the U.S. Federal Reserve Bank of Richmond, Va., found that low-value transactions showed only a small decline in transaction costs “and in some instances actually experienced an increase in costs.”

Klein looked at six months of transaction reports, from July through December 2021, for four transit agencies piloting open-loop payments under the California Integrated Travel Project, or Cal-ITP.

These agencies, which include Monterey-Salinas Transit and Sacramento Regional Transit, accepted a combined 19,904 transactions from Visa- and Mastercard-branded cards and card credentials on NFC devices during the six-month period. The transactions totaled $72,079, with an average transaction size of $3.62. The merchant service charge, that is, the total bank card costs for the transit agencies to collect those payments, were $4,983.12. That works out to an average of $0.25 per transaction, Klein noted.

U.S. Agencies, especially small ones, often can’t aggregate transactions to increase the size of individual transactions. This means that fixed debit card fees hit the agencies particularly hard.

In California, this resulted in the agencies spending just under 7% of the fare revenue they collected from their open-loop trials on interchange and other bank card fees.

“Losing 7% of total fare revenue in transaction costs is significant,” said Klein.

He added that the costs appear to be in line with those disclosed earlier by Mobility Payments, linking an article that appeared in the publication last May.

Costs for Open Payments ‘Can be Uncertain’
A table in the report breaks down the $4,983.12 in bank card fees the California agencies paid. It shows that 72% of the fees came from interchange, 15.9% from network assessment or “scheme fees” and 12.1% from acquiring fees. (See table on this page.)

Another table shows that riders paid for 59% of their transactions with regulated Visa-branded debit cards or card credentials in NFC devices, with another 4.9% from Mastercard-branded regulated debit cards or credentials. The other transactions were from credit cards, unregulated debit cards and prepaid cards or credentials. (See second table on this page.)

“The cost of adopting open payments can be uncertain, and transit agencies that adopt open payments may find that they end up paying a higher percentage of fare revenue in fees than they had expected,” said Klein in the report, adding: “The question of how much transit agencies are paying to collect fares, including via open payments, is often not transparent to riders, taxpayers or local officials.”

He also cited another Mobility Payments article, describing a temporary interchange fee Visa is offering specifically for transit agencies. The rate is believed to be limited to agencies adopting open loop in California. As Mobility Payments has reported, Visa has not said whether it will make the rate permanent or expand it to other regions. The payments scheme, in fact, is not believed to have publicly acknowledged it is offering the special transit interchange rate at all, despite documented evidence. The lower rate is for transaction amounts under $5.

Challenges ‘Not Insurmountable’
Klein writes that “transit agencies and financial institutions are working together to develop solutions to these challenges, but greater innovation in this space is needed to encourage the widescale adoption of open payments in transit.”

He recommends several concrete steps that transit agencies and payments system providers could take.

First, he calls on payments schemes to offer lower interchange costs for transit agencies. This could entail offering transit agencies lower fees via negotiation or changing the fee structure to set up an interchange category specifically for transit agencies, as Visa has done in California.

In addition, Klein said that transit agencies should consider a “broader set of factors” when they make the decision to move from closed- to open-loop payments. This includes being mindful of the impact of offering incentives for riders to load larger sums of prepaid value onto their closed-loop cards. These incentives often put lower-income riders at a disadvantage.

Also, agencies should look at solutions that providers in other high-volume, low-dollar sectors–such as parking, electric-vehicle charging and tolls–have adopted for accepting open-loop payments.

And agencies should be aware of the possible impact of bank overdraft fees on low-income riders who use debit cards to pay for transit.

In the end, for larger transit agencies, it’s not a question of if they move to digital payments, including open loop, but when, said Klein.

But for U.S. agencies, in general, “as long as payment transaction costs remain elevated, the benefits to these agencies of moving toward open payments are more limited, reducing incentives for many transit agencies to move forward with the capital investment required to transition,” he said.

Update: Klein disclosed in the report that his research on open loop was funded in part by the Capitol Corridor Joint Powers Authority, or CCJPA. The agency oversees a commuter and intercity rail service in Northern California and plans to introduce open-loop payments under the Cal-ITP program. Klein said none of the findings, interpretations or conclusions in the report were influenced by any of the funding. End update.

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