How the Fed Has Bungled Durbin

Nearly a decade after the banking regulator’s debit regulation took effect, the legacy has been dramatically higher costs for merchants than Congress intended.

It’s been 10 years since Congress enacted debit card reforms to rein in runaway fees and inject competition via the Durbin Amendment to the Dodd-Frank Financial Reform Act.

Unfortunately, the statute gave the Federal Reserve the authority to develop the ensuing regulations to enact those reforms. The Fed is primarily charged with maintaining the safety and soundness of banks and is conflicted in the role of regulator with respect to debit reforms.

The Fed has failed us all—merchants, consumers, the entire economy—by completely ignoring the clear language in the law. Since the inception of the Fed’s regulation, its actions and inactions have cost merchants and consumers more than $60 billion for debit use in stores, according to estimates from consultancy CMSPI and the Fed.

Total costs have likely exceeded $100 billion once fees related to debit acceptance at online merchants are factored in, along with the fee reductions that should have followed each of the Fed’s own unaudited surveys of the regulated banks.

Furthermore, the Fed has essentially ignored the clear requirements within the law that issuers enable multiple routes for all debit purchases, including online purchases. As a result, online merchants have been denied any opportunity to create competition for online debit purchases (“Routing Rumble,” this issue).

Market Power

It comes as no surprise that, recently, one of the biggest global networks announced increases in fees for using its branded cards for online “purchases (“Interchange: Tweaks Or Trouble?” in Trends & Tactics, this issue). This is further evidence of the market power the networks enjoy over online merchants, which are denied the competition afforded to them by the law by virtue of the Fed’s inaction in enforcing debit routing in the online-payments venue.

While bank executives and shareholders, rewards junkies, and the big networks prosper under the Fed’s oversight, all consumers have suffered and continue to suffer. The cost of payments acceptance is now ranked by most face-to-face merchants as the third highest cost of operation, trailing only the costs of occupancy and labor. For online merchants, it’s often cited as second only to labor.

The high costs associated with payments acceptance factor into the prices all consumers pay for goods and services, including recipients of federal benefits programs as well as those who never use rewards programs.

The banks and the networks have positioned themselves to redistribute wealth by taking away from the poor and giving to the rich by indirectly increasing costs for goods and services and rewarding only those who can afford to enjoy the benefits of their rewards programs.

Those of us who were involved in the political struggle that culminated in the passage of these debit reforms have a vivid recollection of how the Fed mishandled its Durbin regulation, known as Regulation II. We particularly recall the pseudo-logic that it sold to the public, which basically ignored the “incremental cost” mandate in the law.

In promulgating Regulation II:

1. The Fed ignored the plain language of the statute, and instead granted itself broad authority to include costs that clearly fall outside of the incremental costs allowed by the statute in its calculation of the costs incurred by regulated banks.
2. The Fed arbitrarily based the 21-cent fee cap on the costs of the 80th percentile among the regulated issuers that responded to its initial, voluntary survey. This decision flew in the face of the statute’s clear instruction that the allowable fees were to be based upon each issuer’s costs.
3. The Fed awarded issuers a 5-basis-point premium to reimburse them for their fraud losses.

With respect to this last point, despite the fact that U.S. banks and their networks operate one of the most fraud-prone card-payments businesses in the industrialized world, these 5 basis points ironically result in issuers receiving fraud reimbursements that exceed the total amount of fraud. The Fed has essentially turned fraud into a profit center for banks. Remarkable.

A Better Outcome

The Fed’s actions and inactions subsequent to Reg II continue to illustrate the Fed’s contempt for debit reforms, coziness with banks, and disregard for the interests of merchants and consumers. These include:

1. The Fed’s failure to enforce the debit-routing requirements of the law in all channels, particularly online sales, which have grown to account for nearly one-third of all debit transactions.
2. The Fed’s failure to reduce or eliminate the 5-basis-point premium it initially awarded banks when clearly merchants are saddled with increasing responsibility for fighting fraud and for the actual costs of fraud due to the actions of the banks’ networks in shifting liability for fraud to merchants and away from the issuers. The networks tout the efficacy of EMV chip cards in reducing in-store fraud, and yet the premium remains unchanged.
3. The Fed’s failure to reduce the fee cap, even though the banks themselves have informed the Fed that their costs have declined more than 50% since the regulation was put into place.

In contrast to the U.S. Fed, payments regulators outside the United States have administered their laws and regulations far more effectively. Laws curtailing the abuses of the global networks have been passed in Europe, Australia, and Canada, where regulators are more objective and more concerned with sticking to the letter of the law.

Also in contrast to the Fed, international regulators in all of these jurisdictions have mechanisms to periodically review regulations and modify interchange rates accordingly. In the United States, the Fed chooses to review but ignore the results.

The Fed has not acted as an objective regulator, adopting and maintaining a flawed regulation that ignores the law in favor of enriching the big banks. The Fed’s behavior gives us all reason to doubt that it can be trusted to act in the best interests of the country as a whole.

At the very least, the Fed must revise its rule to adopt a rate that is proportional to the most recent survey results. It must also develop an objective mechanism for updating the rate in accordance with the results of future periodic surveys to ensure it is proportional to issuer costs. For all future surveys, the issuer responses must be audited for accuracy and adherence to the regulation.

Merchants and consumers deserve better and Congress surely intended a better outcome than what has been delivered by the Fed!

—Mark Horwedel is a special consultant for CMSPI, an Atlanta-based consultancy.