Experts Predict Industry Turmoil From Swipe Fee Ruling
By Karuna Mintaka Kumar, Columnist
Follow @KarunaMintaka
“Consumers and small business will face higher retail banking fees and lose valuable services as banks rationally seek to make up as much as they can for the debit interchange revenues they will lose under the Board’s proposal. We estimate that users of retail banking services will lose up to $33.4-$38.6 billion in the first 24 months the proposed rules are in effect,” according to the Consumer Impact Study that economists David Evans, Robert Litan and Richard Schmalensee submitted to the Fed in February 2011.
The study focused on the impact of the drastic reductions in interchange fees initially proposed by the Federal Reserve Board in 2011 on consumers and small businesses and further noted that large retailers would receive a windfall that, based on certain assumptions, could equal $17.2-$19.9 billion dollars in the first 24 months the proposed rules would have been in effect. It also found that lower-income households and small businesses would be harmed if the proposed regulations were implemented.
Whether the Fed listened to these economists or not, the Fed withdrew their initial recommendations and just about doubled the interchange fee caps thereby mitigating the harm these economists forecasted. Two and a half years later, we seem to be back to square one after a Judge told the Fed they hadn’t gone far enough in slashing fees.
Ridiculing the Fed, Judge Leon pointed out brusquely, “The Fed didn’t have the authority to set a 21-cent cap on debit-card transactions. 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”.
In an exclusive interview with PYMNTS.com, lawyer Thomas Brown, currently a partner at Paul Hastings and former Vice President, Senior Counsel at Visa U.S.A said, “I think the impact could be reasonably significant. The effects won’t be immediate but essentially it reopens the whole administrative process around the interpretation of the Durbin Amendment with the instruction to the Fed that it needs to lower the cap and reach a different outcome on the exclusivity rules.”
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He further added, “The operational consequences of allowing merchants to dictate how a transaction gets routed and requiring that they be presented with multiple options with the level of each transaction is even more significant for four party networks than the rate cap. It makes those networks less attractive as a platform for reaching consumers with products that hit deposit accounts than other means.”
In his 58-page ruling Judge Leon argued that the cap must go lower, cutting deeper into the $16 billion dollars in revenue that large banks usually reap from the fees. “The Fed’s current implementation of the Durbin amendment has cost banks about half the $16 billion they once made from debit-card swipe fees each year. “If the Fed responds to the ruling by reverting to its original proposal of 12 cents per transaction, revenue for the top 50 credit-card issuers who use Visa and MasterCard networks and have assets over $10 billion would drop to $4.3 billion per year.”
Speaking of the impact of such a ruling, if adopted by the Fed, Gloria Colgan, Managing Director, Market Platform Dynamics, in an exclusive interview with PYMNTS.com contended, “For banks, it creates many questions. If the ruling holds, then many banks will need to figure out how to make up the greater loss in revenue. You would assume that many consumers will immediately feel the impact of those decisions – even greater than the evidence from the initial results ¬- in the form of higher costs to checking, more fees, some consumers losing access to checking altogether, etc. Banks need to maintain profitability and for every loss, gains need to come from somewhere else. For merchants, it’s a windfall. What they choose to do with the resulting profits still remains to be seen.”
Colgan feels it’s a tough situation for small banks in particular, “There may be an opportunity for them to try and capture more customers, but they are in a tough spot. The regulated rate of interchange theoretically doesn’t affect them, but in the long run, merchants also have the ability to prefer cards associated with certain issuers so that could result in a lower volume being routed their direction. They should continue to determine how they can take advantage of their customer relationships and strengthen them in the long run”, she asserted.
Visa, the dominant debit card network, saw its share price plunge the most since December 2010, falling by as much as 10.7 percent in trading and closing down 7.5% at $177,01 the day the decision came out. The same shares shot up more than 10 percent, topping the S&P 500, after the final cap was unveiled in 2011 and surprised the business by being almost twice as high as the Fed’s earlier draft proposal.
