Transcript: Webinar on Fed’s Draft Debit Card Regulations (Part 2)

– Download the Interchange Fee Proposed Rule Draft Notice

– Download the Interchange Fee Proposed Rule Staff Memo

– Watch Durbin Webinar: Analysis of the Fed’s Draft Debit Card Regulation

… Return to Part 1 of webinar transcript

DAVID S. EVANS: So words like confiscatory and constitutional provide a good segue to the next question, which is for Ron Mann. Ron, we’ve talked before about whether the Durbin Amendment is a jobs act for lawyers. Will the Fed proposal settle things, or are we looking for years bickering in court?

RON MANN: I think it doesn’t settle things. I think it settles relatively little, except it sets up the next stage of litigation. You can’t do much to challenge the statute that’s supposed to be implemented by litigation – by regulation until you see what the regulations are. And so the case that TCF Bank has brought is a lot crisper now. (Related Article: Will TCF’s Bill Cooper Topple Durbin?)

I think that the suggestions that Tom Brown has just made, if the Fed goes with the four is enough, much less – if they go with the four is enough proposal, I think you could be sure there’ll be litigation about that. And I think that the fraud provisions pose a problem, too. I take it that the regulation goes into effect, and you can’t charge anything for fraud prevention, what – I don’t know about that, and I think there’s obviously some argument that issuers might take advantage of to suggest that there’s no statutory basis for a cap. If you have somebody who can prove, and I take it that even under the narrowest possible view of cost that 20 percent of the issuers could document, to the satisfaction of a harsh critic, that their costs are more than 12 cents, I think if their costs are plainly more than 12 cents, it’s a reasonable proportion for them to charge 15, and the regulation doesn’t permit that. And so I think you can expect a challenge from that front. So I don’t think this is going to make anybody happy. You suggested in some discussions yesterday that maybe it makes the merchants happy, but I think even the merchants had some hope from the statute, they’re going to clearance at par, talks about comparing it to checks.

EVANS: Back to you, Tim, if the Fed adopts the safe harbor, do you think the card networks will allow issuers to collect something on top of the 7 cents?

TIM ATTINGER: I think, quite frankly, the card networks are going to work as hard as they possibly can to get the number as high as they possibly can, beginning with contesting the 12 cents cap, for the reasons that we’ve all just discussed, that the vehicle, again, a debit card against the deposit account, is the primary way the consumers access that deposit relationship, yet all the relationship management costs and all the costs associated with managing that deposit account weren’t allocated back. And I think most importantly, from a network perspective, nor were the fees that they tend to charge those issuers. So they want to make sure that those fees are included in the issuers’ estimate of cost. (Related Article: Debit Card Interchange Fees Plummet Under Fed’s Proposed Rules)

EVANS: Tim, let me try the question just a slightly different way. Do you envision that the networks are going to allow different issuers to collect different interchange fees? I get 7 cents, you get 7.5 percent, Tom Durkin gets 9 cents and Ron Mann gets 12 cents. Is that a likely result?

ATTINGER: Those relative differential returns from network participation exist already today on the network side. They’re not explicitly spelled out in differential interchange to financial institution, by institution. But in the overall deal and the relation, I don’t think we’ll see a massive differential between under 10 billion and over 10 billion, whether or not there are differential rates for some of the larger institutions remains to be seen, but I don’t think we’ll ever see any evidence, even if they are there.

EVANS: I heard you say what I think is an interesting observation, which is you don’t think that the networks will let the less than $10 billion participants charge more than the 12 cents. You want to elaborate? Because I think that’s the hardest thing to figure out about this legislation, because on the political economy of it, a lot of it is oh, it’s only affecting this small number of really large banks and not affecting any of these smaller banks. But I’ve never been able to understand how is it that small banks are able to charge more.

ATTINGER: No, it disproportionately falls on the head of the small community bankers. That said, I think…

EVANS: It falls on their head if they have to lower their rates, but I’m assuming they will. Is that what you think?

