Debit Interchange Would Get a 12-Cent Cap Under Fed Proposals

Debit card interchange fees would take a draconian cut under two proposals that the Federal Reserve Board floated on Thursday. Both would set caps of 12 cents per transaction, caps that would take most of the profit out of many transactions, especially signature debit. The board also left open the possibility that a debit card could access both the Visa and MasterCard networks for signature transactions, a far-reaching option large retailers sought.

The Fed offered the proposals as part of its mandate under the Dodd-Frank Wall Street Reform and Consumer Protection Act that President Obama signed last July. The law’s Durbin Amendment calls for the Fed to devise regulations that would ensure “reasonable and proportional” debit card interchange applicable only to banks and credit unions with more than $10 billion in assets. The law also says debit card issuers must offer so-called unaffiliated network options for transaction routing and bans issuers and payment card networks from limiting merchants’ choice in routing debit transactions.

The National Retail Federation, which strongly supported the amendment sponsored by Senate Majority Whip Richard Durbin of Illinois, praised the Fed’s proposals. “Any reduction in debit card swipe fees at all, large or small, is a benefit for consumers because retailers are highly competitive and will share that savings with their customers, but the law requires a major reduction,” NRF senior vice president and general counsel Mallory Duncan said in a statement.

But those opposed to interchange regulation were disappointed. “My forecast from the get-go that debit interchange would be reduced on the order of 90% because the Fed would adhere to what Congress instructed it to do in the text of the legislation was borne out,” says consultant and former Visa executive Eric Grover of Menlo Park, Calif.-based Intrepid Ventures. “The chorus of analyst wishful thinking that the reduction would be only 50% because that was ‘reasonable’ has been shown to be just that: wishful thinking.”

MasterCard Inc. general counsel Noah Hanft said in a statement that, “This type of price control is misguided and anti-competitive, and in the end is harmful to consumers.” Statements from Bank of America Corp., the largest debit card issuer, and Visa Inc. and were not immediately available.

Minneapolis-based TCF National Bank, a big debit issuer that is suing the Fed in a challenge to the Durbin Amendment’s constitutionality, said its average debit card yield is 1.35% of the sale (Digital Transactions News, Oct 12). With a 12-cent cap, TCF on a typical $40 debit sale would seemingly sustain a cut of 42 cents, or 78%, on a transaction that would have generated 54 cents without regulation.
 
In their first-ever Webcast meeting, the Fed’s governors, headed by chairman Ben S. Bernanke, heard proposals their staff developed after months of meetings with banks, merchants, payment networks, consumer groups, and others. The staff also surveyed debit-industry players about their expenses. The proposals will be published in the Federal Register as part of a 60-day comment period before the Fed takes final action.

In accordance with the parameters set by the law, the staff recommended allowing issuers to recover costs directly related to the authorization, clearing, and settlement of electronic debit transactions, but not other costs, such as card production and distribution, general costs of deposit accounts, branch costs, and other overhead. (The Fed is asking for comment on a proposed adjustment for fraud-control expenses.)

Under what the Fed staff calls Alternative 1, each issuer could calculate its average variable cost for authorizing, clearing, and settling a transaction, with a cap of 12 cents. If they didn’t want to do so, an issuer could invoke a “safe harbor” of 7 cents. The staff report says 7 cents is the median issuer’s average variable cost for authorization, clearing, and settlement. Issuers with costs in excess of the safe harbor would be permitted to recover those expenses up to the cap, but they’d have to report their expenses. The 12-cent mark corresponds to approximately the 80th percentile of allowable costs of issuers that responded to the survey.

“Setting a cap ensures that no issuer is able to receive an interchange fee at an unreasonably high level,” the report says. “Without a cap, issuers that choose to report their costs to receive an interchange fee above the safe harbor would not have an incentive to control cost, compared to those issuers that accept the safe harbor, because they would receive no mark-up on costs. With a cap however, these issuers would have an incentive to control their per-transaction costs to keep them below the cap.”

Alternative 2 is simpler—any interchange fee at or below 12 cents would be permitted.

The Fed also proposed two provisions to implement Dodd-Frank’s ban on exclusive network affiliations and restrictions by issuers or networks on merchants’ freedom to route debit transactions as they wish. (An example of an exclusive affiliation is a card that only offers Visa for signature transactions and the Visa-owned Interlink network for point-of-sale PIN-debit.) Under Alternative A, each debit card could access one signature and one unaffiliated PIN-debit network. In those increasingly rare types of cards that don’t offer both a signature and PIN choice, a card that didn’t offer PIN-debit could access two signature networks, and a PIN-only card could access two such networks.

The disadvantage of that rule is that it would do little to promote network competition because 6 million of the 8 million U.S. merchant locations that take debit cards do not accept PIN debit, according to Mark D. Manuszak, economist in the Fed’s Financial Structure Section. Thus, a card with just one option for both types of debit would limit merchants’ routing choices.

Under Alternative B, each card offering a signature and PIN option would have to offer access to at least two unaffiliated signature networks (effectively Visa and MasterCard, though Discover might be an option for some banks) and two unaffiliated PIN-debit networks. The Merchants Payment Coalition, a consortium of big retailers, proposed just such a radical option (Digital Transactions News, Dec. 14). But staff members acknowledged that Alternative B has drawbacks. “Such a requirement would entail substantial operational changes by debit card networks, issuers, merchants, merchant acquirers, and their processors,” Manuszak told the board.