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Central Banker | Spring 2011

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How We Arrived at the Debit Card Interchange Fees and Routing Proposals

The new law on debit card interchange fees represents the culmination of efforts in Congress to address concerns that have been under discussion since 1980 about fees charged to merchants by the payment card networks. In Section 1075 of the Dodd-Frank Act, Congress directed the Board of Governors to write regulations applicable to interchange fees. The Board published its notice of proposed rulemaking on Dec. 28, 2010.

Interchange fee issues have multiplied over the years proportionate to growth in the volume of credit card and debit card transactions, as well as increases in interchange fee rates. In an early case decided in 1984, a federal district court determined that interchange fees were a legitimate mechanism to transfer costs from the side of the market that the court found to have lower costs (merchants) to the side with higher costs (card issuers), thereby inducing the side bearing the greater cost to participate. Other lawsuits since then have attempted to address growing concerns between merchants and card issuers. In 2005 and 2006, retail merchants and trade associations filed numerous lawsuits against card issuers alleging that interchange fees were too high and that the collective setting of interchange fees by the payment card associations amounted to illegal price fixing under antitrust laws.

Attempts at direct regulatory intervention began in 2008, when the U.S. House and Senate introduced legislation aimed at interchange fees and various practices of payment card networks. Rep. Peter Welch (D-Vt.) introduced H.R. 6248, the Credit Card Interchange Fees Act of 2008, to prohibit certain electronic payment system network practices and require payment networks to disclose contract terms to merchants without restricting a merchant's use of such information. Rep. John Conyers (D-Mich.) introduced H.R. 5546, the Credit Card Fair Fee Act of 2008, which sought to authorize merchants and card networks that met a market share threshold to negotiate network fees and other terms associated with merchant access to a card network.

Bills introduced in the Senate in 2008 included Sen. Dick Durbin's (D-Ill.) similar companion bill to H.R. 5546 (S. 3086), which included standards applicable to setting interchange fee rates. Under Sen. Durbin’s proposal for setting fees, consideration had to be given to the costs incurred in authorization, clearance and settlement activities necessary to provide and access an electronic payment system. The bill provided that fees could vary based on cost-based differences in types of credit and debit card transactions, including whether the transaction type was signature-based, PIN-based or “card-not-present.” However, fees could not vary based on the type of merchant or volume of transactions (in either number or dollar value). Lastly, Sen. Chris Dodd (D-Conn.) introduced S. 3252, the Credit Card Accountability Responsibility and Disclosure Act of 2008, which directed the OCC to study and report to Congress on the extent to which interchange fees are required to be disclosed to consumers and merchants, and how such fees are overseen by the federal banking agencies.

Both Conyer's bill (Credit Card Fair Fee Act) and Welch’s bill (Credit Card Interchange Fees Act) were reintroduced in 2009. However, the key legislation on financial reform during the 2009-2010 sessions of Congress became the Dodd-Frank Act, which was introduced in the House at the end of 2009 (H.R. 4173). Section 1075 of the Dodd-Frank Act, which was added to the Senate companion bill (S. 3217) in May 2010 by Durbin, provides that the amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction must be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.

Congress directed the Board of Governors to prescribe regulations to establish standards for assessing whether the amount of any interchange fee is reasonable and proportional to the issuer's cost with respect to the transaction. The law requires that the Board consider the functional similarity between a debit card transaction and a payment made by a check, as well as the incremental cost incurred by an issuer in the authorization, clearance, or settlement of a debit card transaction. The Board may not consider other costs incurred by an issuer that are not specific to a particular debit transaction. This approach is substantially similar to Durbin’s 2008 proposal, which required consideration of the costs incurred in authorization, clearance and settlement activities necessary to provide and access an electronic payment system when setting interchange fees. In the Dodd-Frank Act, Congress also authorized the Board to consider allowing an adjustment to the interchange fee amount if the adjustment is reasonably necessary to make allowance for costs incurred by the issuer in preventing fraud in relation to debit card transactions involving that issuer. The Board must publish a final rule establishing standards by the end of April this year.

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