A proposed rule would lower the maximum amount that large debit card issuers can charge merchants for each transaction.
On October 25, 2023, the Board of Governors of the Federal Reserve System (FRB) published a proposal that would lower the maximum interchange fee — transaction fees that a merchant must pay to card issuers whenever a customer uses a debit card to make a purchase — that a debit card issuer can charge per transaction (the Proposal). The Proposal would apply only to issuers with at least $10 billion in total consolidated assets (covered issuers). It would also establish a process and formula for updating the maximum fee amount every other year going forward, based on data voluntarily reported by covered issuers to the FRB.
Current Fee Standards and Proposed Changes
Under the Durbin Amendment to the Dodd-Frank Act, Congress required the FRB to establish standards for determining whether debit card interchange fees are “reasonable and proportional to the cost incurred” by the debit card issuer, taking into account issuer’s fraud prevention expenses. The FRB is also authorized to adjust the interchange fee “in an amount that is reasonably necessary.”
The current rule adopted by the FRB in 2011 (Regulation II) states that the interchange fee a debit card issuer may charge per transaction cannot exceed 21 cents, plus a 5.0 basis point ad valorem component (multiplied by the value of the transaction), less a 1% fraud prevention adjustment.
The FRB noted, however, that the interchange fee standards were first adopted using data reported to the FRB by covered issuers in a voluntary survey conducted in 2010 using 2009 data. Since then, data collected by the FRB has indicated that certain costs incurred by covered issuers have declined dramatically, while the interchange fee cap has remained the same. Therefore, current data suggests that the interchange fee “may no longer be effective for assessing whether . . . the amount of any interchange fee received by a debit card issuer is reasonable and proportional to the cost incurred by the issuer with respect to the transaction.”
Pursuant to more recent data obtained from covered issuers, the Proposal would lower the fee cap to 14.4 cents per transaction, decrease the ad valorem component to 4.0 basis points, and increase the fraud prevention adjustment to 1.3 cents.
The Proposal also contains an automatic update provision, whereby the interchange fee cap would be reassessed every other year by linking the cap to fresh data from the FRB’s survey of covered issuers. According to the Proposal, these updates “would be published without inviting public comment and would be published by March 31 of odd-numbered years, with the new amounts taking effect on July 1 and remaining in effect for two years.”
The Proposal would not impose any new reporting or recordkeeping requirements on consumers or merchants.
Comments on the Proposal are due 90 days after publication in the Federal Register. If adopted, the Proposal would become effective at least 60 days after the final rule is published in the Federal Register.
In its statutorily required economic analysis included with the Proposal, the FRB assessed the various ways that the parties in the debit card industry would be affected. Merchants will face lower fees per debit card transaction, but covered issuers will see decreased revenues. Consumers may benefit if merchants pass along the advantages of lower fees, but they may face negative consequences if covered issuers seek to replace lost revenue on interchange fees with higher fees on debit card accounts or other products and services. According to the FRB, “[t]he net effect on consumers, both individually and in the aggregate, will depend on which of these two effects predominates, which would in turn depend on many factors and is thus difficult to predict.”
Given that the Proposal would maintain the fee cap exemption for small issuers — generally, banks with fewer than $10 billion assets — fintech companies that partner with these small issuers (e.g., neobanks, digital wallets, etc.), may find the Proposal has limited ramifications.
Governor Bowman Dissents
The FRB voted 6-1 in favor of publishing the Proposal. Governor Michelle Bowman objected to the Proposal and issued a strong dissent. She stated that the economic consequences of the Proposal are unclear, and fears that cost-saving benefits will not accrue to consumers (in a separate speech criticizing the Proposal, Governor Bowman feared that “the net result of this proposal may be to simply shift costs from merchants to bank customers, and to make those costs far less transparent”). Detrimental effects may also accrue to smaller issuers subject to the cap (“those with smaller transaction volumes, less negotiating power, and fewer efficiencies in scale”), as they face direct and indirect cost pressures in operating debit card programs.
She was also concerned that lower revenue for covered issuers under the Proposal combined with various other FRB regulatory changes will have a negative cumulative effect on the banking industry: “a lower interchange fee cap, higher capital requirements, new debt-funding requirements, increasing data collection requirements, and many other [regulatory changes] could pose ongoing risks to the health of certain financial institutions and the overall U.S. banking system.” She advocated for a thorough assessment of the broader context and potential consequences of the Proposal before the FRB engages in significant regulatory change.
Latham & Watkins will continue to monitor developments regarding this topic and related areas.