Challenges and Changes Loom as Fed Mulls and Court Considers Debit Interchange Fees

Debit interchange fees may see a revamp — a refashioning of the charges levied on merchants, the likes of which has not been seen in a decade.

Next week, the Federal Reserve will take up an examination of “proposed revisions to the Board’s debit interchange fee cap” per an agenda for that meeting, scheduled for Oct. 25. The Fed is reportedly setting sights on lowering the cap on those fees.

And, separately, the Supreme Court has said it will hear a challenge to those fees.

Below is a bit of a primer as to what’s going on and what may happen — and to whom.

What’s at Stake … and Who’s Affected and Who’s Not

For the last 12 years, the Federal Reserve has mandated, through Regulation II, that interchange fees are capped at 21 cents a transaction, plus 0.05% of the value of the transaction itself, “plus a $0.01 fraud prevention adjustment, if possible.” Some cards are exempt from the cap, namely, prepaid cards and debit cards that are issued by government aid programs .

The Fed has some leeway to lower the caps, which in turn would lower the revenue streams that are meant to help defray the costs tied to card acceptance and for processing those transactions. The cap applies to issuers with $10 billion or more in assets, so this means that smaller financial institutions (FIs) are exempt from the caps.

The fees paid out to card-issuing banks range into the tens of billions of dollars. One Fed report noted that the fees topped $24 billion in 2019 alone.

What About FinTechs?

FinTechs, as is well known, have tended to make interchange a central revenue driver, as they’ve been dependent on customers critical mass and transaction volumes — wrapping services around debit cards — to compete with more traditional brethren.

Because the cap does not apply to smaller banks — and smaller banks have tended to be the partners with FinTechs to issue cards — it may seem like those revenue streams may be safe, for now. And because the fees have not been capped in this space, the FinTechs have been able to charge higher fees to merchants.

Chime, by way of example, notes on its site that it makes money through the process where Visa collects an interchange fee from the merchant for processing payments, and a portion of that interchange is paid out to Chime.

Separately, Revolut’s own financial statements, for the year ending in December 2021 (the latest data available) show that cards and interchange revenue totaled 149 million GBP, or nearly a quarter of the consolidated top line.

In an interview earlier this year with Karen Webster, Sezzle Co-founder and CEO Charlie Youakim and Dave founder and CEO Jason Wilk said neobanks are making, and need to make, moves to diversify beyond interchange, with options that include subscription models.

The Battle Lines Being Drawn

As with any battle, each side has something to say, and each side has skin in the game.

Merchants support a lowering of the cap. In a statement released this week, the National Retail Federation (NRF) said the Federal Reserve should lower the cap.

“Congress told banks a dozen years ago that debit card swipe fees should be ‘reasonable and proportional’ but they’ve never been either,” NRF Chief Administrative Officer and General Counsel Stephanie Martz said in the statement. “It’s time to set the cap that Congress intended and recognize that banks’ costs to process transactions have dropped significantly. Doing so would reduce costs for retailers and give them more savings to share with their customers by holding down prices in a time of inflation. These fees have been too high for too long and we’re glad to see the Fed is finally ready to act.”

The cap has remained in place, maintained the Federation, even though the banks average cost tied to the transactions “has steadily fallen,” dropping to 3.9 cents as of 2019. The NRF said the fees “are among most merchants’ highest operating costs and drive up prices paid by consumers by more than $1,000 a year for the average family.”

The banks have said that the fees are essential to offset costs and are critical in a time when debit card fraud has been on the rise. National Association of Federally-Insured Credit Unions (NAFCU) Senior Vice President of Government Affairs Greg Mesack wrote to the Federal Reserve on Oct. 5 asking the Board of Governors to “avoid an unwarranted review of the regulated debit interchange fee cap.” He noted the fees are proven to help offset costs but may be insufficient to manage and mitigate debit card fraud that has been on the rise in recent years.

“Unlike large financial institutions, credit unions lack the economies of scale to mitigate these costs, which plays a critical role in the disparities seen in per-transaction expenses,” the letter contended.  “Large financial institutions benefit from this fundamental economic principle as they have a substantial volume of transactions, coupled with expansive operational and technological infrastructures that allow for cost efficiencies and reductions.”

Mesack wrote in the letter, “For many community-based financial institutions like credit unions, costs remain considerably high and comprehensive transaction costs remain elusive,” and growing fraud threats add to operations costs.

“NAFCU staunchly oppose any efforts to reduce the debit interchange rate,” Mesack wrote. “We urge the Federal Reserve Board to consider the disparaging effects such a move would have on credit unions and, by extension, the communities they serve.”