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Even small institutions need to consider the impact and speak out.
As lawmakers continue to debate sweeping changes to credit card network requirements, the immediate focus for financial institutions has shifted toward a Federal Reserve proposal that would cut into revenue tied to debit cards.
The Fed is seeking comments on a proposal that would slash covered financial institutions’ interchange revenue by nearly 30%. The proposal, combined with a recent clarification of rules for card-not-present debit transactions, could spell trouble for all debit card issuers.
The 2011 Dodd-Frank Act, which includes the Durbin Amendment, requires the Fed to set interchange limits at a level that is “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.”
The Fed has left the current cap untouched at 21 cents plus .05% of a debit transaction amount with a 1 cent fraud adjustment for those issuers that qualify, since its implementation of the initial rule. The cap sliced related revenue in half, essentially eliminating investments in debit card products for years—with the Fed finding no evidence of merchant savings being passed down to consumers.
A Change Is Looming
The Fed, for over a decade, has found no sufficient reason to adjust the cap. However, the Fed proposed fundamental changes to not only the interchange cap, but how it is set.
The proposal would reduce the fixed fee component from 21 cents to 14.4 cents and the variable component from .05% of the transaction value to .04%. The Fed also proposed raising the fraud prevention fee, if eligible, from 1 cent per transaction to 1.3 cents.
We assert that the changes, if implemented, will directly result in a roughly $4.5 billion decline in interchange income for covered issuers. (Banks with more than $10 billion in assets collected about $16.6 billion of debit interchange fees in 2022, according to the Nilson Report.) It is unclear how much exempt issuers stand to lose, but using the initial implementation of Durbin as a proxy, it will likely be substantial.
The Fed plans to review, and potentially change, the fee cap bi-annually using an automatic mechanism that essentially eliminates public input. Additionally, the Fed intends to implement findings from its cost studies in July, an unpredictable mid-year turnaround that will challenge debit card issuers in terms of budgeting and forecasting.
Smaller Debit Issuers Could Feel the Sting
Though interchange restrictions are meant to impact larger institutions—banks with less than $10 billion of assets are technically exempt from the Durbin rate cap—the Fed found that the pricing for transactions on cards issued by smaller issuers was also impacted.
Fed Governor Michelle Bowman, who dissented with the proposal, has questioned its ability to protect exempt institutions. She argues that, because banks and credit unions of all sizes operate on the same payment rails, smaller financial institutions will eventually face pricing pressure caused from the lower cap. Bowman is concerned that smaller financial institutions will face ongoing fee pressure for operating debit card programs, even if they are exempted from the interchange fee cap.
Although the Fed’s commentary suggests that consumers could benefit, there is genuine concern that their costs will rise while such benefits as lower prices at merchants will never be realized. This occurred in 2011, when nearly a million Americans, many with low incomes, lost access to banking services, according to a study conducted at George Mason University.
Preparing for Sweeping Change
The Fed’s desire to lower the cap comes at a troubling time. The U.S. banking system is contending with myriad challenges, including high-profile bank failures, persistent inflation, high interest rates, liquidity challenges and deposit flight, macroeconomic headwinds, and labor supply issues.
If the proposal passes, small issuers will likely absorb a hit to their debit programs, which will limit consumer choice and erode efforts at financial inclusion.
The proposal is still open to public comment—we urge financial institutions to weigh in on how a lower cap would harm their business models and impact their customers. Financial institutions should begin collecting relevant data to determine what operational changes a fee reduction would mean for their business. It is essential for leaders, especially those from exempt institutions, to make their voices heard.
Myron Schwarcz is chief product officer at Strategic Resource Management, Inc.
