Federal Reserve issues proposed rule on debit interchange fees and network restrictions

Financial Services Alert


The Federal Reserve seeks comment on proposed rules on two alternatives for calculating the reasonableness and proportionality of debit interchange fees, with either alternative setting an initial maximum cap of 12 cents per transaction.

If the rules are adopted, the Federal Reserve states that “maximum allowable interchange fee received ... for debit card transactions would be more than 70 percent lower than the 2009 average.”

Comments are due on February 22, 2011 and the new rule, Regulation II, will take effect on July 21, 2011.

The Durbin Amendment

The Board of Governors of the Federal Reserve System (the Board) adopted a proposed rule on Thursday, December 16, 2010, to implement Section 1075 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), a provision commonly referred to as the Durbin Amendment. The Durbin Amendment instructs the Board to adopt regulations to, among other things, set standards for the reasonableness of electronic debit interchange fees. Interchange fees are a per transaction charge established by networks and paid by merchants to card issuers. In 2009 debit card interchange fees totaled over $16 billion for issuing banks in the United States.

The Board’s proposed rule presents two alternatives for an issuer to establish a “reasonable and proportional” interchange fee and limit the use of interchange fees to recover “variable costs that are directly attributable to authorization, clearance and settlement of the transaction.” Under either proposal, the Board estimates that the maximum interchange fee permitted for debit card transactions will be 70 percent lower than the average fee charged in 2009.

Under the first alternative, an issuer uses a formula to determine the maximum amount of an interchange fee that it may receive based on costs related to the issuer’s authorization, clearance and settlement of the debit transaction. This alternative sets a “safe harbor” at 7 cents per transaction with costs in excess of the safe harbor being recovered up to the 12 cent cap. The second alternative does not involve a safe harbor, only the 12 cent cap.

A Board memo noted that the cap ensures that no issuer is able to receive an unreasonably high interchange fee. The Board believed that, absent a cap, issuers would have no incentive to control cost. The cap would be subject to biennial review by the Board with adjustments made based on issuer costs. Circumvention or evasion of the cap through other forms of fees is prohibited, and the Board is seeking comment on the adjustment of interchange fees to reflect issuer costs associated with fraud prevention.

The new standards are applicable to issuers which, together with their affiliates, have total assets in excess of $10 billion. However, industry participants expect that community banks with assets of $10 billion or less will likely be forced to follow the new restrictions as a business matter because merchants will not be amenable to multiple fee structures dependent on issuer size – notwithstanding the explicit exemption for community banks in the text of both the Durbin Amendment and the Board’s proposed rule.

The Durbin Amendment also directs the Board to adopt regulations prohibiting the use of network exclusivity arrangements and routing restrictions by payment card networks and issuers. The Board’s proposal again contains two alternatives for issuer and network compliance with this prohibition. The first would require two or more unaffiliated networks for each debit card. The second alternative would require two or more unaffiliated networks per debit card for each type of authorization method (e.g., signature or PIN) available to the cardholder.

Comments due February 22, 2011

Comments on the alternatives presented by the Board are due by February 22, 2011 and the new rule, titled Regulation II, will take effect on July 21, 2011 (the one-year anniversary of the Dodd-Frank Act).

See our reports on breaking developments around Dodd-Frank here.