Court ruling on debit card fees favors e-retailers, experts say

A judge orders a reworking of fees that have been inflated by “billions of dollars.”

Paul Demery

A federal judge yesterday ordered the Federal Reserve Board to rework a system of debit card fees for online and offline transactions that he said have been inflated by “billions of dollars.”

“This is absolutely a merchant-friendly decision, whether a merchant is big or small, online or offline,” says George Peabody, senior director of payments consulting firm Glenbrook Partners LLC. A spokesman for the Federal Reserve said the agency is reviewing the judge’s decision.

Judge Richard J. Leon of the U.S. District Court for the District of Columbia found that the Federal Reserve erred in interpreting federal legislation on financial services, the Dodd-Frank Act, including the Dodd Amendment on debit fees, when the Fed set new debit card fees in 2011. Leon said in his ruling that he was inclined to give the Fed in a forthcoming order “months, not years” to rework its debit fee rules.

The Federal Reserve in July 2011 set a cap of 21 cents on debit transaction “swipe” or interchange fees charged by big-bank card issuers with $10 billion or more in assets. Those banks account for about 55% of debit card transactions, Peabody says. The cap replaced a fee schedule, still followed by card-issuing banks of under $10 billion in assets, based on 1% to 1.5% of transaction value plus other processing fees, totaling close to $2 on a transaction valued at $100, he says. He adds that online or “card-not-present” transactions typically run at the high end of the 1% to 1.5% per-transaction fee range to account for the higher risk of fraud associated with online transactions.

In addition to the 21-cent cap, the Fed also allowed 0.05% of the value of a transaction, plus 1 cent for fraud prevention. That compared with an average debit card transaction fee of 43 cents prior to the new rules, the Fed said when it issued the new fee schedule.

The Fed had initially set the cap at 12 cents, figuring that was triple banks’ cost of 4 cents to process each debit card transaction, according to the National Retail Federation, a trade group. The Fed went with the 21-cent cap after banks lobbied for a higher cap, according to Steve Mott, who runs the payments consulting firm BetterBuyDesign and had provided the Fed with payment industry data as it figured the caps.

Retail industry groups objected, contending that the new fee structure was still too high and overly compensated card issuers for their transaction costs, particularly when it involves small merchants selling small-ticket items.

In 2011 the National Retail Federation, the Food Marketing Institute, Boscov’s Department Store and other plaintiffs filed the lawsuit on which Leon issued his ruling this week, with the judge sharply criticizing the Federal Reserve Board. “The Board has clearly disregarded Congress's statutory intent by inappropriately inflating all debit card transaction fees by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit card transaction,” Leon wrote in his ruling.

The National Retail Federation, which represents major retail chains and, through its Shop.org unit, web retailers, says the Fed exacerbated the 21-cent cap by failing to heed the call of the Dodd-Frank law to instill more competition into the debit card marketplace. “Congress clearly told the Fed to introduce competition and transparency into the debit card marketplace by making multiple networks available, so as to reduce swipe fees for merchants and their customers,” says Mallory Duncan, the NRF’s senior vice president and general counsel. “The Fed failed to do so, and the court rightly ruled against them as a result.”

In his ruling, Leon noted that Visa Inc. and MasterCard Inc., which set payment card interchange fees for card issuers, account for 83% of PIN debit card transactions (where card users enter a personal identification number) and 100% of signature debit card transactions. Signature debit card transactions, which account for nearly all online debit transactions, are processed through credit card networks, instead of debit card networks. Without the 21-cent cap, they typically have a higher fee structure compared with PIN debit; Visa and MasterCard attribute the higher fees to higher levels of transaction security.

While payment industry observers say they expect that the Fed will come back with a lower cap on debit interchange fees, it remains to be seen whether it will also set new debit fee rules for the small card issuers with less than $10 billion in assets. The exemption for the smaller issuers, including local banks and credit unions, was intended to recognize the costs they bear in investing a higher percentage of their revenue in their local communities, Peabody says.

The banking industry strongly objected to Judge Leon’s ruling this week. “The price controls enacted as a result of the Durbin Amendment served one purpose—further lining the pockets of our nation’s big-box retailers at their own customers’ expense,” Frank Keating, president and CEO of the American Bankers Association, said after the ruling was announced. He added that retailers benefit from debit card transactions, including faster checkout and lower fraud costs, without paying extra for it.

There are likely to be more payment card battles ahead, Mott says. One in the near term could arise in a challenge by merchants to get banks to lower the high end of interchange rates they charge for credit card transactions, and particularly the highest rates charged for online or card-not-present transactions, he says. “Card-not-present has penalized online merchants for a dozen years, but nearly everyone in the payments ecosystem—except the very biggest banks—are pushing Visa and MasterCard to revise or get rid of card-not-present. So interchange and other battles are just getting under way.”

MasterCard did not immediately return a request for comment. A spokesman for Visa referred a request for comment to the Federal Reserve, which is reviewing the judge's decision.


BetterBuyDesign, debit card fees, Dodd Amendment, e-commerce, e-payments and security, Federal Reserve, george peabody, Glenbrook Partners, interchange, legal and regulatory, MasterCard, National Retail Federation, Richard Leon, Steve Mott, Visa