The Federal Reserve Board on December 16, 2010,  issued a proposed rule to implement the debit card provisions of the Dodd-Frank Act. The proposal will be welcome news to retailers and disappointing to large debit card issuers. However, Fed governors publicly stated that the Fed remains open to substantial changes in the final rule.  Comments are due by February 22, 2011.

Highlights of the proposed rule include:

  • The Fed has determined that the relevant costs for purposes of setting permissible interchange fees are variable costs of authorizing, clearing, and settling debit card transactions. The Fed has further concluded that issuer-paid network fees and the costs of providing cardholder rewards and responding to customer service inquiries are not permitted costs. This represents a very narrow reading of the costs permitted under the Dodd-Frank Act.
  • The Fed has developed two alternative pricing rules on interchange fees and has requested comment on which it should select. 
      • Under Alternative 1 – the provision more favorable to retailers – issuers could receive a "safe harbor" interchange fee up to a maximum of $0.07 on each transaction (representing 18.1 basis points on the average transaction value of $38.58 reported by the Fed). If justified by the issuer’s own average variable cost of authorizing, clearing, and settling debit card transactions, the issuer could charge more than $0.07 per transaction, up to a maximum of $0.12 on any transaction (31.1 basis points on a $38.58 transaction). 
      • Under Alternative 2 – the better provision for issuers  – issuers could receive any interchange fee up to $0.12 per transaction, without regard to the issuer’s actual costs. 

    Issuers will undoubtedly regard these levels of permitted interchange fees unfavorably.

    • Although required by Dodd-Frank to adopt rules relating to adjustments of interchange fees for fraud prevention costs by April 21, 2011, the Fed has stated that it will not have the rules in place on a timely basis. This failure will prevent issuers from charging the full fees contemplated by Congress.
    • Dodd-Frank will require debit cards to be functional on at least two unaffiliated networks. The Fed is seeking comment on whether it would suffice if one network is a signature network and another network is a PIN network or whether a signature-based card would need to function on two unaffiliated signature networks (and whether a PIN-based card should need to function on two unaffiliated PIN networks). The Fed recognizes that the latter option would pose substantial technological challenges and would require substantial additional time and expense to implement. In either event, a network that does not operate throughout the U.S. or whose cards are accepted only at a "small number" of merchant locations would not be sufficient. 
    • Issuers and networks cannot restrict the merchant's choice of which network to use to process transactions. However, a merchant's choice of network would be limited to those networks enabled on a particular debit card.

    TCF National Bank has sued the Fed, arguing that the Dodd-Frank Act restrictions on interchange fees violate the U.S. Constitution because they will prevent banks that, together with their affiliates, have at least $10 billion in assets from recovering the full cost of providing debit cards and generating a fair profit. Unless TCF is successful in this lawsuit, the restrictions on interchange fees will become effective on July 21, 2011. Self-executing Dodd-Frank prohibitions against restricting merchants from offering discounts for specified types of payment (such as cash discounts) go into effect on the "designated transfer date," currently set for July 21, 2011. The Fed has requested comment on when its new network exclusivity and merchant routing rules should go into effect. 

    Ballard Spahr's Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products, its experience with the full range of federal and state consumer credit laws throughout the country, and its skill in litigation defense and avoidance, including pioneering work in pre-dispute arbitration programs. For more information, please contact group Chair Alan S. Kaplinsky, 215.864.8544 or; Vice Chair Jeremy T. Rosenblum, 215.864.8505 or; John L. Culhane, Jr., 215.864.8535 or; Barbara S. Mishkin, 215.864.8528 or; or Mark J. Furletti, 215.864.8138 or




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