For nearly a decade, the Federal Reserve avoided choosing sides in the protracted, high-stakes dispute between banks and retailers over debit card fees.
But after the Fed last week embraced one of the main arguments made by merchants, many observers believe that more bad news is coming for large and midsize banks.
The Fed is required by law to cap the interchange fees that banks with more than $10 billion in assets can collect when consumers use their debit cards at retailers. Since 2011, the limit has been set at 21 cents, plus 0.05% of the transaction. The central bank has long ignored pleas from both sectors to make changes. But now, in light of a decadelong decline in the banks’ processing costs, the Fed faces growing pressure to lower the price ceiling.
“I don’t think the Fed can do anything other than lower the interchange cap. That’s the mandate in the regulation — the interchange rate has to be representative of the costs associated with debit transactions, and costs have certainly come down,” said Sarah Grotta, a debit payments expert at Mercator Advisory Group.
Between 2009 and 2019, the cost of processing debit card transactions at banks with more than $10 billion of assets fell by nearly 50%, according to the Fed. The average cost, excluding fraud losses, fell from about 7.7 cents to 3.9 cents, the central bank said in a report issued Friday.
The same day, the Fed proposed a new rule that would resolve a related issue in a manner that is favorable by retailers. Under the proposal, banks that issue debit cards would be required to offer merchants the choice of at least two unaffiliated networks over which to route e-commerce transactions.
Merchants have long had such a choice on transactions where shoppers swipe their debit cards in physical stores. But banks
In other parts of the U.S. debit card market, the rules on routing choice have facilitated competition that did not previously exist, according to Callum Godwin, chief economist at CMSPI, a payments consulting firm that works exclusively with retailers. “The one place we haven’t seen that is in online debt,” he said.
Sen. Richard Durbin, D-Illinois, who authored the section of the Dodd-Frank Act that required the Fed to impose both price caps and routing choice, last year urged the central bank to focus attention on the fast-growing e-commerce market. The interchange cap, commonly known as the Durbin amendment, applies to banks with more than $10 billion of assets.
In 2019, banks that accounted for approximately half of all debit card transactions did not offer routing choice in any situations where the consumer paid remotely, according to a survey conducted by the Fed.
“We are moving to a cashless society. Whenever someone is paying with a card online, exorbitant fees are involved,” said Leon Buck, vice president of government relations in banking and financial services at the National Retail Federation. “We want the opportunity, as retailers, to have routing choice.”
Bank industry groups responded harshly to the Fed’s proposal. In a joint statement, they implied that Visa and Mastercard, which own the networks over which most remote debit card transactions get routed, offer better security measures than the smaller networks that stand to benefit from the Fed’s proposal.
“By reopening the rules surrounding debit card transactions, the Fed could put the convenience, safety and security that Americans have come to expect when they use their debit card at risk,” said the statement, which was issued by the American Bankers Association and four other groups that represent banks and credit unions.
But several observers indicated that they do not expect the banks will be successful in their efforts to persuade the Fed to change course on the proposal released Friday. Instead, attention quickly turned to the question of whether the Fed is likely to propose a reduction in the fees that banks with assets of more than $10 billion can collect.
The Fed declined to comment. In its notice of proposed rulemaking last week, the central bank noted that it may in the future propose additional revisions to its 10-year-old debit-fee regulations.
Isaac Boltansky, an analyst at Compass Point Research & Trading, argued that the Fed-imposed price cap is likely to remain unchanged in the near term, in part because of the current focus on whether merchants should have more choice regarding the routing of ecommerce transactions.
But the longer-term outlook for banks is more perilous, according to Jaret Seiberg, an analyst at Cowen Washington Research Group. He argued in a research note that the joint statement by five banking and credit union trade groups reflects worries that are bigger than just what the Fed proposed last week.
“It is a concern that this will start a process that could lead to a broader reopening of the rule, including the calculation of the debit interchange rate,” Seiberg wrote. “For now, we believe the current rate is safe. Yet we agree that risk is rising that the Federal Reserve could start a process to curb debit interchange rates.”
President Biden is expected to name four members to the Fed’s seven-member board over the next eight months, and Seiberg predicted that they will be more progressive than the members they replace.
“Interchange is not normally partisan,” he wrote, “But curbing debit interchange could be framed as a way to help small businesses as they recover from the COVID-19 crisis. It is why we see a threat to the Durbin interchange rate for the first time since the Fed adopted the original rate a decade ago.”
Back in 2010, the Fed
An aide to Durbin on Tuesday reiterated the Illinois senator’s position that the current rate for large and midsize banks is too high. The aide, who asked not to be identified, noted that banks charged an average of 44 cents per transaction before the Fed’s price caps took effect.
“Between 22 and 24 cents was a middle ground,” the senator’s aide said. “But as the latest Fed report shows, the actual average cost of a transaction is around 3 cents today.”
