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Emerging Issues


Final Debit Interchange Rule Issued by Federal Reserve Most credit unions have been closely following developments in relation to the proposed debit interchange rule issued by the Board of Governors of the Federal Reserve System (the “Board”) in December 2010, and are aware of the final rule issued by the Board on June 29, 2011 (the “Final Rule”). While the Final Rule certainly appears to be an improvement on the proposed rule, concerns remain as to the potential effect on credit unions. In fact, individual Board members expressed their concern as to the Final Rule’s effect on small debit card issuers such as credit unions. “Reasonable and Proportional” Limit on Debit Interchange Transaction Fees The Final Rule increases the “reasonable and proportional” interchange transaction fees cap from the twelve (12) cent cap initially proposed in December. Under the Final Rule, an issuer subject to the limit must charge debit interchange transaction fees that are “reasonable and proportional” to the cost incurred by the issuer with respect to the debit transaction; an issuer complies with the limit by charging an interchange fee for a debit transaction that does not exceed the sum of: (1) twenty-one (21) cents; and (2) five (5) basis points multiplied by the value of the transaction (this component of the fee is referred to as the “5 bps ad valorem component”). While the Final Rule includes an exemption for small issuers with assets of less than $10 billion in assets, it is unclear whether payment card networks will be able to effect a two-tiered fee structure (i.e., separate fee structures for large and small issuers). The Board noted that payment card networks that collectively process approximately 80% of debit card volume “have indicated that they will establish two separate interchange fee schedules when the rule goes into effect.” However, the Board acknowledged that such indications were not binding commitments by networks. In addition, the Board noted that the Final Rule’s restrictions, including network exclusivity and merchant routing provisions, “could put some downward pressure on interchange fees overall.” The Final Rule’s limit on debit interchange fees takes effect on October 1, 2011. Although the Dodd-Frank Act provided an effective date of July 21, 2011 for the interchange fee limit, the Board interpreted the Dodd-Frank Act as “indicating that Congress intended at least a three-month implementation period before the interchange fee standards become effective.” The Board also stated that the October 1 date coincides with the normal schedule for many network releases of systems changes. According to the Board, the October 1, 2011 effective date balances Congress’s intent to have interchange fee standards implemented promptly with the need to provide issuers and networks sufficient time to implement the new standards. Network Exclusivity The Board also implemented a prohibition on network exclusivity to prevent issuers and payment card networks agreeing to only enable one (1) network on the issuer’s debit cards. The Final Rule requires a debit card to have at least two (2) unaffiliated payment card networks available to process a debit card transaction; an issuer could comply by having one payment card network available for PIN debit transactions and another, unaffiliated network available for signature debit transactions. Issuers must comply with this requirement by April 1, 2012, while payment card networks must comply effective October 1, 2011. Prohibition on Merchant Routing Restrictions The Final Rule also prohibits issuers and payment card networks inhibiting the ability of merchants to direct the routing of debit card transactions for processing over any payment card network that may process such transactions. This requirement takes effect on October 1, 2011. “Fraud Prevention Adjustment” The Board also released an interim final rule on June 29, 2011 (the “Interim Final Rule”) that provides a “fraud prevention adjustment,” under which an issuer may charge an additional amount of up to one (1) cent per transaction to any interchange transaction fee it receives. To be eligible for this “fraud prevention adjustment,” an issuer must develop and implement policies and procedures reasonably designed to:

  1. Identify and prevent fraudulent debit card transactions;
  2. Monitor the incidence of, reimbursements received for, and losses incurred from, fraudulent debit card transactions;
  3. Respond appropriately to suspicious debit card transactions so as to limit the fraud losses that may occur and prevent the occurrence of future fraudulent debit card transactions; and
  4. Secure debit card and cardholder data.

In addition, the issuer is required to review its fraud detection policies and procedures at least annually, and update them as necessary to address changes in the prevalence and nature of the fraud the issuer experiences in debit card transactions and changes in the available methods of detecting, preventing, and mitigating fraud. The issuer must also certify compliance with the above “fraud prevention adjustment” requirements to its payment card networks on an annual basis. The Interim Final Rule also takes effect on October 1, 2011, while comments are requested on the Interim Final Rule by September 30. Potential Impact of Final Rule As stated above, the Board acknowledged that the Final Rule is likely to significantly affect debit card issuers. Analysis prepared by the Board’s Staff indicated that large issuers (i.e., those issuers with $10 billion or more in assets) may likely suffer a decline in revenue from debit interchange fees by more than 40%. Small issuers are exempt from the “reasonable and proportional” fee limit, but still may see debit interchange revenue significantly decline to the extent that their payment card networks are unable to implement a two-tiered fee structure. In addition, the Board recognized that market forces may result in a decrease of interchange fee amounts paid to small issuers. As a result, issuers may likely attempt to offset lost interchange fee income by raising fees or reducing costs. The Final Rule will also likely increase issuers’ costs associated with complying with its requirements. Given the changes made under the Final Rule, your credit union will need to work with its payment card networks to determine what steps need to be taken to comply with the Final Rule, including the cost of any changes that need to be implemented. Beyond changes under its payment card network agreements, your credit union will also need to assess changes in its own business practices and policies and procedures, such as addressing the “fraud prevention adjustment” requirements discussed above. Our office is available to assist your credit union with your questions regarding the Final and Interim Final Rules.