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The Green Sheet Online Edition

November 13, 2023 • Issue 23:11:01

Payments, a retrospective Insider's report on payments Fed plans debit cap haircut

By Patti Murphy
ProScribes Inc

Debit card issuers may want to start bracing for the fallout from the Federal Reserve Board's latest regulatory initiative: driving down debit interchange rates. In a proposal now out for public comment, the Fed said it wants to slash the regulated debit interchange cap by better than 30 percent. If the proposal is adopted as laid out, the new cap would kick in mid-year 2025.

The plan is to lower the cap to 14.4 cents plus 0.04 percent (4 basis points) of the transaction amount, along with 1.3 cents to cover fraud prevention costs. Since 2011, the cap has been 21 cents and 0.05 percent, plus a penny to cover fraud costs.

Under this proposal, the interchange on a $50 debit card transaction would drop from 24.5 cents today to 17.7 cents, the Fed explained in a press release. And get this, going forward the Fed wants to adjust the cap every two years, based on its own data analysis and without the benefit of public comment.

Fed can't get no satisfaction

By way of background, the Fed was charged with regulating debit interchange under the Durbin Amendment to the 2010 Dodd-Frank Act, the omnibus legislation enacted in the wake of the 2008 financial crisis. But it did not apply to all financial institutions; only those with $10 billion or more in assets are subject to caps set by the Fed.

The cap, which has remained unchanged for the past 12 years, amounted to a compromise that did little to quell the imbroglio over interchange. No party—not the banks, issuers or merchants—likes the notion of what amounts to government price controls.

The Fed's latest move is drawing criticism from banks (arguing it's too much of a haircut), merchants (who want the cap to be lower) and even from within its own ranks. Fed Governor Michelle Bowman, in a statement for the record, asserted the proposal "aims to achieve 'rough justice' by establishing a single cap that applies to all covered issuers."

Worse, Governor Bowman added, the change will force banks to raise fees, which in turn could disenfranchise lower-income consumers who rely on low-cost checking accounts tied to debit cards (no checks).

"I am concerned that the costs for consumers – through the form of increased costs for banking products and services – will be real, while the benefits to consumers – such as lower prices at merchants – may not be realized," Bowman wrote. In fact, she added, some banks may be forced to scale back low-cost product offerings, "including options to increase financial inclusion and access for low- and moderate-income individuals and families."

While the cap is only supposed to apply to large financial institutions, Bowman and others have raised concerns about the impact on community banks.

"[T]he agency's cap on debit interchange puts smaller card issuers at a disadvantage due to their smaller transaction volumes and lower negotiating power relative to large issuers," said Rebeca Romero Rainey, president and CEO of the Independent Community Bankers of America. "Durbin Amendment price controls on debit card interchange have distorted the debit card and consumer checking markets solely to the benefit of big-box retailers, such as Walmart, Target and Amazon."

In a statement, Rainey pointed to a Federal Reserve Bank of Richmond study that indicated merchants pocketed billions of dollars in savings when the Fed capped debit interchange back in 2011; fewer than 10 percent of merchants reported passing savings from lower interchange on to customers in the form of lower prices.

For its part, the National Retail Federation, which has been a major lobbying force in Washington for lower interchange, said the haircut the Fed is proposing for debit interchange isn't enough. "[I]t still doesn't get to the 'reasonable' level Congress sought" with the Durbin Amendment, Stephanie Martz, NRF CEO, said in a statement.

What the data says

In a document explaining its proposal, the Fed said the cap reduction was based on an analysis of debit card activity in 2021. Following are highlights, according to a report the Fed published along with the proposed cap change.

  • Payment card networks processed 92.1 billion debit and general use prepaid debit card transactions valued at $4.3 trillion in 2021.
  • Dual-message networks (where transactions are signature authorized) dominated, with 68.2 percent of debit card processing volume and 70.4 percent of debit card dollars processed.
  • The "average fee" for processing regulated debit over single-message networks was 24 cents; the average was 23 cents for dual-message networks in 2021. These fees were deemed not "materially" different from 2011 when the cap took effect.
  • The "average fee" for exempt transactions processed over dual-message networks "gradually increased" from 51 cents to 64 cents during that same time frame, while the fee for those processed over single-message networks fell from 31 cents to 27 cents.
  • Fraud losses on debit card payments have been rising, from 7.8 basis points in 2011 to 17.5 basis points in 2021.

Rainey said in her statement that the Fed's 2021 data bears out the concerns of community bankers in that is shows "low-volume issuers operate their debit card programs at a loss due to their disproportionately high authorization, clearing and settlement costs, demonstrating the Fed's debit interchange caps are not 'reasonable and proportional' as required by the Dodd-Frank Act."

"The Federal Reserve claims to be a data-driven regulator, and as such, has the responsibility to ensure its data inputs actually tell the full story," Rob Nichols, president and CEO of the American Bankers Association, said. "With this proposal, the Federal Reserve is calling into question not just the end result, but the process itself, which has lacked transparency and public engagement."

Gov. Bowman raised another issue which could well hold up the cap revision. Last year the Fed adopted a rule change that required debit card issuers to program their cards so that merchants could choose from at least two networks to process debit card payments, only one of which can be owned by Visa or Mastercard. That rule change took effect this past July.

"We do not yet know the effects of those revisions, and I would have preferred that the [Fed] Board pause to collect data on evolving conditions before proposing this rule change, and follow a more deliberative approach for future updates to the interchange fee cap," Gov. Bowman wrote. end of article

Patti Murphy, self-described payments maven of the fourth estate, is senior editor at the Green Sheet. She also co-hosts the Merchant Sales Podcast, and is president of ProScribes Ink (www.proscribes.net)

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