On June 29, 2011, the Federal Reserve's Board of Governors (the Board) voted 4 to 1 (Governor Duke opposing) to adopt final rules implementing those provisions of the Dodd- Frank Wall Street Reform and Consumer Protection Act that address debit interchange and network routing and exclusivity, among other things, and which have commonly been referred to as the Durbin rules. Section 920 of the Electronic Fund Transfer Act, as amended by Section 1075 of the Dodd-Frank Act, requires that "any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction." Section 1075 requires the Board to issue regulations setting standards for debit interchange fees and instructs the Board to consider the functional similarities between electronic debit and check transactions and to distinguish between incremental costs specific to a certain transaction and the other costs incurred that are not transaction-specific. In addition, Section 1075 permits adjustments to the interchange fee standards for fraud prevention costs based on consideration of specified factors. Section 1075 also limits a payment card network's ability to require exclusivity and implement routing restrictions, to prohibit merchants from offering discounts based on form of payment and to require a minimum transaction amount of more than $10. The Board had issued a proposed rule for comment in December 2010 and had received more 11,500 comment letters.
Interchange Fee Caps. The Board adopted a per-transaction interchange cap consisting of a base component of 21 cents and a fraud loss adjustment of 5 basis points per transaction. The fraud loss adjustment amount was based on data collected by the Board concerning the average per-transaction fraud losses of a median issuer. Under the final rule, each issuer may collect transaction fees that do not exceed this cap without having to demonstrate its own actual per-transaction allowable costs. The proposed rule had offered two alternative frameworks: a cap of 12 cents per transaction with a safer harbor at 7 cents per transaction; and a stand-alone cap of 12 cents per transaction. Rather than adopting either of these approaches in their entirety, the Board used the cap proposed in the second alternative, but significantly raised the cap from 12 cents to 21 cents, excluding the fraud adjustment. The increase was based on the Board's determination that the proposed rule had defined the allowable costs too narrowly. The effective date of the rule on interchange fees is October 1, 2011.
In addition, the final rule implements the statutory exemptions from the interchange fee standards for small issuers (those with assets of less than $10 billion), government-administered debit programs and certain general-use, reloadable prepaid cards. In order to reinforce the exemption provided for small issuers, the Board will publish annually a list of institutions that fall above and below the small-issuer threshold. The Board also decided to conduct an annual survey of payment card networks and publish a list of the average interchange transaction fees paid to covered and exempt issuers.
The rule also prohibits circumvention or evasion of the fee restrictions by prohibiting an issuer from receiving net compensation from a payment card network with respect to debit transaction or related activities within a calendar year.
Fraud Prevention Adjustment. The Board also adopted an interim final rule that permits a fraud prevention adjustment of 1 cent per transaction if the issuer complies with the fraud-related standards set by the Board. The interim final rule permits an issuer to collect the 1 cent fraud prevention adjustment if it implements policies and procedures that (i) identify and prevent fraudulent electronic debit transactions, (ii) monitor reimbursements and losses in connection with such transactions, (iii) respond to suspicious transactions in a manner that limits losses and prevents future fraudulent activity, and (iv) secure debit card and cardholder information. In order to maintain eligibility for the adjustment, an issuer must review its fraud prevention policies at least annually, update the policies as necessary, and certify its compliance with the Board's standards to the payment card networks in which it participates on an annual basis. Although the Board invited public comment, the draft interim rule will become effective on October 1, 2011, the same date as the interchange fee rules, and all comments are due by September 30, 2011.
Exclusivity and Routing. The final rule adopted by the Board limits the ability of issuers and networks to restrict the number of networks enabled on a debit card or a merchant's choice of network through which it routes transactions. The final rule requires issuers and networks to permit transactions to flow through at least two unaffiliated networks without regard to the method of authentication, such as an electronic signature, PIN or other means. The final rule reflects, in part, a concern raised by commenters that restrictions on network selection and authentication methods may have a negative effect on innovation. The staff noted that the choice to not restrict the method of authentication in the network exclusivity rules would permit the development and use of new technologies without having to wait for a competitor to offer the same technology. The network exclusivity rules will be effective with respect to payment card networks on October 1, 2011 and mandatory for issuers on April 1, 2012. The effective date for certain health and other benefit cards and non-reloadable general-use prepaid cards will be April 1, 2013. The effective date for reloadable general use prepaid cards will be April 1, 2013, with the exception that cards sold before April 1, 2013 would not be subject to the rule until they are reloaded, and then the effective date for such cards will be May 1, 2013 or 30 days after the date the cards were reloaded if reloading occurred after April 1, 2013.
The final rule also prohibits issuers and payment card networks from inhibiting the ability of any person accepting debit cards from directing the routing of the transaction over any network that can process the transaction. The provision becomes effective on October 1, 2011. The restrictions on discounts and minimum transaction amounts are not included in the final rule, as they are self-executing.
Additional Issues. In the meeting, members of the Board raised concerns about the effect on smaller institutions and consumers of the interchange fee rules. The staff responded that the net effect on consumers was not predictable at this time and that it will depend both on consumer behavior and the reactions of merchants and financial institutions to the rule. The staff also noted that review of the effect of restrictions on interchange fees by either government intervention or market forces in other countries did not comprehensively predict consumer effect and that merchant discounts may not necessarily be passed on to consumers in the form of lower prices.
In addition, the Board noted concern about whether the exemptions for small issuers, government-administered programs and prepaid card issuers will be effective. To address these concerns, Governor Tarullo offered a proposed informal instruction to the staff to review and comparison of interchange fees for exempt and non-exempt entities at intervals of six and eighteen months after the effective date.
Click here to view the Board's memorandum and here to view the proposed final rules.
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