Judge Leon warned, ‘The Fed has months not years to re write the rule in the light of this decision’.
A central argument that encompasses this debate is that swipe fees, under the Durbin Amendment, must be “reasonable and proportional” to the incremental cost of a transaction. The Dodd-Frank legislation that adopted the Durbin Amendment does not clarify whether the caps should reflect ‘other costs’ incurred by card issuers. The banks hence press for the caps to rise to reflect other costs.
Judge Leon argued that the Fed wrongly interpreted the statue on these costs. “The Fed decided the statute was silent on what other costs could be included in the calculation, and then moved to resolve that ambiguity by including those other costs. How convenient,” Leon remarked. “The statute and the legislative history demonstrate that Congress intended the swipe fee caps to reflect only the costs associated with an individual transaction, not any other costs”, he remarked.
He further added in a statement, “The Fed’s 2011 decision to bend to the lobbying by the big banks and card giants cost small business and consumers tens of billions of dollars and did not do enough to rein in the anti-competitive, anti-consumer practices of Visa and MasterCard.”
Martin Baily, President Clinton’s former top economist, and Litan in their 2011 paper explain why the Federal Reserve Board’s proposed alternatives for regulating interchange fees are not “reasonable” and therefore in direct violation of the statutory mandate that these rules be “reasonable” and “proportional” to the costs incurred by debit card issuers.
The paper explained, “The Board’s December 16, 2010 proposal is not “reasonable” because it would lead to a series of “unreasonable” outcomes, which, in significant part, flow from the predictable responses issuers of debit cards would take in response to the proposal.”
It further added, “Policy makers cannot reasonably assume that banks in competitive markets will sit idly by while being forced to reduce their current market-determined debit card interchange fees, which comprise much of their debit-card revenues and a material portion of bank profits, by anywhere from 73 to 84 percent. To the contrary, banks will attempt to make up as much of the lost revenue as they can by some combination of higher fees on checking accounts, fees or reductions of benefits for debit card use, or more refusals by issuers to permit consumers to conduct higher-cost types of transactions that impose greater fraud risk.”
In November 2011, the National Retail Federation, the Food Marketing Institute and NACS, formerly the National Association of Convenience Stores filed a lawsuit stating the merchants would be substantially harmed by the fees the Fed set under the Durbin Amendment. “The board’s final rule permits banks to recover significantly more costs than permitted by the plain language of the Durbin Amendment and deprives plaintiffs of the benefits of the statute’s anti-exclusivity provisions,” the retailers argued in their complaint.
Evans et al, argue in their research paper published in February 2011, that consumers were unlikely to receive significant savings in the form of lower prices from merchants during the 24 month period after the proposed regulations become effective. Most large merchants would not go to the trouble of reducing prices in the near term in response to the tiny cost reductions they would receive: about 10 cents on an average $59.89 transaction and less than 2 cents on a $10 purchase. Evans, in an exclusive interview with pymnts.com, noted, “The merchants keep saying they are passing savings on to consumers, but they’ve never backed that up. I doubt consumers think they got any money from the massive rate reduction that went into effect in October 2011.”
But, citing a recent push by European Union to cap the charges, Mallory Duncan, Senior Vice President and General Counsel of the National Retail Federation, which brought the case, pointed out that opposition to swipe fees is growing world-wide, “The rest of the world is beginning to understand that this is a game Visa, MasterCard and the banks are playing,” he said in an interview.
Colgan pointed out to the potential unintended consequences as being significant and said, “By requiring that multiple pin networks or multiple signature networks be present on every card, this could cause significant investment to smaller networks – particularly if they need to process signature and aren’t capable of doing so today. The advantage goes to the global networks with the capacity to invest or who have this ability. In addition, it could severely hamper innovation, both within the banking industry as well as innovators because of the decline in revenue as well as investment needed to handle new network requirements. Without appropriate avenues for revenue from these investments, innovation (to the benefit of consumers) could be significantly affected.”