Many banks subject to the Durbin amendment are convinced debit interchange cuts will make free checking or rewards programs impossible to support. What they are not so sure about is what Durbin would mean in the fight against fraud.
The doubts arise from a provision in U.S. Sen. Richard Durbin's (D-Ill.) contentious amendment to the Dodd-Frank Act that was actually meant to throw banks a bone: the ability to exceed interchange fee caps in order to recoup fraud-prevention costs. Some estimate that banks already spend 6 cents a transaction on debit-related fraud losses and prevention. That's half of the 12-cent fee limit that's been proposed for large institutions by the Federal Reserve.
The problem is not just that the Fed's cap is already well under what banks estimate for processing costs, but that Durbin omits debit fraud losses (almost half the total debit fraud costs to banks) as a recoverable expense. The Fed has not yet told banks which anti-fraud costs—such as technology investments—can be defrayed through higher interchange. Nor has the Fed detailed what types of debit-fraud prevention or reduction programs banks would need in place for such expenses to qualify. "The Fed kicked the can down the road," by not clarifying the fraud adjustment levels in its initial proposal, says American Bankers Association spokesman Peter Garuccio.
Issuers had hoped for some clarity by April, but the Fed's postponement of the proposed cap on debit interchange put the fraud issue on hold as well.
The waiting game leaves institutions unsure whether they'll be able to recoup a reasonable return for their anti-fraud investments, and whether fraud prevention efforts against data breaches and identity theft might be hindered under Durbin rules. There's also a debate about whether Durbin might inadvertently shift more fraud loss liability to consumers, if banks drop network-branded debit products in favor of PIN debit cards that lack the $50 maximum liability limits of credit and signature-debit cards.
"If there's a 7-cent safe harbor and a 12-cent cap, that's going to be at a level that's below cost for all the issuers," says Ed Kadletz, executive vice president and head of debit and prepaid cards at Wells Fargo. "It might mean curtailing services, introducing new fees, and reassessing investments you are thinking about making" in fraud and other areas.
If banks can't profitably manage fraud on signature debit, it could mean drastic changes to fraud-protection schemes for consumers, say experts. Some institutions may be forced to unbundle debit-card fraud protections into an optional, fee-based product. They may also tighten the risk parameters on debit-card transaction approvals, which, for card users, could mean more denials at points of sale, says Kadletz.
If Durbin rules restrict banks from adequate fraud compensation, banks ultimately may choose to take away network-branded check cards from some customers, who in turn would have to use checks and PIN debit cards that often don't carry the same zero or limited liability protections afforded Visa or MasterCard signature-based debit transactions.
"Banks may say in future, if we're only getting 12 cents on these transactions, we're going to leave the consumer more out to dry," says James Van Dyke, president of Javelin Strategy & Research in Pleasonton, Calif.
In a 2010 Javelin study on identify fraud, the firm estimated that consumers lost an average $795 in out-of-pocket expenses per fraud loss incident, due in large measure to PIN-debit losses not covered by banks. In Javelin's survey of bank product offerings, 44 percent of banks did not offer zero liability on PIN debit purchases (as is the standard for credit and signature debit card).
In a November 2009 fraud survey by the American Bankers Association (the latest on hand), banks covered $788 million in debit fraud losses in 2008 that otherwise would have been absorbed by consumers.
A Feb. 22 comment letter to the Fed, the law firm Morrison & Foerster cited issuer surveys to estimate that fraud loss and fraud prevention expenses each cost issuers three cents per transaction. That's in addition to another 21 cents needed for network fees, handling customer inquiries, card manufacturing, processing and capital costs on each debit swipe. The firm stated it believed each of those numbers "understate issuer costs," based on the varying economies of scale found between large and small issuers.
Although community and regional banks under $10 billion in assets are exempt from the Durbin rules, there's concern that interchange caps could alter the fraud equation for them, as well. Community banks already argue that caps will drive down interchange fees for all banks due to market forces, and will force them to limit their fraud investments to stay competitive. "If I cannot get paid for the risk I take, I've got to eliminate it," says Sam Vallandingham, vice president and chief information officer of First State Bank in Barboursville, W. Va.
According to observers, the Fed's fraud-cost adjustment guidelines could take shape in one of two ways. One would be to require a "general formula" of basic data security standards for card transactions. Others speculate that it might escalate to specific anti-fraud requirements, including chip-enabled debit cards. In a report last year, Aite Group analyst Gwenn Bezard wrote that the Durbin language encouraging the "development and implementation of cost-effective fraud prevention technology" is clearly a hint at chip-and-PIN—the widespread EMV (Europay, MasterCard and Visa) international standard for chip-based cards that authenticates users' PINs at the point-of-sale, rather than through network channels.
Many still consider chip-and-PIN requirements a long shot because of the adoption costs to banks and merchants. But there are also arguments against the "general formula" standards approach, which some feel provides no incentives for banks to effectively invest in anti-fraud technology. Retailers, meanwhile, argue that looser rules allowing a wider range of fraud expense coverage "effectively passes the costs of fraud tech on to the merchants" through the higher interchange, says Aaron McPherson, practice director and payments analyst for IDC Financial Insights.
