As we previously blogged, the Board of Governors of the Federal Reserve (the “Board”) held an open meeting on October 25, 2023 to discuss the debit card interchange fee cap. The debit card interchange fee cap was part of the so-called “Durbin Amendment” to the Dodd-Frank Act, which required the Board to promulgate a regulation applicable to banks having more than $10 billion in assets establishing maximum debit card interchange fees that are “reasonable and proportional to the actual cost” of processing the transaction. On June 29, 2011, the Board issued Regulation II, which provides that the maximum interchange fee an issuer can receive from a single debit card transaction is 21 cents plus 5 basis points multiplied by the amount of the transaction. This rule also allows issuers to raise their interchange fees by as much as one cent if they implement certain fraud-prevention measures.
Chair Jerome Powell opened the meeting. Vice Chair Michael Barr presented the proposal by reading a prepared statement explaining that the basis for the proposal is to ensure that debit card costs are reasonable and proportional to fees for large issuers. Kriss Wozniak presented to the Board the staff proposal for revisions to Regulation II, the Notice of Proposed Rulemaking, and the biennial report titled 2021 Interchange Fee Revenue, Covered Issuer Costs, and Covered Issuer and Merchant Fraud Losses Related to Debit Card Transactions. Mr. Wozniak highlighted that three components (base, ad valorem, and fraud prevention adjustment) were calculated based on 2009 data when Regulation II was enacted in 2011 and has not been revised since enactment. The proposed revisions would update all three components of the interchange fee cap based on the latest data reported to the Board by covered issuers regarding debit card transactions performed in 2021. Under the proposal, the base component would decrease from 21 cents to 14.4 cents, the ad valorem component would decrease from 5.0 basis points (multiplied by the value of the transaction) to 4.0 basis points (multiplied by the value of the transaction), and the fraud-prevention adjustment would increase from 1.0 cents to 1.3 cents for debit card transactions subject to the interchange fee cap.
The proposed revisions would codify in Regulation II an approach for updating the three components of the interchange fee cap every two years based on the latest data covered issuers reported to the Board. Historically, the Board has reported the data two years after its collection. For example, the 2023 published report covered 2021 data and the 2021 report covered 2019 data. Staff believes that directly linking the interchange fee cap to data from the Board’s biennial survey of covered issuers should ensure that any interchange fee subject to the cap will be reasonable and proportional to the cost incurred by the issuer with respect to the transaction, as required by the Durbin Amendment. Staff indicated that the current report evidences that transaction-processing costs of the average debit card transaction declined by nearly 50%, from 7.7 cents in 2009 to 3.9 cents in 2021 with declines in fraud losses over the same period. Mr. Wozniak cited an example that the interchange fee cap on a $50 debit card transaction would decline from 24.5 cents under the current rule to 17.7 cents under the proposed rule.
The Board voted 6-1 to approve the publishing of the Notice of Proposed Rulemaking in the Federal Register and the publishing of the biennial report. Governor Michelle Bowman voted against the publishing of the proposed rule and biennial report.
Governor Michelle Bowman raised concerns about the data collected from covered issuers, unintended consequences on low and moderate income customers, and whether there was a basis to support the benefits suggested by staff that merchants would pass the costs savings through to consumers. Governor Bowman issued a public statement that she read during the meeting addressing the consequences and costs, the formula for periodic updates, the scope of the rule, and the transition period. Governor Bowman stated that “the fee cap aims to achieve ‘rough justice’ by establishing a single cap that applies to all covered issuers.” She described the rules as regressive rulemaking and emphasized that policymakers must understand both the intended and unintended consequences. Governor Bowman also questioned whether the brief 60-day transition period would place an undue burden on banks.
The Board published a press release shortly after the meeting. The proposed rule has a 90-day comment period once published in the Federal Register and the Board stated they are interested in reviewing the comments submitted. The proposed rule would, if adopted, become effective at least 60 days after the final rule is published in the Federal Register.