ATTINGER: Well, I think they may. I think they may, but I think what you’ll find is, the networks will rely on the community banker associations to lobby for a differential allocation, and the networks will support that. But I don’t think you’ll see a network proactively tell a financial institution that is 10 percent of their volume that another institution that is one-tenth of a percent is going to be getting a higher unit rate. I don’t think you’ll see that happen. Not without a lot of wrangling first.

EVANS: The staff was asked about how this was going to affect consumers, and they were pretty candid that they really didn’t know how it was going to all net out. They could benefit, consumers could, or then again they could lose. I’d like you to focus on what you think is going to happen over the next one, two, three years. So what happens to consumer fees for bank accounts?

ATTINGER: Yes, I think fees for bank accounts are going to go up, whether those are account based or transaction based remains to be seen. But I think consumers are going to pay more to access funds in – on deposit and to have deposit relationships like they’ve had in the past. I think the days of free checking accounts are over.

EVANS: Anyone else have a different view on whether the banks are going to increase the fees for the depositary account?

TOM BROWN: David, I think that’s consistent with the evidence that you and your co-author, Howard Chang, found in reviewing the impact of the intervention with respect to interchange in Australia, which is I think, at least on the preliminary sketch of the math, of similar, if slightly even less magnitude. I think if we sort of step back and try to figure out what the implications are of the Fed’s rate cap, I don’t think you need a Ph.D. in Economics to figure out that if you’re cutting the revenue associated with this product by somewhere in the order of 70 percent to 80 percent, that fewer of those transactions are going to be supplied. I think the question is, where do they go? My intuition is not that they go to community banks cash and check, even if we assume that community banks are able to maintain the higher revenue stream associated with the current prevailing rate tables. This legislation creates a huge wedge between what we know merchants are willing to pay for the delivery of these transactions and what the statutory mandate would have them pay. And I think that people are going to look for ways to recover that loss. I think that the transition costs will be born by consumers because that seems to be what happens when we see this kind of intervention in the economy, either in the form of shortage of supply or increase in price.

EVANS: So let me ask Tom Durkin, will merchants pass the interchange fee cost savings on to consumers in the near term?

TOM DURKIN: I don’t really see that happening. That’s small reduction in price from an individual transaction. It isn’t going to make any difference to the typical consumer undertaking the transaction. And so therefore, there’s no point in doing it. I don’t see the savings being passed on to the consumers. (Related Article:Dodd-Frank Chief Author Opposed to Feds Initial Debit Proposal)

EVANS: OK, I’m going to turn to some of the questions that we’ve gotten from the audience now. Let me toss this out to anyone who wants to take it. This is a question from Stu Weiner, which is now that the interchange fee for signature and PIN is going to be the same, what does this mean for the future of signature debit? 

BROWN: Well, so David, I have to do this question, and I saw it when it came up, too. He wondered whether people would abandon signature in light of the higher fraud cost purportedly incurred on signature. I’d have to say that – I think it’s an interesting question, and it’ll be interesting to see how things play out. My intuition does not run in that direction. If we go back historically, and this is just largely informed by the facts that came out in connection with the In Re: Visa Check/MasterMoney Litigation, now almost a decade ago – or more than a decade ago. The business case for the deployment of PIN pads was really driven by the fact that the merchant cost associated with the transactions was lower. Signature does not, as Ellen Ritchey pointed out in The Lydian Payments Journal that was distributed earlier this month, add any security protection because it’s just another bit of static data. So I – and given the functional imitations associated with PIN authorization versus signature – I would be surprised if we didn’t being to see a slow but steady decline of PIN volume relative to signature, not that PIN disappears but just that since its primary advantage relative to signature has been eliminated, since they’re now going to be the same rate, I just don’t see why people use PINs at all. (Related Article: Is the PIN Mightier Than the Sword in Fighting Fraud?)

