Is a Lower Debit Cap Coming?

Pressure is building on the Federal Reserve to take action on a debit card interchange-fee regulation that it has left intact for 10 years despite sweeping changes in the payments business, including an onrush of e-commerce transactions over the past year.

In part, observers are reacting to a report the Fed released last month indicating that issuers’ authorization, clearing, and settlement (ACS) costs for debit have declined dramatically over the years.

In 2019, those costs came to 3.9 cents per transaction, roughly half the costs in 2009, according to the report. At the same time, the 10-year-old Fed ceiling on debit card interchange, which flows to issuers, in 2019 was greater than total ACS costs plus fraud losses for nearly 79% of covered issuers and close to 100% of covered transactions, the report says.

The Fed set the debit cap at 21 cents, with an additional penny allowed for fraud-prevention costs and 0.05% for recovery of fraud losses. The ceiling, which applies to financial institutions with $10 billion or more in assets—the so-called covered issuers—came in response to the Durbin Amendment to the Dodd-Frank Act of 2010.

The latest Fed report indicates online transactions, known as card-not-present volume, sustained $12.40 in fraud losses per $10,000 in volume in 2019, up from $7.80 in 2011. Merchants absorbed 56.3% of these losses, up from 52.8% in 2017, according to the report, indicating that percentage could be even higher now with e-commerce volume booming since the onset of Covid-19.

The report’s numbers lead some observers to predict the Fed will approach covered issuers with a revised fee cap that could be significantly lower than the current one.

“There may be some horse trading,” says Steve Mott, who follows the issue closely as principal at consultancy BetterBuyDesign. He predicts the Fed may ultimately lower the cap as much as 4 cents. The Fed did not respond to an inquiry from Digital Transactions.

Adding to the pressure on issuers is a lawsuit filed in April that claims the debit interchange ceiling is now too high and seeking to force it down.

The case, filed in U.S. District Court in Bismarck, N.D., by the North Dakota Retail Association and the North Dakota Petroleum Marketers Association, argues merchants have paid “billions” of dollars more than they would have had the Fed followed the letter of the Durbin Amendment to the 2010 Dodd-Frank Act with respect to debit costs.

The action came as debit payment volumes skyrocketed last year with U.S. consumers’ shift to debit cards in the face of the pandemic. On the Visa network alone, debit payment volume totaled $2.23 trillion in 2020, up 15.2% over 2019, a year that saw a 9.7% growth rate.

In a separate action, the Fed at the same time released a proposed rule that would seek to ensure that merchants can choose between at least two unaffiliated networks for card-not-present transactions in the same manner as for card-present ones.

The Durbin Amendment sought to boost competition by requiring a minimum of two unaffiliated networks for each debit transaction. But merchant groups have long complained that alternative cards presented for e-commerce transactions will work only with a PIN, forcing consumers to default to a global network and negating merchants’ routing choice.

“[M]erchants are often not able to choose from at least two unaffiliated networks when routing card-not-present transactions, according to data collected by the Board and information from industry participants,” the Fed document says.