September 2022 – If a German tourist withdraws cash from an ATM in Prague, the ATM screen may display a choice whether the tourist’s euro account should be charged in the currency of their account (i.e., euro), or in the local currency – Czech koruna. If the tourist chooses the former, they opt for the so-called Dynamic Currency Conversion (DCC) service.
DCC is a service enabling instant currency conversions for card-based transactions. DCC was introduced in 1996 to allow cardholders to pay in their home currency when making payments in foreign currencies. This can be either an ATM withdrawal or a card payment at a point-of-sale (POS) terminal in a foreign country. By using the DCC service, the amount of the transaction in the local currency is instantly converted into the currency in which the cardholder's account is held.[1]
How DCC works
When making payment card transactions abroad, cardholders may be offered an instant conversion of the transaction amount into the currency of their account. This means that the cardholder’s account will be charged in the cardholder’s home currency rather than in the local currency, and the cardholder will immediately know the exact amount to be deducted from their account. The currency conversion is carried out by the payment service provider operating the ATM or payment terminal, if DCC is provided at a POS. Otherwise the payment card issuer makes the currency conversion if the DCC service is not selected.
DCC service may appear attractive because the currency conversion takes place instantly at the POS, and the cardholder knows in real time how much they are charged in their home currency. By contrast, if the DCC service is not selected, the cardholder does not know the exact amount to be deducted from their account until the transaction is settled and the cardholder views their account statement. Proponents of DCC have pointed out that people tend to feel more comfortable using their home currency, as this eliminates the uncertainty regarding the currency conversion rate. This may be especially convenient when making payments in lesser-known currencies, where the cardholder does not know the market exchange rate.
Criticism
Despite its advantages, several studies indicate that paying in the cardholder’s home currency by using the DCC service is generally the more expensive option.[2] DCC has long been a subject of criticism on the grounds that DCC providers add a significant margin to the currency exchange rate, making the rates given by DCC providers far less appealing than the market rates at the time of the transaction.[3]
This additional charge might theoretically be justified by the added value of the DCC service. For many people, it may be easier to understand prices displayed in their home currency rather than in the local currency. DCC further eliminates the risk that the currency conversion rate will change to the detriment of the cardholder during the period between the transaction initiation and settlement (some payment card issuers use the exchange rate valid at the time the transaction is settled rather than at the time the transaction is initiated).[4], [5]
The benefits of DCC, however, come at a high cost. According to a 2018 report,[6] DCC transactions generate the highest margins for payment service providers per transaction, followed by surcharges. In Europe, exchange rate mark-ups range from 2.6 per cent to 12 per cent.[7] These figures are in line with findings of the Stiftung Warentest consumer organisation in its 2019 study.[8] While the average mark-up across Europe is around 5 per cent, the study also found an extreme case of 13.7 per cent cost differential from paying in euro rather than in Czech koruna at an ATM in the Czech Republic. The added value of DCC can hardly justify such high margins.
Some may argue that cardholders are free to choose if they wish to use the DCC service or not. As DCC is always an optional service, they have an option to reject DCC and be charged in the local currency. However, it may be difficult for some cardholders to understand the choice – for example when making an ATM withdrawal in a foreign country. Should their euro account be charged in euros or the local currency? The euro may sound more logical at first glance, yet it is usually the more expensive option. Cardholders may thus choose the DCC service without understanding its mechanics and associated exchange rate mark-ups. The less convenient option, with the exchange rate calculated using DCC, also often appears more logical. The DCC option is usually offered on the ATM screen on the right (as a logical next step), while rejecting the DCC service is displayed on the left side of the screen, which some cardholders may interpret as a step back.
In certain situations, cardholders might not even be able to make the choice. For instance, when a customer pays a bill in a restaurant, it may happen that restaurant staff not only inserts the total amount to be paid but also automatically confirms that the amount will be charged in the customer’s home currency. The currency conversion is thus made by the DCC provider (by using the DCC provider’s exchange rate) without the customer’s knowledge.
Finding a solution
Although certain consumer interest groups have called for banning DCC, it may in fact be convenient for cardholders to opt for DCC in certain situations. This could be the case when the cardholder does not know the exchange rate of the local currency in a foreign country. The cardholder might not have access to the internet to check the exchange rate online, and DCC could be the only way to find out how much they are charged in their home currency. Further, it can be argued that DCC service providers promote competition, as cardholders have another option on how to convert the currency. From this point of view, a complete ban on DCC appears disproportionate and overly restrictive.
