Reviews Are in on Fed’s Final Debit Rule: Thumbs Down from Both Retailers And Banks

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The Federal Reserve’s final rule governing debit cards, released on Wednesday, seems to have pleased neither merchants nor banks. Retailer organizations almost universally denounce the Fed’s final rule as “irresponsible” and a departure from the intent of Congress, whose Durbin Amendment to the 2010 Dodd-Frank Act the Fed is implementing.

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Bank executives, meanwhile, express some relief at an interchange allowance higher than originally proposed by the Fed but criticize the rule’s price controls and warn its exemption for small banks won’t work in practice.

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The Fed’s final rule comes after seven months of heated comment and debate touched off by a proposed rule the central bank issued in December. In the final rule, which the Fed board approved Wednesday, issuers with more than $10 billion in assets are limited to 21 cents plus 0.05% in interchange on debit card transactions. The Fed stunned bankers but delighted merchants with its December proposal, which capped interchange at 12 cents, down 73% from a 44-cent average. The final rule, which cuts average interchange by more than 40%, also allows big banks to collect an additional penny on each transaction to recover certain fraud-prevention costs if they follow Fed guidelines.

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The agency also ordered issuers to support at least two unaffiliated debit networks and told banks and card networks to refrain from interfering with merchants’ ability to choose which network to send transactions through.

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Besides the higher interchange cap, banks also won a concession on timing. Most of the Fed’s provisions take effect Oct. 1, about 10 weeks later than the July 21 effective date contemplated by the Durbin Amendment. This follows a dramatic—and heavily lobbied—U.S. Senate vote earlier this month in which a bill proposing a six-month delay on the Durbin Amendment failed to pass.

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Reactions from both retailer and banking interests on Thursday show passions have scarcely cooled in the wake of the Fed’s long-awaited final rule, with both sides expressing dismay and frustration. Merchants, in particular, express shock and anger at the ruling.

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A statement from the Merchants Payments Coalition, a lobbying group of dozens of state and national merchant groups, quotes executives from the National Association of Convenience Stores (NACS) and the Food Marketing Institute, the supermarket industry association. Both groups use the word “irresponsible” to describe the Fed’s action, as did the MPC itself.

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The Fed “made significant concessions to the country’s biggest banks and deviated from the proposed rule and the intent of the law,” the MPC’s statement says. The group held out the possibility of challenging the final rule in court. “The Merchants Payments Coalition is exploring all available legal options to address the irresponsible mistakes made in writing this rule,” according to the statement.

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“I’m disappointed but I understand how wealthy the banking lobby is and how connected they are with the Fed,” Mitch Goldstone, president and chief executive of Irvine, Calif.-based ScanMyPhotos.com, tells Digital Transactions News.

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Goldstone, however, still calls the final rule “a great first step” and says merchants will get a shot at a bigger target in September 2012, when their proposed antitrust class-action challenging credit card interchange goes to trial. ScanMyPhotos is a plaintiff in that suit pending in U.S. District Court in Brooklyn, N.Y. “The big number is credit cards,” he says.

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Banks welcomed the higher cap but, in an argument they have made since the Durbin Amendment first emerged 13 months ago, they also criticized the regulation as an exercise in price control. “It’s still a price-fixing situation, but we’re stuck with it because that’s what Congress told the Fed to do,” says Bob Steen, chairman of Bridge Community Bank, Mechanicsville, Iowa.

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While banks like Bridge are exempt, Steen and other community-bank officials warn that merchants will discriminate against higher-priced cards from exempt issuers. The final rule, Steen says, contains little reassurance for small banks. “There are so many ways retailers can discriminate, and they will do that,” he argues. Meanwhile, he says, the central bank has dealt all banks a hand “that allows us to limp along—we’re not going to make any money.”

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Visa Inc. refused to comment on the new rule in advance of a planned July 6 briefing on its financial outlook. Investors in Visa and MasterCard Inc., meanwhile, greeted it warmly. Visa’s shares closed up 15% Wednesday and MasterCard’s rose 11.3%, though both companies were off about 2% at mid-day Thursday.

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Part of Wednesday’s rise was likely the result of the Fed choosing the so-called Alternative A to implement the Durbin Amendment’s network-routing provisions. The option calls for each debit card to offer one unaffiliated network, such as a PIN-debit network not affiliated with the card’s mark for signature debit, two affiliated PIN-debit networks, or two unaffiliated signature debit networks. Under the more complex Alternative B in the original proposal, each card offering a signature and PIN option would have had to offer access to at least two unaffiliated signature networks and two unaffiliated PIN-debit networks.

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“On this front, the Fed’s decision to go with Alternative A was a welcomed development, as these sets of rules are less draconian and therefore less disruptive to [MasterCard] and [Visa] models,” says an analysis from investment firm Goldman Sachs & Co. A second “incremental positive” for the networks, according to the analysis, is that the Fed’s broader view of interchange now includes issuers’ network costs, not just the authorization, clearing, and settlement costs described in the December draft rule.