The New Push to Reduce Interchange Fees

When you need to pick up the tab, how do you pay? For many Americans the answer is their debit card. Debit cards are the most popular form of noncash payment and, for many banks, that makes interchange fees (fees paid between banks for the acceptance of card-based transactions) a key source of revenue. A revenue source that may now be at risk. The Federal Reserve Board proposed a new rule that would considerably lower the interchange fee cap that debit card issuers may charge a merchant’s bank (an acquiring bank) for processing debit card transactions.

Under the current rule, each interchange fee received by a debit card issuer for a debit card transaction can be no more than the sum of 21 cents plus a small ad valorem component keyed to the amount of the transaction and a fraud prevention adjustment. The proposed rule would lower the cap of the base component to 14.4 cents per transaction. To make sense of those numbers here is an example of what that means for a $50 debit card transaction. Under the proposed rule, the maximum permissible interchange fee for a $50 debit card transaction would be 16.4 cents (plus a potential fraud adjustment), down from 23.5 cents under the current rule. Applying the change to one transaction makes it look like no big deal. It’s seven cents. For the market as a whole, this could mean billions of dollars.

In addition to lowering the interchange fee cap the proposed rule would also institute automatic adjustments to the cap every other year based on data collected in a survey of large debit card issuers. These updates would not be subject to public comment with updated caps taking effect in July of those years and remaining in effect for two years. So, once (and if) the proposal rule goes into effect, there will be rolling adjustments not subject to bank comment in odd-numbered years.

Lastly, a bit of “good” news for smaller institutions. To the relief of many, the proposed rule leaves an exemption in place for “small issuers,” defined as debit card issuers with assets of less than $10 billion. With that noted, however, small issuers do not exist in a vacuum, and they may see their revenues impacted by downward fee pressures in the interchange market.

The Board’s stance is that the proposal would primarily impact merchants by lowering their costs of accepting debit card transactions while decreasing revenue for debit card issuers. The proposal would generally decrease the interchange fee paid by an acquirer on an average transaction performed using a debit card issued by a covered issuer, which would in turn decrease a merchant’s costs by decreasing the merchant discount that the merchant pays to its acquirer for a debit card transaction and, hopefully, these savings would be passed on to their customers and reduce costs.

There is, however, anecdotal evidence that we are already seeing the reverse effect with merchants either up-charging or offering a discount of 3-4% in some cases for cash payments. The impact of the proposed rule across the payments ecosystem may also be exacerbated by the Board’s recent revisions to debit card transaction routing rules for card-not-present transactions. In any case, if there is a shift towards cash payments, that may shrink the interchange fee market and any debit card issuing bank’s piece of the pie, in addition to other potential risks associated with cash transactions. The proposed rule’s comment period ends on February 12th.1