MANN: I agree. I think he’s totally right about that. I think that the merchants shouldn’t want people to use PINs since the price is the same, because PINs slow down the transaction. What the merchants want is a card that people can wave at a terminal from 30 feet away, and it charges the price and you walk out the door and they have the money without the consumer even noticing they paid. They don’t want the consumer to have to stop and type in a number and slow down the checkout line and focus on how much they’re being charged. They want the payment transaction to take a quarter of a second. And PINs, if they’re not cheaper, and the only reason you use them is for consumers who feel more comfortable because of the security. It’s just to make the consumers feel better, and if there’s some consumers that feel better, well then maybe it justified having the terminals.

EVANS: Let me ask a question that’s sort of a good follow-on to the what happens to PIN debit. I don’t know whether any of you guys checked in what was happening to the stock prices of companies in the checking industry yesterday. So what do we think is going to happen to the paper check as it? Does it have a new lease on life or not?

BROWN: I think this has to be a question for Tom Durkin, since he used to work at the Fed.

DURKIN: Oh, I don’t know that it actually is a Fed issue. It’s a consumer issue. Consumers have already shown that they like the availability of a debit transactions and the use of plastic cards. And they’re used to the speed of transactions and use checks at the point of sales, as you know, are very difficult, which is a good part of the reason for the enthusiasm over debit transactions anyway. And so I think that the cost to the allocation of the revenues and things like that, all of those things may be up in the air right now, but consumers’ enthusiasm for the checking product, I don’t see that increasing at all.

MANN: I think what merchants have to fear is, let’s suppose that some group of banks decide, which I think they might, that they have to start charging a per account – a per transaction fee for debit card use at the point of sale. I think what we know from countries that have imposed even very small per transaction fee – fees, that’ll drive consumers away. And so if banks charge even 10 or 20 cents for each debit transaction, I think you’ll see a substantial amount of consumers that will switch back to using checks. And so the merchants are going to face the fact that it costs them a lot more money to accept a check than it does for them to accept a debit card or a credit card, even though the check clears at par, because they have to have the staff person stand there and take the check, and then they have to do something with the check to process it. And I think they will be very affected if you see people driven into using checks by debit card transaction fees. I assume from listening to Tim that banks have been trying to figure out a way to manage a relationship without doing that, but that’s just the most obvious way to recover the revenue stream.  I assume it’s going to be considered.

EVANS: We have a couple of questions from the people in the community banker community. So let me raise the question, which is at the end of the day, what does this mean for community banks? What’s going to happen to their ability to collect debit card interchange fee revenues? (Related Briefing Room: Dealing with Durbin)

BROWN: I think it’s an excellent question, David, and from my perspective, it’s one of those issues that remains to be seen. You asked earlier whether networks will continue to support, as the statute sort of outlines, differential interchange based on size of asset of institution. It’s possible. It’s also possible to imagine that won’t happen.  The little story that I tell myself when I think of that is, so somebody has to go in and tell Jamie Dimon that he’s getting 7 to 12 cents, but a community banker is going to get 44 to 56 cents on that same transaction. And I just don’t see that that’s going to work for him.

ATTINGER: Yeah, I was just going to add, Tom, I don’t see how anyone has that conversation. That’s just a non-starter. Even if it’s possible to do that, I don’t see how that makes business sense.  

EVANS: So I’d like to close out the discussion today by – there are lots of interesting things to talk about. I’m not sure whether you guys had had the chance to actually go through the very long document that the Fed put out, but there are all sorts of additional questions that are posed, including how you deal with PayPal and all sorts of things like that. So we could probably spend the afternoon going through a variety of additional issues are really quite interesting in the Fed proposal. But I’d like to close this out by really asking just a procedural question. I’d like maybe the two lawyers and also Tom Durkin to give a sense as to what’s going to happen over the next roughly 60 days. The Fed is taking comments up until February 22nd, and then they’re going to reconvene, I guess, and figure out what to do. Tom Brown, let me start with you. What happens over that period of time? What are the participants in the industry, including the merchants, going to be doing? What’s going to happen over the next two months?

