As the details of the Restoring American Financial Stability Act of 2010 continue to be hammered out, an amendment introduced by Sen. Dick Durbin, D-Ill., to regulate fees levied on merchants for card transactions appears to have secured its place. On June 21, 2010, both houses of Congress agreed on a provision to regulate debit card interchange.
The reconciled amendment allows the Federal Reserve to cap debit card interchange at a level that's "reasonable and proportional" to the cost of processing debit transactions; it gives the federal government a year to determine what that rate is; and it exempts debit cards issued by banks with assets under $10 billion.
Patricia Hewitt, Director of the Debit Advisory Service for Mercator Advisory Group, said the impact of interchange regulation is potentially significant, though difficult to predict.
"Debit cards represent the majority of transactions in the United States, so from a card perspective, I think we have to look at it at a very macro level," she said. "We don't know what the ripple effect is going to be when we potentially radically change a pricing model connected to the majority share of payment transactions in the United States. But that's going to have an impact."
The amendment also allows merchants to decline credit and debit cards for purchases below $10 (on which interchange sometimes exceeds the retail profit margin). And it prohibits the monopolization of debit card processing - meaning debit cards must link to at least one other back-end processing network besides the one owned by the card's brand.
So Visa Inc.-branded debit cards that connect only to the Visa-owned debit processing network Interlink will be required to connect to another back-end system as well; the same goes for MasterCard Worldwide-branded cards that currently use only MasterCard's debit processing network, Maestro.
"Passage of this measure gives small businesses and their customers a real chance in the fight against the outrageously high 'swipe fees' charged by Visa and MasterCard," Durbin said in a statement on his website. "It will prevent the giant credit card companies from using anti-competitive practices ... and restore common sense and fairness to this broken system."
The finished amendment largely resembles the one Durbin introduced to Congress in June 2009, but it does make some concessions to the issuing banks and card companies that lobbied fiercely against it.
Among them are the exclusion of a provision that would have allowed merchants to offer discounts to consumers who pay with cash (something they are already allowed to do under card brand rules as long as disparate retail prices for the same item are not posted based on payment method); the exemption of government-administered cards and reloadable prepaid cards from regulation; and the consideration of fraud prevention in determining a "reasonable and proportional" debit interchange cap which, according to industry analysts, may yield interchange caps that vary depending on merchant type.
"By factoring in risk, they're allowed to set different card expenses based on historical risk factors for certain types of merchants, as well as the usage of the cards," said Jeff Fortney, Vice President of Clearent LLC, an ISO.
Fortney said the provision calling for "reasonable and proportional" debit rates leaves the issue "wide open." He believes Durbin's interchange amendment is a political move to assuage the retail industry and that it's unlikely to carry much weight.
"I think it's much to do about nothing right now," Fortney said. "I don't think the Feds are going to waste their time on this. Given a year to come up with a fair and reasonable rate, do you think they're going to spend much time analyzing this? I don't. I think they're going to contact the networks and say, 'OK, guys, show me why you're charging this.'"
Fortney added that ISOs could benefit from the requirement that debit cards connect to multiple processing networks.
"Let's say I'm charging a fee for accepting PIN-based debit," he said. "I'm going to charge 20 cents plus network fees. My merchant could gain by being tied to a network that has a lower cost, but I could gain, too, because maybe I could charge 25 cents instead of 20, since I know everything's going to a lower cost, and PIN debit network fees aren't going to be so high."
But others anticipate negative repercussions. A report from Mercator, "The Durbin Amendment: Impact Analysis," predicts issuing banks will compensate for reductions in interchange by charging new fees to consumers or by increasing existing ones.
Such fees would offset any possible savings to consumers from lowered retail prices that may stem from regulated interchange rates, the report indicates.
The paper also predicts that community banks could suffer if merchants steer customers away from debit cards issued by smaller banks (those with assets under $10 billion) that aren't regulated and charge higher interchange.
"Should interchange differential between the two tiers [of banks] be significant enough, merchants would have a strong motivation to 'steer' consumers away from using their community bank or credit union cards," the report states. "Large merchants have been very successful in incorporating technology into their point of sale systems to steer consumers to use sometimes cheaper PIN debit transactions ... such systems could easily be engineered to identify cards from more expensive small issuers and to prompt consumers to use some other tender type."
The Electronic Payments Coalition expressed displeasure with Durbin's amendment. "Consumers will pay higher fees, lose rewards programs and have limited choices for debit cards due to the disruption this amendment will bring to the economics of the debit card market," the coalition said in a statement.
According to the National Retail Federation, debit card interchange accounts for $20 billion of the approximately $48 billion banks generate in swipe fees each year.
But for Adil Moussa, Analyst for Aite Group LLC, the effect on revenue is not as important as the fact that debit card interchange regulation opens the door to regulation of credit transaction processing, thereby cutting into an even more important source of revenue.
"For banks, revenue from debit isn't really the first money maker," Moussa said. "It's the lending they do ... the interest rates and the fees they're able to charge people for having [credit card] accounts. Those are really the first two main ones.
"We've already seen some regulation against charging outrageous fees on those accounts, so this is chipping away some more at bank revenues. What that's going to do is put a lot more pressure on the banks to come up with new fees that they will charge the consumer."
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