Fed Proposes ‘Draconian’ Cuts In Interchange Revenue

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WASHINGTON – Industry experts are predicting that the Federal Reserve’s proposal to cap debit interchange fees at 12 cents per transaction could lower revenues for credit unions and banks by billions of dollars a year.

“This is a substantial part of our non-interest income,” said Jim Blaine, president of North Carolina State Employees’ CU, which earned $20 million–about 20 cents per transaction–on debit card interchange through the first ten months of the year. Reflecting a growing trend among credit unions and banks, the majority of the $20 billion credit union’s card transactions are now debit, and not credit.

Though SECU is one of just three big credit unions which will come under the rule–those under $10 billion in assets are exempt–industry observers are predicting the Fed’s fee structure is certain to have an industrywide impact because the two major card networks, Visa and MasterCard, have indicated they will not institute a bifurcated fee structure.

Jeff Tassey, chief lobbyist for the Electronic Payments Coalition, which counts CUNA and NAFCU as members, said the Fed’s proposal would amount to “draconian cuts from the current interchange rates for transactions.” He estimated it would lower current fees by as much as 70% to 90% for the affected institutions, and by extension credit unions and banks that are currently exempt from the Fed proposal. “It’s a massive reduction,” said Tassey.

The Fed’s proposal comes as new studies show that debit cards have become the most frequently used non-cash payments, exceeding credit cards and checks. Debit card fees, which amount to as much as a third of the $60 billion in credit and debit card interchange paid last year, are a rapidly growing market, with credit unions having earned as much as $2 billion in debit fees alone last year.

The worst part of the Fed’s proposal, according to SECU’s Blaine, is that the reduction in fees is not expected to accrue to consumers–as Congress intended in directing the Fed action, but to retailers, who have been lobbying Congress for controls on interchange. “I don’t believe the savings will be passed on to the consumer,” Blaine told the Credit Union Journal. “This is a move to lower the income of financial institutions and raise the income going back to merchants.”

Blaine does like the idea of setting a flat fee, rather than allowing the card networks to set fees based on a percentage of a purchase price. “Processing a transaction for a few dollars is not a whole lot different than processing a transaction for a couple of thousand dollars,” he said.

The Fed offered the proposals as part of its mandate under the Dodd-Frank Wall Street Reform and Consumer Protection Act that President Obama signed last July. The law’s Durbin Amendment calls for the Fed to devise regulations that would ensure “reasonable and proportional” debit card interchange applicable only to banks and credit unions with more than $10 billion in assets. The law also says debit card issuers must offer so-called unaffiliated network options for transaction routing and bans issuers and payment card networks from limiting merchants’ choice in routing debit transactions.

CUNA President Bill Cheney said after the Fed issued the rule for a 60-day comment period that credit unions hope the final rule will take into account all costs for offering debit programs, especially those for fraud prevention and resolution. “If we’re not allowed to take all costs into consideration those costs will have to be passed on to the consumers,” said Cheney. “Somehow the costs are going to have to be accounted for.”

During yesterday’s hearing at the Fed several staffers and Fed governors said their initial reaction was not to include fraud-related costs in setting allowable interchange fees because it is difficult to apportion costs for debit programs. But they are willing to listen to industry representatives during the comment period on this matter.

In accordance with the parameters set by the law, the staff recommended allowing issuers to recover costs directly related to the authorization, clearing, and settlement of electronic debit transactions, but not other costs, such as card production and distribution, general costs of deposit accounts, branch costs, and other overhead.

The proposal would also bar the major networks, Visa and MasterCard, from restricting the networks over which a debit transaction may be routed, a practice known as “network exclusivity.” This would allow card issuers to shop for the lowest cost network, including potential new ones, to route their transactions, and discourage networks from setting high processing fees.

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