The Federal Reserve Board will likely have to go back to the drawing board to set the “swipe” fees banks charge merchants for debit-card transactions, and both big-box retailers and small-business merchants could eventually benefit. In the meantime, they will still pay a debit-card transaction fee lower than what they paid when the fees were unregulated.
Federal District Court Judge Richard Leon on Wednesday rejected the Fed’s 21-cents cap on swipe, or interchange, fees the regulator set in October 2011. The Fed is required to set the cap by a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act called the Durbin Amendment.
In a sharply worded opinion, Leon said the Fed’s rule “runs completely afoul of the … design and purpose of the Durbin Amendment.” The judge said that in setting the cap the Fed incorrectly calculated the costs bank-card issuers incur to process debit transactions, and therefore fixed the price too high.
While the Fed could appeal the ruling, and probably will, “the opinon is not written by a judge who thinks he is going to be overturned on appeal,” says Margaret Tahyar, a lawyer in the financial institutions practice at Davis Polk & Wardwell. “Of course, it is a closer call than the opinion would lead you to believe.”
Leon described the board’s interpretation of the Durbin amendment as “utterly indefensible” and the regulations it established “seriously deficient.” The Fed was in error because, in setting the debit-transaction fee, it went beyond the wording of Durbin and included issuer costs that it was not authorized to include, according to Leon’s opinion. Durbin called for the Fed to set a fee that was “was reasonable and proportional” to the costs issuers incur in a debit transaction, including authorization, clearing and settlement fees.
But in coming up with the its final standard interchange fee of 21 cents (plus 0.05 percent of the transaction), Leon said, the Fed accounted for such issuer expenses as network connectivity and software; transaction monitoring; and allowance for fraud losses. The Fed had originally set the fee at around 12 cents.
Although the court decision vacates the rule, the existing cap will remain in place while the case goes through an appeal. If the Federal Reserve loses the appeal, it will “unleash” a whole new round of rulemaking, says Tahyar. “The [original] rule took a year and a half and had 11,000 comments,” says Tahyar. “We probably have the 21 cents for another year, probably two.”
A revised rule would likely set a lower swipe-fee standard. Prior to the Fed’s setting of debit-transaction fees, issuers were charging merchants an average of 44 cents.
From 1998 to 2006, interchange fees for debit-card transactions in which customers enter their PINs more than doubled, outpacing other card-network-interchange fees, according to the court’s opinion. By 2009, banks were reaping $16.2 billion in revenue from the fees.
American Bankers Association president Frank Keating issued a statement on Wednesday saying the ruling would “harm banks of all sizes” and that “the price controls enacted as a result of the Durbin amendment served one purpose — further lining the pockets of our nation’s big-box retailers.”
One of the plaintiff’s in the case, NACS (The Association for Convenience and Fuel Retailing) applauded the ruling, saying “We look forward to the Fed revisiting their initial analysis that concluded the actual cost of a debt transaction was only 4 cents. The Fed should produce a debit-card rule that lowers these outrageous fees.”