As the Curtain Falls, Durbin Comments to the Fed Show a Sharp Divide

Tuesday is the final day for commentators to submit their opinions to the Federal Reserve Board about the board’s proposed rules to implement the interchange regulations and other debit card provisions of the Dodd-Frank financial-reform law’s Durbin Amendment. Samples from the approximately 2,700 comments that have rolled in over the past two months show the issuer-merchant divide over interchange is as sharp as ever, though some recent commentators give new insights about the potential effects of Dodd-Frank on their businesses.

Some merchants and merchant groups are pressing for a home run, which in this case would be no interchange, or at-par pricing, reminiscent of the early days of point-of-sale PIN-based debit. “There is no reason for interchange to flow from merchants to card issuers as those issuers save money on every debit card transaction because it is already cheaper than a check transaction,” says letter from a hodgepodge of restaurants, convenience stores, supermarkets, and other retailers and merchant trade associations that uses about 90 pages to list its signers. “For this reason, among others, the final rules can move further toward the check system that has served the nation and the economy very well for many years without interchange fees.”

Other letters reflect the growing fears by small banks, credit unions, and financial companies that wouldn’t be directly regulated that they nonetheless will suffer collateral damage. That could happen in a number ways, but especially if merchants, which will get new transaction-routing freedoms under Durbin, transfer more debit card transactions to the lowest-cost network a debit card offers. Durbin exempts the debit card interchange revenue of financial institutions with less than $10 billion in assets as well as that of issuers of government prepaid cards and general-purpose reloadable (GPR) prepaid cards not marketed as gift cards. For big issuers of regular debit cards, the Fed on Dec. 16 proposed two plans, both of which would have 12-cent transaction caps. The board is expected to issue final rules in April.

In a blunt letter, NetSpend Holdings Inc., a large prepaid card program manager, said the Fed’s proposal does not meet the Durbin Amendment’s mandate of “reasonable and proportional” interchange pricing for non-exempt prepaid card issuers. The letter cites data in the Fed’s draft notice saying that the median per-transaction processing cost for prepaid cards is 63.6 cents. “Accordingly, the Board appears to have determined that an issuer should lose 51.6 cents on each covered prepaid transaction,” NetSpend said. The letter says replacement revenue sources, such as fees, could hurt unbanked consumers, the core customers of GPR cards.

NetSpend does not issue cards itself but uses partners such as The Bancorp Bank and MetaBank. Both of those institutions are exempted by virtue of being GPR issuers and having less than $10 billion in assets, but if they and other prepaid issuers don’t toe the line regarding other provisions in Dodd-Frank, their interchange could become regulated. For example, GPR prepaid issuers may not charge overdraft fees or a fee for a cardholder’s first monthly withdrawal from an ATM in the issuer’s designated ATM network. NetSpend asked to Fed to clarify that the exemption would not be lost if the cardholder chooses to use a non-designated ATM network in his local area that would cause the issuer to charge a fee.

“We believe the current wording of [the proposed rule] is potentially confusing, and could be construed as imposing upon the issuer the obligation to waive the first withdrawal fee each calendar month at any ATM where the card can be used, regardless of whether it is part of the issuer’s proprietary network of ATMs,” the letter says.

Meanwhile, the president and chief executive of a rural Iowa bank wrote that he believes Durbin’s regulations would cut his bank’s non-interest income by 10%, even though his bank is exempt from regulation. “The FRB has proposed artificially low caps on debit interchange that do not reflect the true costs of running a secure, reliable, and efficient debit network,” wrote Kevin M. Black of Somers, Iowa-based Heartland Bank. “This will force financial institutions, such as ours, to raise consumer fees or reduce debit services.” Black didn’t say how he arrived at his 10% revenue cut, but his views reflect those of many other correspondents from credit unions and small commercial banks.

“Putting aside the government-intervention aspect, I would think and hope that proposals like this would take into account the ‘realistic’ impact that will take place rather than the ‘political’ impact of the proposed legislative change,” wrote David M. Kreiman, executive vice president of Glenview State Bank in Glenview, Ill., a north suburb of Chicago. “What is the goal here, after all? We know that the two-tier approach will not offer relief to banks with smaller assets …”

NetSpend asked that the Fed force the payment card networks to honor the exemption for small issuers and government and prepaid cards. “The Board does not include any provisions mandating that such exemptions, where available to an issuer, be honored by the networks,” its letter says. “We believe that when including these exemptions within the Act, Congress intended that issuers actually be able to take advantage of them, such that the underlying policy objectives of Congress in crafting those heavily negotiated exemptions would be capable of being achieved.”

Visa Inc., MasterCard Inc., and the electronic funds transfer networks set debit card interchange rates. Visa has committed to a two-tier interchange schedule, one reflecting regulated rates once the Fed issues them, and an unregulated one similar to current pricing. But Dodd-Frank doesn’t explicitly tell the networks how they may set their interchange schedules.