Another option to regulate DCC is to impose limits on currency conversion rate mark-ups. In 2015, the EU introduced caps on interchange fees for payment card transactions,[9] which effectively decreased the price of card-based payments across Europe. However, it may be complicated to agree on the actual limit of conversion rate mark-ups, especially if the limit is to apply to all currency pairs. As some national currencies are more volatile than others and, therefore, pose a higher risk for DCC service providers, a universal cap applicable to all currency pairs does not appear to be a viable method.
In the EU, lawmakers decided not to ban the DCC service (as it can prove useful in certain situations)[10] nor did they impose a cap on exchange rate mark-ups. Instead, detailed transparency requirements on currency conversion services have been introduced in the revised Cross-Border Payments Regulation[11] to increase consumer protection in the field of cross-border payments. Under the Cross-Border Payments Regulation, the party providing the currency conversion service at the ATM or POS is required to disclose some key pieces of information on the screen before the cardholder authorises the payment. That should ensure that the cardholder makes an informed choice on how to complete the payment. The information includes (i) the amount to be paid in the currency of the cardholder’s account (i.e., the DCC value in the cardholder’s home currency), (ii) the amount to be paid in the local currency[12] (i.e., the non-DCC value), and (iii) the percentage mark-up over the latest available euro foreign exchange reference rate issued by the European Central Bank (ECB).[13]
Currency conversion services at a POS or an ATM must provide this information before the initiation of the payment transaction[14] in a clear and accessible manner, e.g., by displaying this on the ATM or POS terminal.[15] Payment service providers are also expected to make this information available in an easily accessible electronic platform, i.e., on their customer websites and mobile banking applications. In addition, payment service providers must remind the cardholder of their applicable currency conversion charges when a card-based payment is made in a foreign currency through widely used electronic communication channels such as SMS messages, e-mails or push notifications of the cardholder’s mobile banking application.[16]
Assessment of EU transparency requirements
It is good news that the EU did not introduce a complete ban on the DCC service, at it would be an overly restrictive intervention in the payment services sector. Although a cap on currency conversion mark-ups of DCC providers may seem the most straightforward solution, EU lawmakers did not introduce such a cap either. The approach taken by the EU is probably the least invasive of all the options discussed above. The logic behind the transparency requirements introduced under the Cross-Border Payments Regulations is to provide the cardholder with sufficient information about currency exchange rates and charges to make a free and informed decision on whether to opt for the DCC service or not.
Unfortunately, these transparency requirements do not solve the problem where the POS terminal operator selects the DCC option instead of the cardholder. This might be the case, for example, in a restaurant where the total sum of the customer’s spending (including a tip in the amount determined by the customer) is entered into the terminal by restaurant staff. Staff may also tend to choose how the amount will be charged to the customer (and select the DCC option) so that the customer can only initiate the payment transaction by their payment card.
To this end, cardholders would benefit if they could block the DCC service for a particular payment card so that transactions with DCC can never be executed. Technically, this should not be a problem, as some banks already offer this functionality.[17] Unfortunately, the number of payment service providers offering this function is low. A higher level of consumer protection could be achieved if the option to block the DCC service for a particular payment card were available to all cardholders. To this end, the obligation for payment service providers to provide their customers with such an option should be enshrined in law.
Conclusion
Regulatory requirements on DCC introduced by EU lawmakers in the Cross-Border Payments Regulation significantly increase the transparency of the DCC service and enable cardholders to make a free and informed decision whether to use the DCC service or to opt for payment in the local currency. Compared to an absolute ban on DCC or a cap on currency conversion mark-ups, these requirements represent minimal regulatory intervention into the payment services market.
It remains to be seen whether the transparency requirements under the Cross-Border Payments Regulation will solve the entire problem with DCC. The new rules became effective just a few months ago, and it is still early to draw any conclusions. That said, the transparency requirements can only work if cardholders can choose if they wish to opt for the DCC service or not. Cardholders, however, may be deprived of this choice, e.g., if the DCC service is pre-selected by the POS terminal operator. Unfortunately, the rules on DCC introduced in the Cross-Border Payments Regulation do not address this situation. A higher level of consumer protection could have been achieved if each payment service provider were obliged to give its customers an option to block the DCC service for a particular payment card. Unless the payment services providers are required by law to make this option available, it can hardly be expected that they will offer this option voluntarily.
For more information, please contact the author of the article.