In a history making live webcast, the Federal Reserve Board announced proposed debit card Interchange rates and rules under the controversial Durbin amendment of the Dodd-Frank financial reform act. Noting the short time frame provided by the bill to undertake such an important and complex issue, the Fed voted unanimously to submit proposed debit rule recommendations for public comment.
In the debate over fees, the Fed is looking for input on the provision requiring debit Interchange to be “reasonable and proportional” to the cost that card issuers incur. The Fed is proposing to two alternatives: a $0.07 safe harbor price along with a $0.12 cap or a $0.12 cap for all transactions. When questioned about the choice to set price, the Fed argued that by placing values in the standard, it provided an economic incentive for greater operational efficiency. They also cited lower compliance costs. In establishing these prices, the Fed was directed to compare similarities between debit cards and checks that clear at par. They decided to limit debit cost considerations to authorization, clearing and settlement functions because checks are not authorized, but did not include the cost of rewards programs or the cost of operating cardholder help desk. Small bank issuers, prepaid and government cards have an exemption to this part of the regulation; however the effectiveness of this exemption is in question.
The Fed also put forth proposals dealing with the requirement that all debit cards operate on at least two competing networks. There are no debit issuers that are exempt from this part of the regulation. Again, two alternatives were suggested. The first would require a card to have two unaffiliated networks, one signature debit and one PIN debit. However, since the majority of merchants do not have the ability to accept PIN debit this is not considered a viable routing option. Therefore the second proposal, favored by the Fed,requires two unaffiliated signature debit networks and two unaffiliated PIN debit networks per card.
Two fraud prevention adjustments under consideration include the introduction of “major innovation” and a review of other reasonable fraud programs. However it was suggested that these rules will not be finalized by the time the law goes into effect. There was no discussion of the actual costs of fraud and no distinction between signature and PIN debit rates so apparently PIN security is not under consideration.
It will be interesting to follow the comments to these proposals. The major issues appear to be the difficulties of implementation and the unintended consequences of such major government regulatory intervention. The Fed noted in their research on the cost of delivering debit that some issuers have very high cost today (more than the current Interchange revenue they take in) while other large issuers have very low cost that skewed their analysis. Will this mean only a few very large issuers survive, resulting in limited consumer choice? What will be the impact on small community bank issuers that were to be exempt from this regulation? The Fed is suggesting that it may be too costly for the card brands to maintain two debit prices (one regulated and one exempt) and even if they go to the added expense of doing this, there is no way to recover this costs and, in the end, it may prove useless if merchants effectively steer consumers. Market forces from the network routing choices will also impact the true viability of the exemption. How will merchant acquirers, POS terminals and the merchants themselves manage two or perhaps four unaffiliated network choices on a single card. And how do you route a Visa account number through MasterCard anyway? Will banks need to issue debit plastic with both a MasterCard logo and card number and a Visa logo and card number? How expensive and confusing is debit going to get and will issuers continue this line of business with pricing caps set below the full cost of delivery and compliance much less a reasonable profit?
One can envision many small bank issuers getting out of the business. Others are likely to join in the legal battle already under way. Currently the Durbin Amendment is being challenged in a lawsuit from Minneapolis’ TCF National Bank on the grounds that the law goes too far. Obviously the Durbin Amendment will hurt community banks and credit unions, which will impact small businesses and consumers alike. The outlook for consumers includes higher bank fees with reduced benefits, choice and service. What looks like a big win for national chain merchants now, could back fire if banks move consumers to higher priced credit with incentives or start charging consumers for issuing and using debit. It is reasonable to expect banks will find ways to make up for lost income with higher fees on other payment services like increasing the cost of handling cash, checks and ACH processing. And if exemptions fail to protect small banks and credit unions, driving them out of issuing or out of business, it too will have a negative impact on small and mid sized community businesses.
With the cuts to Interchange revenue so deep, it appears the future of America’s favorite payment method - the debit card, is in doubt.