The year 2010 will be remembered as when the federal government got involved in how much interchange banks and credit unions earn on their debit card transactions.
The regulations came in form of an amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act that had been principally sponsored by Sen. Richard Durbin (D-Ill.).
The amendment was the unexpected culmination of years of lobbying from merchant associations that complained they were having to pay too high a price for accepting credit and debit cards. But all the lobbying came to naught until, according to one source, Durbin was contacted by a very important constituent.
Thomas Brown, an adjunct law professor with the University of California Boalt School of Law, told a June conference on interchange that the Durbin amendment should more appropriately be called the Walgreens amendment. He said that Durbin only drafted the amendment after taking a call from the CEO of Walgreens. Brown is also former senior counsel for Visa Inc. A spokesman for Durbin denied the accusation.
Durbin's amendment to the bill instructed the Federal Reserve to craft regulations that would limit debit card interchange to only what is "reasonable and proportional" to the costs of issuing the cards. The regulations are not drafted yet, but analysts expect that the regulator will include the costs of card fraud in the calculation but not overhead and marketing. The end result is liable to be about a 40% drop in debit card interchange, more for debit card transactions that are authorized with a signature.
Two reports that appeared at the end of the year tried to predict the regulations likely impact.
"The New Order: How Interchange Regulation Will Change the U.S. Payment Industry," published by the Aite Group and "Interchange Regulation: Implications for Credit Unions," published by the Filene Research Institute considered the impacts of what their researchers considered the most likely Federal Reserve regulations.
But both reports pointed out that the amendment will not likely succeed in that goal both because differentiating between card issuers by size will be beyond the ability of many merchants and because the law leaves room for merchants to choose payment networks that will not pay as much to issuers.
"Though larger retailers will be sophisticated enough to use BIN tables to decide what to pay which banks, millions of merchants won't have the level of sophistication required to enforce the exemption rule," Aite wrote in its report.
The Filene report said, "Institutions with less than $10 billion in assets may be shielded from the 'reasonable and proportional' interchange standards, but they will still be subject to 'multi-homing'-the requirement that each card be capable of processing a transaction on more than one network." The report's author, Adam J. Levitin, an associate professor of law at Georgetown University Law Center in Washington, said, "Competition among networks will allow merchants to route transactions to the network that saves them the most money, which will push down income for issuers."
But beyond the impact to interchange income, both reports discussed some of the other changes that the firms said are likely to come about because of the new interchange rules.
For example, the new regulation may do a lot to revive regional PIN-debit networks that have been losing ground for years to national PIN-debit networks. This would be because the new regulation prevents debit issuers from establishing their debit networks in a way that maximizes their income. In effect, Aite pointed out, this will limit the reliance on Visa's networks.
"At a minimum, the law is putting a stop to years of Visa's gaining market share in PIN debit," Aite wrote. Visa will no longer be able to sign exclusive deals with debit card issuers for its Visa signature debit network and Interlink PIN debit network. And banks will not be able to switch debit card transactions exclusively through Visa, the report said.
Levitin forecast that market pressures will also lead debit networks to adopt a two-tier interchange system and schedule to keep transaction volume from smaller debit issuers.
"It is unlikely, therefore, that networks will adopt single-tier pricing," Levitin wrote. "Instead, the networks are likely to move to separate pricing for small issuers."
Significantly, both reports predicted that the new regulation will drive some additional innovations in the payments industry. The Aite report estimated that banks will increase their offerings of prepaid cards which to help avoid or mitigate the debit interchange cut. They may also begin to shift their debit card marketing to where they will try to establish more relationships with merchants to increase debit traffic.