Looking Ahead: Fed’s Rule Will Complicate Debit Game for All Players

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Fully a week after the Federal Reserve issued its final rule on debit card pricing and routing, payments experts are busy parsing the central bank’s language. One thing seems likely: The controversial rule, which banks and networks must start following by Oct. 1, will have a disparate impact on payments players, reshaping the business in favor of prepaid products and away from signature debit.

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It also raises as many questions as it answers.

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For one thing, some aren’t even certain the final rule is final. “Everybody has to get ready for changes down the line,” Andy Brown, director for product marketing management at Omaha, Neb.-based payments-software vendor ACI Worldwide said on Wednesday during a panel discussion. Brown, an observer of payments regulation outside the U.S., said regulators typically tweak rules in the light of experience. “This reg will probably get changed in one or two years,” he predicted. “Every regulator we’ve seen [overseas] has always come back and changed things again.”

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He refrained from speculating on what changes might be made, but the panel agreed the Fed’s room for maneuver is constrained by Congress. The Fed’s rule implements the Durbin Amendment to the Dodd-Frank Act, passed by Congress last year. “Durbin is picking up on trends like addressing high fees and allowing choice for retailers,” Brown noted. Added Jim Schlegel, senior product manager at ACI: “Durbin is law. This isn’t something that is a proposal or a recommendation.”

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Brown and Schlegel were among ACI officials who spoke during a conference call sponsored by the company to discuss the Fed’s debit card regulation, which came more than six months and thousands of comments after its preliminary rule appeared in December. For banks with more than $10 billion in assets, the rule caps debit card interchange at 21 cents, with a 0.05% allowance for fraud losses. Issuers can earn an additional penny per transaction if they meet certain criteria for fraud-prevention efforts. The rule also requires all issuers regardless of size to support at least two unaffiliated debit networks, and bars them from interfering with merchants’ ability to choose networks.

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Brown wasn’t the only speaker who didn’t see finality in the Fed’s pronouncement. Merchants, the putative victors in a months-long struggle with banks to get first the Durbin Amendment and then the Fed rule into place, expressed bitter disappointment last week that the Fed’s price cap turned out to be fully 9 cents higher than the limit set out in the December proposal. Now, said Rob Seward, a product line manager at ACI who works with merchants, retailers must follow through on promises to pass interchange savings on to their customers. Such promises were a key factor in the merchants’ effort to position debit card interchange as a consumer issue. “I think retailers have won a round in a bout, but the bout is far from over,” he said. “Retailers have appealed to the public. Now they need to ask themselves, are they prepared to extend their savings to consumers?”

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Acquirers, too, may well find themselves in a tight spot, said Dan Heimann, ACI manager of solutions consulting. They may be tempted to pocket some of the interchange savings, since they are technically the entities that pay interchange, passing the cost on to merchants along with a markup. Twenty-one cents is less than half the 44-cent average interchange fee the Fed found in research it conducted last year.

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But competing processors and independent sales organizations will work hard to educate merchants, Heimann warned. “This is going to blow some doors open for competitors,” he said, who will scoop up merchants that find they’re not receiving all of the savings from their current processor. He conceded, though, that this will be tougher for small merchants, whose rates are typically tiered according to volume and other factors, making it hard to isolate the interchange component.

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As a consequence, many merchants will demand transparent markups over interchange, the panel said. “This is an opportunity for more merchants to go out and ask for pass-through pricing,” Seward said, referring to a pricing structure often called interchange plus. The difficulty of managing a two-tier pricing scheme—one tier for small banks, the other for the large, regulated issuers—may well force acquirers to adopt pass-through pricing, Seward noted, if only to manage the complexity. Visa Inc., which announced in January it will adopt a two-tier system in response to Durbin, was expected late Wednesday to discuss the impact of the Fed’s rule on its operations.

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Several of the panelists predicted issuers will likely move resources into reloadable prepaid cards, which are exempt from the price cap. This could include new rewards programs to encourage usage, they said. At the same time, they noted, issuers will probably strip rewards from their signature-debit programs, which will be priced the same as PIN debit but incur higher fraud costs. “I don’t think anybody can afford to offer rewards programs for signature debit,” Heimann said.

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That may not be the only way in which consumers lose out. The final impact on them, the panelists said, is clear as mud. Said Brown: “It’s a very murky area whether the consumer actually gains.”