Fed Questions Viability Of Two-Tiered Interchange System

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WASHINGTON-Federal Reserve Chairman Ben Bernanke expressed doubt last week on the workability of exemptions for credit unions and small banks from the debit interchange price controls required under the Dodd-Frank Financial Reform Act.

Bernanke raised concerns about how the exemption for institutions under $10 billion will be enacted, noting that the market is likely to drive more transactions to lower-priced debit cards mandated for the institutions over $10 billion. "We are not certain how effective that exemption will be," said the Fed Chairman during testimony before the Senate Banking Committee. "It is possible that because merchants will reject more expensive cards from smaller institutions or because networks will not be willing to differentiate the interchange fee for issuers of different sizes, it is possible that the exemption will not be effective in the marketplace."

Credit unions and community banks have argued that the exemption will force merchants to discriminate against their higher-fee cards, which will force the smaller institutions to charge the same, lower fee as large banks. Bernanke acknowledged that possibility this morning, saying "it's possible merchants will reject cards from smaller banks."

Proposed rules unveiled by the Fed in December would limit fees for the biggest banks to seven to 12 cents per transaction, a 73% percent drop from the current 44-cent average.

The stakes are huge for credit unions which earned an estimated $2.6 billion last year-well more than half of all their net income-from debit card interchange. Interchange for credit unions from debit transactions now exceeds by far all revenues earned on credit card transactions.

Bernanke's comments came the same time as the House Financial Services Committee was holding a hearing on implementation of the debit card provision, known as the Durbin amendment because it was sponsored by Sen. Richard Durbin (D-IL). A credit union representative, Frank Michael, president of Allied CU of Stockton, Calif., was scheduled to testify, along with Sarah Raskin, one of the Fed's seven Governors, and representatives from the banks, Visa and the merchants groups.

The Fed's Raskin echoed concerns expressed by Fed Chairman Ben Bernanke on the viability of the exemption for smaller institutions. She also doubted whether the Fed has the authority to extend the exemption to the network exclusivity and routing provisions of the Durbin amendment, saying the law only applies the exemption to the price control provisions.

The Fed Governor said the Fed would consider a delay in the July final date for a new rule if Congress says so, but that is up to Congress and not the Fed.

Allied CU's Michael, who was representing CUNA at the hearing, said the proposed rule will have dire effects on credit unions. The proposal, he told lawmakers, "will make it more expensive for my members to access their checking accounts, and I know that this is not what Congress intended because Congress included an exemption for institutions like Allied."

"When the law was passed," he said, "the chief proponent said credit unions like mine, 'would not lose any interchange revenue that they currently receive.' We were skeptical about this statement in July and, unfortunately, the proposed Fed rule makes it clear that that will not be the case."

"There is no guarantee that all of the payment networks will operate a two-tier system," Michael said. "Even though Visa has said it would, it is not clear when it would start, for how long, or under what conditions it would do so. Visa is just one of several payment card networks. Who is to say the others will operate this way?

"Even if they do, with the passage of time, market forces will cause at least some convergence of prices for the two tiers in the absence of full implementation of the exemption that Congress intended," said the credit union executive.

"In our view, the Fed's proposal errs by failing to include a provision enforcing the small issuer exemption... We would hope the Committee would encourage the Fed to use (its) authority to enforce the exemption and protect small issuers," Michael testified.

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