Update: It's Official. The financial regulatory overhaul bill finally became law when President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Interchange regulation makes the cut as the House and Senate reconciled their differences on Senator Durbin’s amendment to the proposed Restoring American Financial Stability Act of 2010. The proposed Interchange amendment compromise must still survive a bipartisan conference committee.
If the bill is passed, the Federal Reserve Board would gain the authority to establish rules and regulations related to the Interchange fees that issuers could earn with respect to debit card transactions. The Federal Reserve would have nine months to set Interchange fees and one would expect that they would provide several months after this decision for the payment industry to implement these changes.
With the prospect of debit Interchange falling, merchants should start now to position themselves to take advantage of these developments. The first and most important step merchants should take is to look at their merchant account pricing plan. Merchants may not benefit from lower debit Interchange if their merchant rates are billed on a bundled, blended, tiered, or non-qualified surcharge basis. If you are not on a direct Interchange pass through pricing plan already then you should take action now. Open your browser and keyword search "merchant Interchange rate quote" or simply visit http://merchantrates.com for an instant quote.
Highlights of the Durbin Interchange amendment modifications with commentary
Exemptions for government administered cards & reloadable prepaid cards
The latest version of the debit Interchange amendment exempts federal, state and local government program debit and prepaid cards from Interchange regulation. The compromise exempts reloadable prepaid debit cards from Interchange regulation. The compromise is an attempt to protect the unbanked from being driven to payday lenders and other non-bank entities for their financial needs.
Viewpoint: This means that bank issuers will earn Interchange as set by MasterCard and Visa, not as mandated by the Fed, for these debit card products. It just so happens that this is the fastest growing segment of debit card issuing, covering everything from government benefit programs to corporate paycard programs for direct deposit of payroll. If the Fed cuts debit Interchange too far, one can envision banks moving more and more consumers to exempt prepaid card accounts. Instead of drawing off your checking account balance, your bank may simply force you to transfer funds to your prepaid account.
Already banks are evaluating the profitability of their debit card programs in light of changes to Regulation E, where the Federal Reserve will require that customers opt into POS overdraft protection. As a result of these new rules fewer debit card transactions will be approved, which means both lower Interchange income and less overdraft-fee income. Obviously banks will be forced to replace this lost income. Many in the payments industry believe that cardholders will be the biggest losers as a result of this latest Interchange legislation. Banks will be exploring all their options but it is likely consumers will now face a future of new fees and reduced benefits, including the possible introduction of monthly fees on checking accounts or higher minimum balances on free checking accounts.
Definition of Interchange transaction fee
The compromise amendment now provides for the Fed to regulate debit Interchange, but not network fees that Visa and MasterCard charge for themselves, as long as they are not used to circumvent Interchange fee regulation.
Viewpoint: Visa Inc. and MasterCard Inc. share prices dropped in May but climbed on the announcement of this revision, freeing Visa and MasterCard to continue to set and charge Dues & Assessments, Access fees, International and Cross Border fees, Penalty fees, etc. on all transactions that flow through their networks.
Fraud prevention costs
The compromise provides that the Fed can adjust the Interchange rate received by a particular card-issuing bank if the bank demonstrates that the adjustment is reasonably necessary to cover fraud prevention costs incurred by the bank.
Viewpoint: There would be an application process and the outcome here could mean that every bank has its own unique debit Interchange as decided by the government. Loss rates rose 43% on signature debit cards and 24% for PIN-debit cards in 2009, according to a Pulse EFT survey of the debit market. With the U.S. still stuck on legacy mag-stripe payment technology, these numbers are likely to grow. How the Fed will treat different banks differently will be interesting if not political.
And of course, it’s easy to imagine that while debit Interchange may go down, the cost to manage all these different possible rate schedules will increase. Where one set of Interchange is in place for all banks now, having a unique Interchange fee schedule by bank will raise the costs to process, fund and bill merchants for debit card payments under all these new government regulations.
Discounting between card networks
This compromise includes a provision directing the Fed to issue rules preventing card networks from requiring that their debit cards only be used on one debit card network. Removed from the amendment is the ability for merchants to offer customers a discount to use one card network vs. another.
