Fed ordered to rewrite debit cap rule

The Federal Reserve faces an order to rewrite its debit interchange rule after the 8th U.S. Circuit Court of Appeals upheld a lower court's ruling that the cap the Fed set in 2011 was too high. In a decision dripping with sarcasm, the court agreed with a district court ruling that the Fed must "come up with a fee structure that reflects the statute Congress wrote."

The Durbin Amendment to the Dodd-Frank Act instructed the Fed to set a cap on debit interchange for financial institutions with assets of $10 billion and above. The cap it came up with, in 2011, limits debit card interchange to roughly 25 cents—a flat fee of 21 cents, plus 0.05 percent of the transaction value and an optional 1-cent adjustment for meeting fraud prevention standards.

Corner Post, a truck stop and convenience store established seven years ago in North Dakota, challenged the rate asserting it was too high vis-à-vis issuers' actual expenses. The District Court agreed, and now so has the Court of Appeals.

Not 'close enough for government work'

A three-judge panel of the appeals court asserted that the Fed did what the statute prohibited, namely consider costs that are "not specific to a particular electronic debit transaction." In its decision, the court wrote, "The clearest sign of regulatory drift was the flat 21-cent cap because it applied to every transaction no matter its cost."

What matters in regulating interchange fees under the statute is "incremental" costs, but that requirement "appears to have been pushed to the side," the ruling stated. "[I]gnoring what it was supposed to consider and considering what it was supposed to ignore would place the agency on the wrong side of its 'statutory authority'," the court wrote.

The court further explained, "The statute requires the Federal Reserve, in regulating interchange fees to 'distinguish between' a single transaction's 'incremental cost' and 'other costs incurred by an issuer which are not specific to a particular electronic debit transaction.' It does not take much detective work to figure out that the Federal Reserve 'shall…consider' marginal costs in setting debit card interchange fees, but not fixed costs."

The ruling continued, "The Federal Reserve is supposed to set 'standards,' plural, not a single uniform cap like the one imposed here." At a minimum, the court wrote, "the Fed must sort costs into those that are transaction-specific and those that are not. Not just pick a number and hope it is close enough for government work."

Merchants cheer as FIs balk

The Merchants Payments Coalition praised the decision. It "confirms what merchants have said for more than a decade: the Fed let the nation's biggest banks charge far more than the law allows," said Doug Kantor, a member of the MPC executive committee and general counsel at the National Association of Convenience Stores.

In a statement, a coalition of financial institution trade associations balked at the decision. "The Durbin Amendment's government price controls have harmed consumers from the start," the groups stated. The appeals court decision, it added, "threatens to compound that harm by preventing regulated interchange fees from reflecting the real costs banks incur to process transactions, prevent fraud and protect customer data."

This likely is not the last word on debit interchange caps. Another federal appeals court is considering a similar case in which a federal district court upheld the Fed's rule in a suit brought by a Kentucky pizza parlor.

In an amicus brief filed in that case, Senator Dick Durbin, the Illinois Democrat for whom the Durbin Amendment is named, argued that the Fed succumbed to lobbying by the banking industry in setting the cap. "The deviations that the Board made from the Durbin Amendment's text and purpose…have caused the debit system to suffer greater inefficiency and unnecessarily excessive fees with American businesses and consumers paying the price," Sen. Durbin said.

If the litigation ultimately results in a lower cap, covered issuing banks would collect less interchange revenue on debit transactions. Merchants could see lower acceptance costs, depending on their pricing agreements. For ISOs, payment processors and acquiring banks, the effect would depend on how those agreements pass through interchange costs, with potential changes to merchant pricing and margins.

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