Dodged the Durbin Bullet
As I reviewed the final rules on debit interchange fees the Federal Reserve Board passed in regard to the Durbin Amendment to the Frank-Dodd Act I was struck by how much more favorable the final rules were to the industry to those that had been originally proposed. Had the Federal Reserve Board adopted the most stringent of the proposed rules, the impact on the industry could have been enormous.
To provide a framework for this article, the Durbin Amendment to the Frank-Dodd Act was the law enacted by Congress to regulate, among other things, the cost that issuers can charge as interchange per debit card transaction. This law directs the Federal Reserve Board to then formulate specific rules that determined exactly what the interchange costs would be. Initially a set of rules was proposed to allow for public comment on the proposed rules before the final rules were announced. Just recently, taking into account the public comments, the final rules were announced as to the allowable interchange costs that can be charged by issuers for debit transactions. Also remember these are interchange costs and not the costs that are actually charged to the merchants.
In the first proposed rules, one of the alternatives had been for a issuer specific approach that allowed for a interchange transaction fee of certain allowable costs up to $0.12 per transaction and a safe harbor at $0.07 per transaction. The term “issuer specific” meant that each issuer that was governed by the law would only be able to charge the $0.12 rate if the issuer could actually show that its costs were that high. If they were not then the most that the issuer could charge was $0.07 or whatever the actual cost was subject to the cap.
The issuer specific approach would have meant a whole new level of oversight by the Federal Reserve Board over our industry. The government would have had to set up a new governmental body to analyze the actual transaction costs for each issuer. This would have necessitated a whole new set of reports that issuers would have to develop to “prove” what their actual cost were in providing debit card transactions. Thankfully, the government determined this type of additional oversight would “increase the burden on [government] supervisors to assess compliance and make it impossible for networks and merchants to know whether issuers were in compliance.” So the issuer specific approach was rejected in the final rules.
Compared to the proposed rules, the final rules were also more favorable for the industry to the extent that the conclusions of the Board took an approach that increased the potential costs that were included to determine the final transaction fee. The Durbin Amendment states the allowable fees should be “reasonable and proportional.” As further instruction the law provides that incremental costs that are incurred by the issuer for the transaction should be included in the allowable costs, while other costs not specific to the transaction, such as overhead, could not be considered.
The law left open some question of what should and should not be included in the costs that could be considered in determining the allowable fees for debit transactions. One issue concerned reward programs and whether their costs should be included to determine the allowable fees. Merchants argued that such costs should not be included as they are not directly related to processing a debit transaction. Others warned that if these costs were not included all rewards programs likely would disappear overnight.
Again in the final rules, the Federal Reserve Board came down on the side of the industry. It allowed the inclusion of additional costs that may be considered in determining the reasonable and proportional fee. Although it did not allow things like rewards programs to be considered, the final rules did allow “network processing fees; fixed electronic debit transaction processing costs; fraud prevention costs associated with authorization; and the allowance for fraud losses.” What this means is that even though the original proposed rules had recommended at most a $.12 fee, the final rules call for a $0.21 transaction fee, plus 5 basis point ad valorem component.
The final rules have a dramatic impact on the amount of fees that may be collected pursuant to the Durbin Amendment. If the Federal Reserve Board had adopted the most restrictive initial proposed rules, then interchange would be $0.07 per transaction unless an issuer spent a considerable amount of money to prove that its costs were greater than that. As it stands, the new $0.21 transaction fee is a 200% increase in the fees that the issuers can collect, not taking into account the ad valorem component.
Also, since the issuer specific model was not adopted, issuers do not have to prove what their actual costs are to the government and the government does not have to employ hundreds of more people to make sure the issuers are accurately reporting their costs. This is likely a considerable cost saving for the industry.
The new rules could have turned out a lot worse for our industry. Fees collected could have been a third or less of what was is now allowed and our industry would have been subject to an entirely new level of regulation and scrutiny. As it turns out, the industry dodged a bullet by the Federal Reserve Board essentially rejecting the initial proposed rules and instead reaching a much different conclusion in the final rules that were adopted.
The information contained herein is for informational purposes only and should not be relied upon in reaching a conclusion in a particular area. The legal principles discussed herein were accurate at the time this article was authored but are subject to change. Please consult an attorney before making a decision using only the information provided in this article.