Viewpoint: Many merchants who have PIN pads often employ so-called PIN prompting when a debit card is swiped. I’ve not read where PIN debit network rates are regulated under this proposed legislation. PIN debit rates have been rising faster than signature debit costs, with new announced rate increases almost monthly (see the past 5 year history of Interchange changes). If PIN debit is also exempt we may see banks changing their tune and pushing PIN at the POS. For a long time now, banks have been accused of steering their cardholders to signature to earn higher Interchange. If this is true then merchants can expect this experience repeated in favor of PIN. Will banks simply remove the MasterCard or Visa logo from our debit cards?
Discounting between forms of payment
The original Senate amendment provided that card networks cannot prevent merchants from offering a discount for one form of payment vs. another (cash vs. check vs. credit vs. debit). The compromise clarifies that these discounts cannot be offered if the discounts differentiate between card issuers or card networks. The compromise further clarifies that the discount must be offered to all prospective buyers and disclosed clearly and conspicuously to the extent required by federal and applicable state law.
Viewpoint: Merchants will need to consider all the relative costs of the different payment options, compare each to set pricing policies and plan a way to manage, disclose, educate and steer their customers’ payment choices. While merchants under current rules are able to provide a lower cash price, few do it today. Probably for a reason that a new study from Lightspeed Research, titled “U.S. Consumer Card Spending: The Potential Impact of the Durbin Amendment,” found; 88% of consumers oppose the idea of being charged a higher price for using credit or debit for a purchase, while only 44% are in favor of receiving a discount for using cash.
And will more mega banks, which are specifically targeted under this legislation, turn to American Express for debit card issuing in order to earn more fee income? I’m unable to determine if this legislation impacts AmEx as they are a closed loop payment system where there is no Interchange per se. If it is true that consumers drive payment acceptance terms more than merchants, could it be that merchants will eventually try to steer consumers to MasterCard and Visa with discounts?
Setting of maximum/minimum transaction thresholds
The compromise says a minimum may not exceed $10 and that the Fed may decide at some point to increase that dollar amount. The compromise also limits the ability to set maximums for payment to the Federal government and colleges and universities.
Viewpoint: Both PIN and signature debit card transactions are still in a growth mode primarily by replacing cash at the point of sale. 58% of debit transactions are now less than $20. The Lightspeed Research study also revealed that for purchases under $10, fully one-third of all consumers prefer using plastic to cash and more than two-thirds of U.S. consumers oppose the idea of not being able to use a debit or credit card for small-dollar purchases. 53% indicate that they would not shop as often at stores that imposed limitations.
The research results confirm what we already know about payments, that consumers alter their shopping behavior based on merchants’ payment acceptance policies. While the median debit transaction declines and consumers increasingly favor debit cards for small-ticket transactions, it will be interesting to see if merchants will adjust their payment policies.
Non-discrimination between cards issued by different banks
The amendment says merchants may not discriminate between debit or credit cards on the basis of the issuer who issued the card.
Viewpoint: Exempt from this legislation are community banks and credit unions with assets of less than $10 billion, or 99 percent of all U.S. lenders. Depending on which bank issuers are in your town, you may or may not see debit fees impacted that much since the debit Interchange fees they collect are, in theory, to remain unchanged. The exemption would make their cards more expensive for merchants to accept than those issued by bigger banks. Does this put them at a disadvantage compared to large issuers? Or will consumers flock to community banks who, with higher debit Interchange, will be able to continue to provide key benefits like free checking or even debit card reward programs? If more consumers bank with credit unions and community banks, will that simply result in debit Interchange as usual?
Authority of the Federal Reserve Board vs. the Consumer Financial Protection Agency/Bureau
The amendment provides that regulatory authority shall remain with the Fed.
Viewpoint: Some experts believe Interchange fees merchants pay for debit card purchases could be cut by 50% to 75% while others think that the Fed will be much more conservative and not make drastic cuts given the impact they believe it will have on the health of the banking recovery and consumers. If the Fed doesn’t lower standard debit programs by much, the numerous exemptions, added complexity and compliance costs may offset the benefits to small and mid sized businesses.
One thing is for sure, these added regulations will have an impact on the payments industry now and lead to more and more government regulations trying to keep up as the market adjusts around them. And Vantage will be here to guide our clients through any changes.
As your merchant services provider, Vantage receives no part of Interchange. Our goal is to help our clients manage Interchange qualifications to achieve the lowest bottom line costs. By direct pass-through of all Interchange categories, Vantage clients will realize an immediate savings once any debit fee reductions are enacted.