The Fed Touches Off the Latest Interchange Battle

The National Retail Federation and the Merchants Payments Coalition have lined up against the Federal Reserve, arguing that while a rate reduction on debit card transactions is welcome, the Fed’s proposed pricing does not go far enough.

The two industry trade groups sent letters to the Fed last month on the final day for comments on the regulator’s proposed interchange rate reduction plan for debit. In October, the Fed requested comments on the plan and set a deadline of Feb. 12 to receive comments. In January, the Fed extended the deadline to May 12.

Last fall, the Fed proposed an update to all three components of the interchange fee cap—the current base component, ad valorem component, and fraud-prevention adjustment—established under Reg II of the Dodd Frank Act, also known as the Durbin Amendment, which was signed into law in 2010. The amendment applies to debit card issuers that have at least $10 billion in assets.

Using data voluntarily reported by large debit card issuers, the Fed proposed cutting the maximum base amount from 21 cents per transaction to 14.4 cents, and lowering the fraud-loss recovery component from five to four basis points. The Fed also proposed raising the fraud-prevention component from a penny per transaction to 1.3 cents.

In its letter to the Federal Reserve, the NRF argued that the debit cap should be lowered to 10.5 cents per transaction and that the Fed should set tiered interchange rates based on banks’ debit card transaction volume. Interchange is paid by merchants and constitutes a revenue stream for card-issuing banks.

Both the NRF and the MPC contend the Fed’s proposed rate reduction would give debit issuers average profit margins of 270%, which they say is nine times the 30% average profit margins large banks make on their businesses overall.

“The [debit interchange] rate ought to be capped at 6 cents per transaction, as the average cost of a debit transaction for banks is 3.9 cents,” says Doug Kantor, an MPC executive committee member and general counsel for the National Association of Convenience Stores. “[Large] banks earn a 35% margin on debit transactions, which is higher than the profit margin on their business as a whole.”

But banks aren’t happy, either. In response to the Fed’s proposal, the American Bankers Association and eight other bank and credit union groups sent a letter to the Fed urging it to withdraw its proposed rate adjustments. The groups also argue the proposal would violate the law by prohibiting  banks from recovering costs
they incur in “providing affordable debit card programs.”

Should the proposed rate adjustments go into effect, the banking groups calculate consumers would pay an estimated $1.3 billion to $2 billion more annually in account fees. Meanwhile, they say, it is unlikely merchants would pass any cost savings on to consumers.

The proposed adjustment is overdue as debit card issuers’ costs have declined about 50% since the Fed began gathering data from large issuers on those costs,
argues Eric Grover, principal at the Minden, Nev.-based consultancy Intrepid Ventures.

“The Fed should have lowered the cap sooner, but the proposed cap is reasonable and proportional to debit-processing costs,” says Grover, who nonetheless has long argued the Durbin Amendment should be repealed. “Banks will complain and there may be lawsuits filed, but a significant reduction in debit interchange will happen.”

Grover points to how banks and merchants have dug in their heels on the matter. “This a forever war. Banks want Durbin repealed, and no matter how big the proposed rate reductions, merchants will complain it is not enough,” Grover says. “This is an old issue that [is] not going away.”