By Mark Brady and Ross Federgreen
CSRSI, The Payment Advisors
The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed by President Obama on July 21, 2010, is now the law of the land. Included in the act is the Durbin Amendment, a provision in the final bill aimed at debit card interchange fees and other issues to increase competition in payment processing.
Section 1075 of the Act ("Reasonable Fees for Rules and Payment") offers implications for acquirers and issuers. The Federal Reserve Board still has to write specific rules for implementing the new regulation; the devil will be in the details. The following discusses some of the major points of Section 1075 and provides our take at this point in time. Issuers must provide costs to justify debit interchange rates
Section 1075 states that "the amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer." This is the most far-reaching piece of Section 1075. Experts predict electronic debit may surpass cash in the next few years. According to the National Retail Federation, merchants pay approximately $20 billion annually in fees for accepting debit cards. American Banker's PaymentSource.com estimates that if debit fees are cut by 50 percent, $4.15 billion in interchange fees for Visa Inc. issuers and $1.45 billion for MasterCard Worldwide issuers would be eliminated. As such, the stakes are significant.
Several years ago MasterCard and Visa justified interchange rates, at least in part, on a cost basis. They now promote their product based on value. For example, in January 2010, The New York Times reported that, according to Visa, merchants' cost for accepting debit hasn't gone down because the cards provide greater value than they did previously and that merchant acceptance has doubled in the last 10 years, so the costs of accepting debit cannot be too onerous.
The article also quoted Elizabeth Buse, Visa's Group Executive, International, who said the fees are "not a cost-based calculation but a value-based calculation" and William M. Sheedy, Visa's President for the Americas, who said, "Debit has become so mainstream, some of the people who have benefited have lost sight of what their business model was, what their cost structure was."
The Fed is requiring issuers to provide information biannually on costs "in connection with the authorization, clearance or settlement of electronic debit transactions." It further stipulates that "costs incurred by an issuer which are not specific to a particular electronic debit transaction shall not be considered."
Section 1075 states that the Fed may allow for "an adjustment to the fee amount received by an issuer if such adjustment is reasonably necessary to make allowance for costs incurred by the issuer in preventing fraud in relation to electronic debit transactions."
Given that fraud rates for signature debit are much higher than for PIN debit, it will be interesting to see how issuers and the Fed deal with that aspect of the law. Will the Fed address the issuer promotion of signature debit versus PIN debit due to higher fraud rates for signature? Or will the Fed disallow a portion of signature debit fraud from issuer's cost calculations?
Also, Section 1075 states "any fraud-related adjustment of the issuer ... takes into account any fraud-related reimbursements (including amounts from chargebacks) received from consumers, merchants or payment card networks in relation to electronic debit transactions." This appears to say fraud-related chargebacks issuers return to merchants (and are not successfully represented back to issuers) must be removed from the issuers' interchange cost workups. Many fraud related chargebacks are not returnable to issuers per MasterCard and Visa rules. Will the Fed require issuers to eliminate these chargebacks from their cost workups?
Finally, the law allows issuers to include data security costs in their fraud calculations. While issuers certainly incur costs for data security, it is the acquiring side of the business that is responsible for data security breaches. These acquiring costs include reimbursement to issuers for new card reissuance in the event of data security breaches. Will the Fed consider these acquiring data security costs in the issuer interchange cost calculations?
The cost data will provide the Fed significant information about this market - information issuers may not be happy to provide. In 2009 the Government Accountability Office requested some of these costs and had a difficult time obtaining this information.
The Fed intends to prescribe the new regulations no later than nine months after the law was signed. This means the new interchange rates will probably be determined in the first quarter of 2011 or early second quarter.
Section 1075 states that the regulations will not apply to any issuer that, together with its affiliates, has assets of less than $10 billion. As such, most U.S. banks will be exempt from Dodd-Frank, even with their affiliates included. How will these banks react to their exemption? How will it affect their merchant business? Will they be helped or hurt?
Governments appear to have exempted themselves from the interchange transaction fee regulation for "a debit card or general-use prepaid card that has been provided to a person pursuant to a federal, state or local government-administered payment program." The U.S. government was obviously concerned about the debit card issuing impact on its own government card programs.
The regulators appear to be concerned that the card companies will substitute increased network fees for interchange rate decreases. As such, the Fed will "prescribe regulations to ensure that a network fee is not used to directly or indirectly compensate an issuer with respect to an electronic debit transaction, and a network fee is not used to circumvent or evade the restrictions of the regulation."
Also, issuers may not restrict the number of payment card networks on which an electronic debit transaction may be processed. This may help MasterCard, which trails Visa significantly in debit card transaction volume. Concern also exists among issuers that the United States will further pressure MasterCard and Visa to lower network fees.
The law allows merchants to establish minimum and maximum dollar values for credit card transactions: "A payment card network shall not, directly or through any agent, processor, or licensed member of the network, by contract, requirement, condition, penalty, or otherwise, inhibit the ability ... to set a minimum or maximum dollar value for the acceptance of credit cards." Merchants may not differentiate between issuers or between payment card networks, and the minimum dollar value may not exceed $10.
Minimums at the POS are much more pervasive than maximums and are bound to confuse merchants, as the new rule does not apply to debit card transactions. Many transactions under $10 involve signature debit cards. Clerks at the POS are going to have a difficult time distinguishing between debit and credit cards; they will understandably think the $10 minimum applies to all cards. It's bound to result in confusion at the cash register.
The regulation also allows maximum limits to be set by merchants, specifically citing "institutions of higher education." Colleges and universities have been among the most likely entities to set maximums. Again, maximums may not differentiate between issuers or between payment card networks and apply to credit card transactions only.
The regulation stipulates that networks may not "inhibit the ability of any person to provide a discount or in-kind incentive for payment by the use of cash, checks, debit cards or credit cards to the extent that - the discount does not differentiate on the basis of the issuer or the payment card network." The discount must be applied to the advertised price of the item or service. As such, a "card price" cannot be added to the regular price of an item in the form of a surcharge.
The card brands and issuers appear to have given up little here, except that merchants can now offer a discount for, say, PIN debit. As the MasterCard and Visa rules are now written, discounts for cash are allowed under these conditions. These cash discounts have been common in gas stations for several years.
It's difficult to predict whether the new discount provisions will be utilized by a significant number of merchants, especially small merchants. Many big-box and wholesale or warehouse merchants do not offer discounts for entering a PIN at the POS, but they make sure a PIN pad is right in front of the customer at checkout.
MasterCard, Visa and card issuers may have successfully avoided repeating their Australian experience several years ago when courts in that country allowed merchants to surcharge transactions. Over the next several months, as the Fed issues drafts of the new regulations, there will be more to say about the Dodd-Frank Act and it's implications for the major card brands, issuers and acquirers. Stay tuned.
Mark Brady is a Team Member at CSRSI, The Payment Advisors, a leading electronic payment consultancy specifically focused on the merchant. You can reach him by email at firstname.lastname@example.org or by phone at 866 462 7774, ext. 5 Ross Federgreen is founder of CSRSI, The Payment Advisors. He can be reached at 866-462-7774, ext. 1, or email@example.com.
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