Federal Courts May Reshape Debit Card Industry in U.S.

by Patricia Hewitt 0

In a further illustration of thedetermination of merchants to wrestle control over cost of paymentacceptance away from the global card networks, a Federal Court thisweek validated their argument that Regulation II rules were counterto the intent of Congress in writing the Durbin Amendment, and ineffect, ordered the Federal Reserve to revisit its regulation.Another hearing has been scheduled for Aug. 14th. The FederalReserve has not responded as of this writing.

The court was not ambiguous in citing that the existing debitinterchange fee cap was improperly calculated and included costsover and above basic authorization, settlement, and clearing. Italso ruled that debit network routing choices were not provided forall authorization types, which Mercator Advisory Group interpretsas meaning two networks for PIN transactions and two networks forsignature transactions. So far, we have seen nothing mentionedspecifically about the fraud adjustment component of theregulation.

With the ruling as it stands today, the court sends the FederalReserve back to reconsider its original regulations in a muchnarrower corridor and reopens the subject to the court of publicopinion nationwide.

Assuming the Federal Reserve rolls back debit interchange feelevels to its original draft level, which was $0.12, the retailchecking account segment could see approximately $5 billion ofcapital shifted from financial institutions to merchants. But thereare other ways the Federal Reserve could approach the problem. Theoriginal legislation was written in a heated atmosphere underintense scrutiny from all sides. Now that three years has passedfrom the signing of the Dodd-Frank Act that contained the DurbinAmendment, more information is available on the impact of thelegislation, more data has been gathered, and therefore, a morenuanced view of the debit industry is possible.

Thus, assuming that the Fed will simply roll back pricing so tospeak, may not be correct. Even though the original debitinterchange fee cap was adopted as a fixed fee across the industry,it was intended as a ceiling and in these new rules, the Fed may bemore stringent as to how that ceiling is applied, for example,allowing for differentials between processing costs of signatureand PIN transactions. But this is mere speculation at this point;the only surety is that if debit interchange fees are rolled backin any material way, the industry is once again, up for anothermajor correction.

Checking account fees will rise, although we doubt that anyissuer will try to connect fees directly to a debit card, butrather we would expect to see more transaction-based fees. Prepaidcards, which are currently exempt (under certain circumstances)will get a big boost as replacement products for traditionalchecking accounts (assuming there are no changes to how the currentexemption is applied), and signature debit transactions willcontinue to decline as issuers shift to more cost-effective PINtransactions. These potential market changes are not new, butsimply echo the transition already taking place in the market as aresult of Regulation II. Ultimately, if these economic levers aremoderated, it will only serve to accelerate the changes takingplace in retail financial services today; moving them even furtheralong the path of becoming value-based, lifestyle-oriented servicesprovided to consumers across a wider array of participants anddelivery channels as a fee-based product.

Mercator believes the more dramatic impact would be if there aretwo debit networks required for each authorization type. In ouropinion, this would drive the industry in a direction that has beencontemplated, but is completely unknown from a business model,operational governance, branding, and technology perspective. Eventhough Regulation II allows for two signature networks, we areunaware of any issuer implementing such a design. Further, theunstable state of EMV technologies to support dual-network routingwill be materially impacted by such a change.

In effect, a mandate to support four networks per debit card wouldcreate the requirement that the industry build an almost entirelyinteroperable payments infrastructure across the United States.That infrastructure would be one where a transaction (anytransaction, not just debit) could move between and across networksat will. Some would look at this and say that it could break themarket open for new and exciting payment possibilities and otherswill say it will simply break the market.

This first take on the court ruling is just that and we willcontinue to modify and recalibrate our opinions and analysis asmore information is known and industry participants, including theFederal Reserve, formally react.

For the latest News Headlines and Featured Storiesrelated to the court’s ruling, visit the Compliance and RegulationStrategy Session.