By Patti Murphy
The Takoma Group
As the clock ticks down to the start of interchange regulation, pressure is mounting on Congress and the Federal Reserve Board staff to put the brakes on a plan to cap debit card interchange. It's not just bankers who are squawking, either.
Fed Chairman Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair both expressed concerns about the proposed regulations during a Feb. 17, 2011, hearing before the Senate Banking Committee. "The full policy ramifications - who's paying for what, who's going to pay more and who's going to pay less under this - is something that maybe wasn't dealt with as thoroughly as it might have been," Bair said.
The Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is named for the senator who proposed the interchange provisions, Richard Durbin, D-Ill. Included during last minute negotiations over House and Senate versions of the reform bill, the Durbin Amendment instructs the Fed to issue rules to ensure that the interchange fees charged to merchants for accepting debit cards and paid to card issuers are assessed at rates that are "reasonable and proportional" to costs incurred by issuers.
It also deep-sixes card company restrictions on merchant acceptance, such as rules regarding network exclusivity, merchant routing, and discounts for preferred payment methods (for example, debit cards or cash). Community banks - those with assets below $10 billion - are exempt from the legislation. So are prepaid debit cards.
Under orders to have final rules in place by July 21, 2011, the Fed released a set of proposed rules for public comment in December; comments were due by Feb. 22. The Fed's proposal (which is almost 100 pages long) offers two options for capping debit card interchange; either way, the most an issuer covered by the rules would be allowed to collect would be 12 cents a transaction, which works out to be a 70 percent reduction in average debit card interchange assessment in 2010 (44 cents), according to the Fed's calculations.
Opponents contend the Fed's proposal goes too far. "Based on our personal experience, and those of peers, this cap is neither reasonable nor proportional," said Michelle Mattson, Manager of Genisys Credit Union in Auburn Hills, Mich.
Durbin Amendment supporters (just about everyone in the retail merchant community) insist federal price controls are necessary and will benefit consumers in the end because, once the load of this onerous cost is lightened, retailers will pass those savings on to their customers.
James C. Miller II, an economist who served stints as Chairman of the Federal Trade Commission and Director of the Office of Management and Budget in the 1980s, wrote an article posted recently to the website Politico. "With retail competition so intense, all consumers are likely to benefit - users of cash, credit and debit," Miller wrote. "Merchants simply won't miss an opportunity to compete on price to draw traffic into their stores."
Fed Board Governor Sarah Bloom Raskin suggested under questioning by the House Financial Services Committee Subcommittee on Financial Institutions and Consumer Credit, however, that there's no way to discern if consumers will indeed benefit. "The statute didn't instruct us to look at the consumer effect," she said during a Feb. 17 subcommittee hearing.
Three economists collaborated to measure the impact the proposal will have on consumers, and the results aren't pretty. David S. Evans, who lectures at the University of Chicago Law School, Robert E. Litan, a senior fellow at the Brookings Institution, and Richard Schmalensee of the MIT Sloan School of Management, submitted extensive comments to the Fed detailing how consumers and small businesses will be disproportionately affected by the proposed interchange caps.
The trio predicted, for example, that the number of unbanked Americans will rise as more lower-income households reduce dependency on previously free or low-cost checking accounts. Small businesses that don't take debit cards will be big losers, too, since they'll end up paying more for bank services without the offsetting benefits that might accrue from lower interchange.
Consumers and small businesses can expect to take a combined hit of between $33.4 billion and $38.6 billion during the first two years if the proposal takes effect, they predicted in a paper titled Economic Analysis of the Effects of the Federal Reserve Board's Proposed Debit Card Interchange Fee Regulations on Consumers and Small Businesses. So, who are the winners then if the Fed's proposal is adopted? "Large retailers would receive a windfall," the economists wrote - between $17.2 billion and $19.9 billion in the first two years alone.
Henry Helgeson, Co-Chief Executive Officer of the Boston-based ISO Merchant Warehouse, agreed retailers will be the big winners if the Fed goes ahead with its proposal. Helgeson also suggested the proposed rule could have unintended consequences on an economic recovery. "If consumers are the engine that drives the economy, then credit and debit cards are the lubricant," he said.
And these days consumers like using debit cards. According to the Fed, 35 percent of noncash payments in 2009 were made using debit cards, compared with 22 percent by check, 20 percent by credit card and 5 percent using prepaid debit cards. Fiserv Inc. reported recently that its Accel/Exchange debit network saw a 30 percent spike in transactions last year, for a total of 1.2 billion debit card transactions.
As for financial institutions, Fed Board Governor Raskin said under questioning in the House that the plan for capping debit interchange shouldn't be a problem for most, since it only applies to the largest card issuers. She also said the Fed's analysis suggested the 12-cent cap was within the range of interchange assessed by 80 percent of debit card issuers covered by the rule.
In theory, smaller financial institutions (community banks and credit unions) should be rejoicing over their exclusion from Durbin Amendment restrictions since they can continue collecting 40 cents or more in interchange on POS debit card payments. But they aren't.
"Despite the statutory attempt to separate out smaller banks from the price controls embodied in the Durbin Amendment, the marketplace will do what it always does: drive business to the lowest cost option," said Ken Clayton, General Counsel for Card Policy at the American Bankers Association.