BROWN: So this is the full employment period for lawyers. So there are a number of lawyers who’ve not yet been engaged to help the Fed think through these issues. And there are now, as you point out, a ton of questions that are embedded in the proposed rule on which the Fed is seeking comment. And parties are going to engage lawyers and start filing public comments. The Fed will digest those comments and then issues its response to the comments and its sort of presumably proposed final rule. And that would be what the Fed Board would then act upon next spring. There are a number, then, of sort of tactics in play aside from sort of pushing comments to the Fed. We all know that there’s a new Congress coming into town, in just a couple weeks, and it’ll be interesting whether people look not necessarily to cut the Durbin Amendment from Dodd-Frank, but at least to extend the timeline to allow consideration of some of the really complicated issues that staff, I think, confessed yesterday, that just had not had a chance to fully digest. I think you could make a really strong case that we should at least give folks more time before we issue a final rule that would upset the delivery of, oh I don’t know, somewhere on the order of $800 billion to a trillion dollars in transaction volume every year.

DURKIN: I think people will also be lobbying Congress, as Tom suggests, to try and see – I guess I’m – one strategy, as he suggests, is to try and get Congress to put this on hold. Another strategy is for people who will be influential in the new committees to discuss with the people who are in the Fed process, how satisfied or dissatisfied they would be with resolution of the various issues. Obviously, they can’t directly affect it. I think the third thing that’s going to be going on is I think people will be getting everything ready to institute litigation and challenge the regulations. I think the day the regulations get adopted by the Fed, there will be several lawsuits, much like the TCF lawsuit, that’ll be ready go and filed. (Transcript: Famed Lawyer Looks to Dethrone Durbin)

EVANS: Ron, this is going to be a massive increase in the cost to consumers who, even if merchants did pass on some of the costs, wouldn’t be observable to consumers? Do you see that as leading to any pushback in Congress, or do you think that the banks have such a negative image that it’s not going to really matter?

MANN: I do think there’ll be pushback in Congress. I’m not the person who’s trying to craft what the banks should tell Congress, and they have very capable people to do that. But my assumption is that the basic pitch is a regulation that’s going to stifle the ready ability of consumers to spend is not the right thing to do at a time when the economy’s about fallen to a double-dip recession, because if this is going to increase the costs to consumers of trying to spend their money, they’re going to spend less, and that’s a bad idea.

EVANS: Tom Durkin, does the Fed staff go on vacation, at least when it comes to this issue?

DURKIN: No, they aren’t going to go on vacation. They, I think, would like to. I was at the board meeting yesterday. I was in the boardroom, and I talked to some of the people afterward, and that is something that they would certainly like to do. But as I mentioned jokingly, just that to somebody, the answer was, no, I can’t do that because this isn’t the only Dodd-Frank thing that I’m working on. And so I am part of this taskforce and that taskforce and so forth. The Fed has a fairly limited staff. It’s not a large agency by Washington standards, and people get pulled into other things. If you’re the expert in this area of payments, there may be some other things closely related that you’ll get involved with. But I don’t think I ever remember anything quite so controversial in combination with such a short time period.

And so the staff is going to be overworked, and there are a lot of things that they are going to have to do. For instance, we’ve already heard about the lawyers. Many lawyers and many issuers are going to want to come in and speak with governors, with the staff and so forth. There’s procedures for doing that under the Administrative Procedures Act. You have to have a minutes writer there. You have to keep records and things like that. You have to list who was there and so forth and so on. All those things are fine and good, but it sucks up an awful lot of people’s time. And then when the comments come in on February 22nd, they all have to be summarized. The law requires that they take them all into account, in some sense. That means they have to either agree with them and accept them or disagree with them and say why. And this is going to be a very difficult procedure, and somebody just mentioned, Tim I guess, that there’s also going to be litigation forthcoming. They have to talk about what does this mean for that and so forth and so on. And so it’s going to be very difficult, and while they would like to be vacation, I think their vacation probably lasted last night from the time that the board meeting ended until the first thing this morning.

EVANS: So I guess on the bright side, Tom Brown, this is a full employment act for lawyers and you forgot to mention economists. I was struck by the fact that there was only one submission by an economist, by anyone, in the submissions that went to the Fed prior to the proposals being submitted, which is, I think, a quite astonishing situation for a massive rate-making hearing, which is what this is.