In a October 25, 2023 letter, the Consumer Bankers Association, American Bankers Association, American Association of Credit Union Leagues, Credit Union National Association, Electronic Payments Coalition, Independent Community Bankers of America, Mid-Size Banks Coalition of America, National Association of Federally-Insured Credit Unions and National Bankers Association urged the Board to reject further changes to Regulation II and the opportunity to rebut any merchant assertions prior to the Board’s vote yesterday. The Consumer Bankers Association, The Bank Policy Institute, and The Clearing House issued a joint statement in response to the proposed changes to Regulation II stating, “The last time the Federal Reserve placed a cap on debit transaction costs, two things happened: the availability of free checking accounts declined and merchants pocketed the difference in cost, defaulting on their promise to the American consumer to lower costs at the counter. Attempting to revisit the failed policy in a world where technology and fraud prevention costs are even higher will exacerbate these problems and further harm consumers.” The statement highlighted the four realities of Regulation II: (1) merchants did not decrease prices; (2) customers have experienced decreased access to free checking accounts; (3) fraud costs have risen; and (4) non-covered issuers were impacted by the interchange fee caps. The American Bankers Association issued a statement expressing their disappointment with the Board’s proposed changes to Regulation II, stating:
“As the Federal Reserve concedes, this proposal has the potential to make checking accounts, debit cards and a range of financial products more expensive for American consumers, while delivering an unprecedented gift to big-box retailers that have shown no inclination to pass any savings along to customers. Far from holding community banks harmless as the Fed claims, smaller institutions will be sharply impacted by this change, as revenue they use to pay for a range of financial products and services is reduced. Regulation II has also accelerated consolidation in the industry and more small banks are covered by these caps. If enacted, this government price cap would result in reduced fraud protection and reduced access to debit cards, which no one should want, including merchants. Even more troubling is the idea that the Fed wants to automate this misguided process and policy and repeat it every two years.”
The biennial report includes covered card issuer data from 2021 and indicates that payment card networks in the United States processed 92.1 billion debit and general-use prepaid card transactions valued at $4.3 trillion with card not present transaction volume increasing to 32.1%. As previously stated in the staff report, the charged interchange fees remained higher than issuers’ actual costs. The average per-transaction authorization, clearing, and settlement costs, excluding issuer fraud losses, among covered issuers were $0.039 in 2021, which was the same as the 2019 cost. The report found that merchants absorbed 47% of fraud losses, issuers absorbed 33.5% of fraud losses, and cardholders absorbed the remainder. Prepaid cards experienced the highest fraud increase.
Pending litigation against the FRB is seeking to invalidate Regulation II’s uniform standard for reasonable and proportional interchange fees on debit cards. The complaint alleges that issuers continue to profit from debit card fees at retailers’ and consumers’ expense notwithstanding the requirement that the fees be reasonable and proportional. The plaintiffs argue that the Durbin Amendment requires a case-by-case approach to whether an interchange fee is reasonable and proportional, not a single standard as the FRB adopted in 2011. In connection with this litigation, the U.S. Supreme Court agreed to decide when a right of action first accrues for an Administrative Procedure Act challenge to a final rule issued by a federal agency—when the final rule is issued or when the rule first causes injury. Notably, the proposed rule continues to use an uniform standard for all issuers.
Additionally, this summer, Senator Dick Durbin and Representative Lance Gooden introduced “The Credit Card Competition Act of 2023” to regulate interchange fees on credit cards by requiring certain credit card issuers with over $100 billion in assets to enable at least two credit card networks on their credit cards, and at least one of those networks must be a network other than Visa and Mastercard. The Act does not apply to networks that are the card issuers, such as cards issued by American Express and Discover. The bill has failed so far to gain any traction in Congress. We recently released the Understanding the Credit Card Competition Act a/k/a Durbin 2.0 episode of our Consumer Finance Monitor Podcast in which we discussed the Act’s implications and political prospects.