Proposed Debit Interchange Rule’s Effect on Credit Union Relationships with Payment Card Networks
By Styskal, Wiese & Melchione
February 2, 2011
Recent changes proposed by the Board of Governors of the Federal Reserve System (the “Board”) affecting debit interchange fees and routing of debit transactions may potentially impact credit unions’ contractual relationships with payment card networks such as Visa or MasterCard. The Board published a proposed rule on December 28, 2010 (the “Proposed Rule”), which includes the following three (3) key components that could impact credit unions that issue debit cards:
1. A limit on debit interchange fees that a payment card network pays to debit card issuers. 2. A prohibition on issuers and payment card networks restricting the number of networks over which a debit card transaction can be processed to less than two (2) unaffiliated payment card networks. 3. A prohibition on issuers and payment card networks restricting a merchant’s ability to direct the routing of debit card transactions.
The Proposed Rule is open for comment until February 22, 2011, and the Board must issue a final rule by April 21, 2011, which will become effective on July 21, 2011.
Limit on Interchange Fee Amount
The Proposed Rule includes a “reasonable and proportional” limit on interchange fees paid by a payment card network, such as Visa, to a debit card issuer. Under the Proposed Rule, there are two (2) alternatives proposed by the Board to implement this requirement. The first alternative provides that the issuer can receive an interchange transaction fee that is the greater of: (1) seven (7) cents per transaction; or (2) the costs attributable to the issuer’s role in authorization, clearance, and settlement of the transaction, subject to a cap of twelve (12) cents per transaction. Under the second alternative, an issuer would comply with the standard for interchange fees as long as it does not receive an interchange transaction fee exceeding twelve (12) cents per transaction. The Board will consider comments received in response to the Proposed Rule in deciding which of the two (2) alternatives to implement in the ultimate final rule it will issue.
The Proposed Rule prohibits circumvention or evasion of the above limits on interchange transaction fees. As an example, circumvention or evasion occurs if the total amount of payments or incentives received by an issuer from a payment card network in connection with debit card transactions during a calendar year, excluding interchange transaction fees that are passed through to the issuer by the network, exceeds the total of all fees paid by the issuer to the network for debit card transactions during that year. According to the Board, this is meant to curb networks finding other ways to compensate issuers for debit card transactions, such as through incentive payments and/or fee rebates provided based on the issuer’s debit card transaction volume.
However, we note that the above limits on interchange fee amounts do not apply to issuers with under $10 billion in assets as of the end of the previous calendar year. Despite this, there are concerns among smaller issuers under the $10 billion threshold that payment card networks will be unable to implement a two-tiered interchange fee schedule, under which smaller issuers receive different, higher interchange fee amounts than larger issuers subject to the “reasonable and proportional” requirement. Assuming that your credit union is under the $10 billion threshold, it may wish to seek confirmation from its payment card network that a two-tiered fee schedule will be implemented; it is our understanding that Visa recently announced plans to implement a two-tiered fee schedule by the Proposed Rule’s projected implementation date.
Prohibition on Network Exclusivity
The Proposed Rule also prohibits issuers and payment card networks from restricting the number of networks over which a debit transaction may be processed to fewer than two (2) unaffiliated payment card networks. Currently, many issuers and payment card networks enter into exclusivity arrangements, under which the issuer either enables only one payment card network on the debit card it issues or requires that merchants route transactions over a specific payment card network in exchange for financial incentives paid by the network to the issuer. The Proposed Rule requested comments as two (2) alternative approaches for implementing the restrictions on debit card network exclusivity.
The first alternative requires a debit card to have at least two (2) unaffiliated payment card networks available to process a debit card transaction. For example, under this alternative an issuer could comply by having one payment card network available for PIN debit transactions and another, unaffiliated network available for signature debit transactions.
The second alternative requires an issuer to issue a debit card having at least two (2) unaffiliated payment card networks available for processing a debit card transaction for each authorization method (i.e., signature and PIN) available to the cardholder.
Prohibition on Merchant Routing Restrictions
The Proposed Rule 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. Currently, many payment card networks require merchants to route debit card transactions over the network designated by the issuer or the payment card network. The Proposed Rule would allow merchants to designate preferences for the routing of transactions with regard to the networks enabled on a specific debit card.
Potential Impact of Proposed Rule
Notwithstanding the exemption for debit card issuers with less than $10 billion in assets, it remains to be seen what effect the final rule will have on the interchange fees paid to such issuers by payment card networks. Credit union industry groups have speculated that even if a two-tiered fee system is available, market forces may result in a decrease of interchange fee amounts paid to small issuers and/or merchants preferring larger issuer’s cards because of their lower interchange fee amounts.
In addition, the restrictions on network exclusivity and merchant’s ability to route transactions to the networks of their choice will impact the amount of interchange fees paid to issuers. As mentioned above, merchants may prefer networks (and issuers) that impose lower interchange fees, potentially resulting in reduced interchange income to smaller issuers.
In addition, it is our experience that payment card networks routinely include minimum processing requirements in their agreements with issuers and impose penalties to the extent such minimum requirements are not met. If your credit union’s agreement with its payment card network requires the credit union to meet any minimum processing and/or volume based targets, it may become difficult to meet such targets after a final rule is issued and could result in the credit union having to pay penalties to the network.
Given the numerous pending changes in this area, your credit union should work with its payment card network to determine whether it is prepared to implement the requirements to be imposed under the future final rule. In addition, your credit union will need to determine the impact of the final rule on its agreement with its payment card network. To the extent that your credit union is negotiating an agreement or an extension of a current agreement with its payment card network, it should ensure that its negotiations and the agreement address the impact of the final rule. If your credit union has any questions regarding the Proposed Rule, our office is available to provide any assistance needed.