Fed's Debit Incentive for Banks UpheldExperts Debate Long-Term Impact of Supreme Court Decision
The long-running legal battle over the Federal Reserve's debit interchange fee structure has ended now that the U.S. Supreme Court has denied retailers' petition for another look at the legality of the fee structure introduced in 2011.
On Jan. 20, the Supreme Court declined to review a federal appellate court's March 2014 ruling, which supported the Fed's right to offer banking institutions a financial incentive to enhance debit fraud prevention investments, such as EMV (see Court Ruling: A Fraud Prevention Boost?).
While some experts predict the high court's decision is likely to spur more banking institutions to push forward with their issuance of EMV-compliant debit cards, others say the case will have little impact on banks' strategies.
How the Fee Structure Works
The Fed's debit fee structure, which took effect in October 2011, was implemented to help soften the blow banks and credit unions took after interchange income was decreased under the controversial Durbin amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Under the 2010 Durbin amendment, the proposed interchange fee income cap was set at 12 cents per debit transaction for banking institutions with more than $10 billion in assets. Before that amendment, these institutions could charge merchants up to 44 cents for each debit transaction.
But the Fed's 2011 revamped fee structure capped the interchange fees banking institutions could charge merchants at 21 cents, and offered a five basis point adjustment to cover potential losses from fraudulent debit activity. Additionally, to offer institutions an extra incentive to invest in fraud prevention, the Fed included a 1-cent-per-transaction fee option, which could be added by banking institutions that prove they're using the additional income to fund fraud-prevention investments (see The Fed's Impact on Fraud Funding).
Catalyst for Change?
Fraud expert Avivah Litan, an analyst at the consultancy Gartner, says the end to the legal battle over the Fed's debit interchange fee structure will give banking institutions the revenue assurance they need to move forward with EMV.
"We will see more aggressive rollouts of EMV debit cards now by the issuers," Litan predicts. "Financial institutions will have more incentive to move forward with EMV debit now that they know where the fee structure stands. ... Without the fee structure in place, the financial institutions couldn't properly plan and budget for their EMV programs."
But Randy Vanderhoof, executive director of the EMV Migration Forum, says that despite the long-running legal battle over the Fed's fee structure, most of the U.S.'s largest institutions have already begun issuance of EMV debit cards to comply with the upcoming liability shift date.
After October, fraud that results from magnetic-stripe transactions will be the responsibility of the issuer or merchant that is not EMV-compliant (see EMV: U.S. Won't Make October Deadline).
"The thought of the Supreme Court taking up this [fee structure] issue was very remote," Vanderhoof says. "And small banks and credit unions are not covered under the Durbin interchange rules."
Al Pascual, director of fraud and security at Javelin Strategy & Research, also contends that most large institutions, which have the most to gain from the Fed's interchange incentive for fraud prevention, have not been delaying their EMV debit rollouts because of the pending court case. But he points out that had the Fed's new fee structure not been upheld, future investments in more advanced EMV technology would be more difficult for banks and credit unions to afford.
"Larger issuers had the most to gain or lose, from a revenue perspective, but they were already wholly committed to EMV, as are smaller issuers that have little flexibility in managing their fraud costs and want to avoid any liability issues," Pascual says. "But should the issuers have lost this revenue stream, that could have had long-term implications for the rollout of subsequent technologies, like contactless EMV cards, which are much more expensive than the initial contact-based cards being rolled out by most issuers this year."
David Pommerehn, senior counsel and assistant vice president of the Consumer Bankers Association, says the Supreme Court's decision definitely puts "a little more certainty" behind what banking institutions can afford to spend on fraud-prevention investments. But he also says the incentive offered by the Fed is not a long-time guarantee.
"It could change in the future," Pommerehn says. "The Fed has the authority, and actually the mandate, to re-evaluate the allowable provisions under Reg II every two years."
Regulation II (Debit Card Interchange Fees and Routing) establishes standards for assessing whether a debit interchange fee received by a debit card issuer is reasonable relative to the costs incurred by the issuer.
"So, the Fed certainly could wind down some of those provisions as they see fit, if they see that their calculations deem it requires a smaller interchange amount," Pommerehn adds.
Retailers Disappointed with Ruling
Back in 2012, a handful of retailers and retail associations, including the National Retail Federation and NACS, filed a lawsuit challenging the Fed's debit interchange fee structure. In July 2013, a district court ruled that the Fed's fee structure for debit interchange was too high for retailers. But the fee structure remained in place while the Fed appealed that ruling.
In July 2013, an appellate court reversed the lower court's decision, thus upholding the Fed's interchange structure. This week, the U.S. Supreme Court refused to review the appellate court's decision.
Lyle Beckwith, senior vice president for government relations at NACS, expressed disappointment with the Supreme Court's rejection of the case, portraying the Fed's fee structure as unfair to retailers. "It is unfortunate that the Supreme Court would not hear about the legal problems with the Federal Reserve's debit swipe fee rules," he says. "Banks should not be allowed to use centrally price-fixed fees to make margins of 500 to 1,000 percent or more on debit swipe fees.
Mark Horwedel, CEO of the Merchant Advisory Group, which represents 85 of the largest U.S. merchants, says the Fed and banking institutions had overblown the adverse impact the Durbin amendment would have had on fraud prevention if the Fed had not approved the new debit interchange fee structure. And he contends that the argument that some banks were holding off on their EMV debit rollouts because of the litigation surrounding interchange fees was nothing more than "posturing."
"EMV is mostly paid for by the merchants, while the benefits mostly go to the networks and the issuers," he says. "The 1-cent was just another gift from the Fed in the first place, without any real basis."