Even the Fed's Advisory Council, a group representing each of the 12 Reserve Bank districts, has expressed broad and deep opposition to the Fed's proposal, "which we strongly believe misinterprets the Durbin Amendment," the group wrote in a letter to the Board.
One concern often raised is that smaller institutions, despite an exemption from the rules, will be forced by competitive pressures to lower debit card interchange and to recoup losses from new revenue sources. A recent survey by the Independent Community Bankers of America of its members indicates 93 percent expect to impose new fees on customers to make up for lost interchange revenues (new monthly, yearly or per-transaction fees).
The Credit Union National Association has warned that all of its members will be hit hard financially by the capping of debit interchange and may be forced to scrap debit cards or impose new fees on checking accounts, debit cards and other services. "All of this is going to have a harmful impact on Main Street, one that ultimately will prove costly to millions of American consumers," Bill Cheney, CUNA's CEO, wrote in a recent article carried by the Huffington Post website.
In an effort to respond to concerns raised about the Fed's rate capping plans, Visa Inc. recently indicated it would create a new two-tier pricing structure for debit card interchange: one that can be applied to issuers bound by regulated interchange and another for cards issued by smaller, exempt institutions. But that seems to have done little to quell industry concerns.
"Despite Visa's actions, the Durbin Amendment requirements will not prevent large retailers from steering customers to cheaper-rate cards issued by large banks," said Karen Thomas, ICBA Senior Executive Vice President for Government Relations and Public Policy, in a statement issued by the group. "ICBA will continue to work with the Federal Reserve and other policymakers and the networks to address the association's significant concerns."
Those concerns are spelled out in the ICBA's comment letter on the Fed's proposed new interchange regulations. They are also addressed in a comprehensive comment letter - signed by every U.S. bank and credit union trade association - that urges the Fed to fundamentally revise its proposal for the Durbin Amendment's implementation. Both letters referenced concerns raised by Fed Chairman Bernanke under questioning by the Senate Banking Committee on Feb. 17 that the Fed is "not certain how effective the [small bank] exemption will be."
Another concern raised over the Fed's proposal is that it doesn't take into consideration costs associated with fraud prevention and losses. "The cost of fraud to a bank can be significant," the ABA wrote in a letter to the Fed.
"In fact, fraud costs can more than offset all of the revenue a bank issuer may receive from interchange fees. Retailers are guaranteed payment when they swipe a debit card and obtain authorization. Even in cases where there are insufficient funds in an account or the card is counterfeit, the retailer gets paid, and the bank that issued the card suffers the loss."
Further complicating matters, fraud costs vary from issuer to issuer. Given the economies of scale inherent in payments, costs incurred by the largest issuers in preventing and answering for fraud are not representative of those incurred by issuers with smaller portfolios, the ABA and others noted.
Helgeson, who has been following the debate in Washington, said momentum is growing for at least a delay in implementing the Durbin Amendment. In addition, he noted that retired Sen. Christopher Dodd, D-Ct., and Rep. Barney Frank, D-Mass., for whom the Dodd-Frank Act is named, have expressed reservations about capping interchange. "Things that have happened these past few weeks lead me to believe that sometime between now and July they're going to put the brakes on this," Helgeson said.
Not if Sen. Durbin gets his way, however. In a recent letter to the ABA, Durbin assailed the trade group's arguments against the legislation and the Fed's proposal, and he vowed to "vigorously oppose efforts to block the implementation of this needed reform."
Regardless of what happens in Washington, Helgeson said ISOs and merchant level salespeople (MLSs) are well-advised to start planning now for life after implementation of the Durbin Amendment. "We're spending a lot of time on what-if scenarios here," he said.
If the proposal stands as offered by the Fed, ISOs and their partners will need to go through re-pricing exercises. "We're going to have to pass on savings to merchants," Helgeson said.
He added that "you might see a land grab," suggesting savvy marketers will capitalize on the changes to woo merchants away from competitors.
Mike Kelly, General Manager of Accel/Exchange, expects PIN debit to become a differentiator and that issuers who promote debit will have a leg up on those that don't. "Culturally, we think real-time functionality is in demand - especially PIN debit," Kelly said. "The model is very safe and secure; merchants know this, and the issuers know it too."
If debit interchange is capped at 12 cents, issuers will want the added protection against fraud that PIN debit provides, and they will scrap programs that reward signature debit use, Kelly added. And if that's the case, it could create opportunities for ISOs and MLSs to up-sell an estimated 6 million merchants that today lack PIN pads.
The message to the acquiring sector, then, is to start planning now for life under some type of interchange controls - whether it's the 12-cent cap the Fed is proposing, or whether the Fed gets sent back to the drawing board and the July implementation is postponed. "There are a lot of ISOs out there waiting for their processors or the big acquirers to tell them how it's going to work," Helgeson said. "That's absolutely the wrong strategy."
Patti Murphy is Senior Editor of The Green Sheet and President of The Takoma Group. She is also the founder of InsideMicrofinance.com. Email her at patti@greensheet.com.
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