December 20, 2010

WASHINGTON — The Federal Reserve, fulfilling a Congressional order to examine whether merchants were being charged excessive fees to process debit-card transactions, has proposed new rules that analysts said could cut those fees as much as 90%, reported The New York Times. “It’s bad for the issuers and the card networks,” Rod Bourgeois, a payments analyst at Sanford C. Bernstein, told the newspaper.

As part of the Dodd-Frank Act’s overhaul of the financial code, Congress directed the central bank, which oversees the regulation of electronic payments, to ensure that the swipe fees charged by the banks and payment card networks like Visa and MasterCard were “reasonable and proportional” to the cost of processing the transaction.

The Fed has proposed limiting interchange fees from 7 cents to 12 cents per transaction, or approximately 0.3% of the face value of a purchase. Merchants now pay debit-card processing fees averaging about 1.3%, according to the Times, citing the Nilson Report, a payment industry newsletter. Smaller retailers are charged more because of lower transaction volume and limited bargaining power, said the report.

The Fed proposed that it re-evaluate the fee cap every two years and asked for more time to consider whether it should be increased to reflect the costs of fraud protection.

The National Association of Convenience Stores (NACS) called the Fed’s proposed rulemaking related to debit-card swipe fees a “positive step” and said it will continue to push for the reforms demanded by Congress and consumers alike. “The proposed rules are a positive step in addressing the anti-competitive behavior of the banks and credit-card companies and an acknowledgement of the voice of American small businesses and consumers,” said NACS president and CEO Hank Armour in a separate statement.

Both Visa and MasterCard argued that the Fed had not considered all the costs incurred to operate debit-card programs.

Visa said it had “concerns that the [Fed’s] proposal includes artificial caps on debit interchange that do not realistically reflect the value of card acceptance.”

MasterCard went a step further and openly criticized the proposal, saying it would simply shift costs to consumers from merchants. “This type of price control is misguided and anticompetitive and in the end is harmful to consumers,” Noah J. Hanft, MasterCard’s general counsel, said in a statement cited by the paper.

Gate Petroleum, which operates about 100 gas stations in the Southeast, has seized on a separate piece of the Dodd-Frank Act that lets merchants charge different prices to customers using different forms of payment, said the Times. This fall, Gate began offering a discount to customers who used cash to buy one of the company’s new prepaid fuel cards. Just over two months into the discount program, about 20,000 cards are in use, the company said.

David Dill, the company’s vice president for sales and marketing, said Gate saved about 4 cents a gallon whenever it made a sale that did not touch a Visa or MasterCard payment network. Customers receive a discount of 3 cents a gallon; the other penny goes toward the cost of operating the card program. “It’s really a loyalty program for the customer,” Dill told the paper.

For years, some stations charged higher prices when customers used credit cards, sometimes simply in defiance of the card processing contracts and other times taking advantage of legal technicalities, the report said. In many states, stations could comply with the rules by posting separate prices for cash and credit.

Dodd-Frank lifted that barrier by allowing merchants to steer customers toward the payment method that is cheapest for them to process, without having to post separate prices.

Dodd-Frank also forces Visa, MasterCard and others to compete more aggressively for merchants’ business by requiring that all debit cards run on the networks of at least two different payment companies. So when a customer uses a Visa debit card, for example, the merchant could process the transaction on a network other than VisaNet.

Through exclusivity agreements, many debit cards run on the network of only one payment company. The change will take effect in July, after a review by the Fed.

Taken together, these measures significantly strengthen the hand of merchants. Analysts expect merchants to negotiate sharply lower prices with the banks and reclaim a portion of the tens of billions of dollars they spent last year on processing fees for debit and credit cards.

“All of the sudden, the merchants have bargaining power,” Bourgeois said. “They have an ability to drive prices down because there will be multiple payment brands on every card, and on top of that, the merchants will have the ability to use the lowest-cost route of whatever payment network they choose.”

The banks are setting out to make up for the expected drop in card processing fees, the report said. Bankers say they may offset part of the lost revenue by assessing higher monthly fees on deposit accounts. Debit cards offering rewards points, which cost merchants more to process so they can cover the cost of the programs, could be another casualty, added the report.

The Fed has requested comment on a proposed rule that would establish debit-card interchange fee standards and prohibit network exclusivity arrangements and routing restrictions. The Fed’s proposal would implement the debit-card interchange fee and routing provisions of the Dodd-Frank Wall Street Reform & Consumer Protection Act.

The proposed new “Regulation II, Debit-Card Interchange Fees & Routing” would establish standards for determining whether a debit-card interchange fee received by a card issuer is reasonable and proportional to the cost incurred by the issuer for the transaction. These standards would apply to issuers that, together with their affiliates, have assets of $10 billion or more. Certain government-administered payment programs and reloadable general-use prepaid cards would be exempt from the interchange fee limitations.

The Fed is requesting comment on two alternative interchange fee standards that would apply to all covered issuers: one based on each issuer’s costs, with a safe harbor (initially set at 7 cents per transaction) and a cap (initially set at 12 cents per transaction); and the other a standalone cap (initially set at 12 cents per transaction). Under both alternatives, circumvention or evasion of the interchange fee limitations would be prohibited. The Fed also is requesting comment on possible frameworks for an adjustment to the interchange fees to reflect certain issuer costs associated with fraud prevention.

If it adopts either of these proposed standards in the final rule, the maximum allowable interchange fee received by covered issuers for debit-card transactions would be more than 70% lower than the 2009 average, once the new rule takes effect on July 21, 2011.

The proposed rule would also prohibit all issuers and networks from restricting the number of networks over which debit-card transactions may be processed. The Fed is requesting comment on two alternative approaches: one alternative would require at least two unaffiliated networks per debit card, and the other would require at least two unaffiliated networks per debit card for each type of cardholder authorization method (such as signature or PIN). Under both alternatives, the issuers and networks would be prohibited from inhibiting a merchant’s ability to direct the routing of debit card transactions over any network that the issuer enabled to process them.

According to the recently released 2010 Federal Reserve payment study, debit card use in the United States now exceeds all other forms of noncash payments and, by number of payments, represents approximately 35% of total noncash payments.

Comments on the proposal are due by February 22, 2011.

NACS and other organizations that are part of the Merchants Payments Coalition (MPC) will carefully study the rules the Fed has proposed and offer its suggestions for strengthening the final rules, which the Fed expects to publish in April 2011 and go into effect June 21.