BROWN: I think there can be case studies written about how various participants approach the process and information that could’ve been brought to bear and that wasn’t. Ron Mann pointed out, and David, you’re one of the foremost experts on two-sided markets in the entire world, there’s not a single side to the two-sided literature in the Fed’s 163-page notice of proposed rule, which I find very surprising and shocking.

MANN: I think it’s one thing to say we don’t care because we’ve been told that we’re supposed to establish a cost basis for the fee. OK. I can understand that. But it’s another thing to tell somebody who’s actually an academic economist like Ben Bernanke, there’s a market failure here because competition, everybody’s lowering prices, which is just transparently wrong for reasons he would understand. He actually is an economist. Maybe I’ll – mostly staff people – well all the ones I know are lawyers, but when the people that are writing the rules so transparently don’t understand the economics of the industry, it’s breathtaking. It’s one thing to write a rule and say, we think this is a really bad idea. It’s another thing to say, we’ve looked at this and we see this terrible market failure and have no sense of the economics of it. And I think that’s just begging for litigation.

EVANS: I want to thank you all very much. I think I can also guarantee you that there is going to be lots of discussion coming from others in many other directions over the next few months. And now that I’ve seen the Fed’s proposal, my guess is we’re going to be talking about this subject for perhaps many years. So, thank you all very much. Have a great rest of the day, and since this is the last time I’ll be talking to many of you before the holidays, Merry Christmas, Happy New Year, Happy Holidays.

… Return to Part 1 of webinar transcript “Deep Dive Into Durbin” Speaker and Moderator Bios

Tim Attinger/Managing Director: Product development and innovation expert
As the former head of Global Head of Product Innovation and Development for Visa Inc., Tim had global responsibility for product strategy, platform development, and P&L management for Visa’s mobile, money transfer, and eCommerce business units, as well as product innovation, security solutions, healthcare and IP strategy.  In this role he led a number of innovation efforts related to debit cards.

Tom Brown/Senior Expert: Partner at O’Melveny & Myers
Tom Brown is a partner in O’Melveny’s San Francisco office and a member of the Financial Services Practice.  Tom’s practice focuses on competition law and legal issues affecting the financial services industry. Tom has been litigating cases, including class actions, in the financial services industry for more than a decade.  He was a member of the trial team that handled the defense of the then largest civil antitrust class action in U.S. history for Visa U.S.A. Inc., In re Visa Check/MasterMoney Antitrust Litigation.  He has helped numerous other financial services companies, including Capital One and PayPal, defend against class actions, including an ongoing case challenging the use of PayPal in the eBay marketplace.

Tom Durkin/Senior Expert: Economist and former Federal Reserve Board director
Tom was a Senior Economist at the Federal Reserve Board for more than 20 years and was the Regulatory Planning and Review Director for ten. As a result of this experience, he is deeply knowledgeable about how the Federal Reserve Board approaches regulation. He has also written extensively on consumer credit and its regulation. His most recent book, Truth in Lending, Theory, History, and a Way Forward, will be published by Oxford University Press in the Fall of 2010.

Ron Mann/Senior Expert: Law professor and business advisor to the payments industry
Ron is one of the leading global authorities on the law and economics of payments. He has authored numerous authoritative books and articles on the law of payments including Payments Systems and Other Financial Transactions.  He is a Professor of Law at Columbia University.

David S. Evans/Founder and Managing Director: Economist and business advisor to the payments industry
David is one of the leading global authorities on interchange fees and financial regulations.  His recent work has focused on helping payments businesses discover and ignite profitable innovation.  He is the co-author of the leading text on the payments industry, Paying with Plastic: The Digital Revolution in Buying and Borrowing, as well as leading texts on driving innovation in two-sided markets including Catalyst Code: The Strategies Behind the World’s Most Dynamic Companies and Invisible Engines: How Software Platforms Drive Innovation and Transform Industries.


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