OCC backs banks in fight against Illinois interchange law

Andrew Harrer/Bloomberg

WASHINGTON — The Office of the Comptroller of the Currency has filed a legal brief supporting the banking industry's challenge to Illinois' prohibition on interchange fees, stating  the law interferes with federal banking authority. 

Prohibiting interchange fees would "erode this essential infrastructure, leaving national banks with extraordinary operational burdens that likely will be passed on to consumers in the form of higher fees, reduced services and weakened fraud protection," the OCC wrote in the brief filed Wednesday. "The [Interchange Fee Prohibition Act] prevents or significantly interferes with federally authorized banking powers that are fundamental to safe and sound banking and disrupts core functionalities that drive the nation's economy."

The IFPA — signed into law in June — bars financial institutions from charging interchange fees on tips as well as state and local tax portions of transactions. The Illinois law also limits an institution's ability to use transaction data for anything beyond processing payments or legal obligations. 

The OCC said these restrictions could force banks to halt credit card usage in Illinois, interfering with banks' rights under the National Bank Act. Therefore, the agency wrote, the law is unconstitutional under the Supremacy Clause.

"To comply with the IFPA, institutions would be forced to incur extraordinary costs in creating new systems and processes to effectuate the IFPA's first-of-its-kind exclusion of tax and gratuity amounts from the processing of interchange fees," the OCC said in its brief. "Compliance with the IFPA alone would seemingly require national banks to accommodate the taxation schemes of hundreds of Illinois localities, thereby frustrating the purposes of the national banking system and impairing national banks' ability to effectively and efficiently conduct the business of banking."

The OCC's preemption powers, rooted in the Supremacy Clause, allow national banks to bypass state laws that conflict with federal authority. However, recent Supreme Court rulings have restricted these powers, requiring courts to independently review state laws and apply stricter standards, like the significant interference test from the Dodd-Frank act, rather than deferring to the OCC's interpretations. 

The interference standard, established in the 1996 Supreme Court case Barnett Bank v. Nelson and later codified in Dodd-Frank, states that a national bank can only preempt state laws if those laws significantly interfere with the bank's ability to exercise its powers. This means that if a state law merely adds minor burdens or regulations but doesn't substantially hinder the bank's operations, the state law would not be preempted.

Hsu says OCC will update its state preemption standards

The OCC warned that if the IFPA stands, it could lead to a fragmented national payment system as other states follow suit. The agency also expressed concerns the law's restriction on data usage would hinder banks' ability to use transaction data for critical functions like fraud detection, risk management and consumer services.

While the law is set to take full effect July 1, 2025, TD Cowen analyst Jaret Seiberg said the agency's brief could bolster the likelihood a federal judge temporarily blocks the law from taking effect as the case continues. A hearing on the banking industry's motion for the preliminary injunction is scheduled for Oct. 30.

"An injunction is critical as we do not see how banks will be able to exclude taxes and tips from interchange fees as merchants do not transmit itemized bills," Seiberg wrote in a note. "At its most extreme, it could force banks and networks to at least temporarily block the use of credit cards in the states."