On June 29, 2011, the Federal Reserve Board issued a final rule to implement the Durbin Amendment to the Dodd-Frank Act, which, among other things, restricts interchange fees for certain debit card issuers and limits the ability of networks and issuers to restrict debit card transaction routing, including through exclusivity arrangements. The following is a summary of the final rule. A comparison of the final rule to the original proposed rule from December 16, 2010, is attached as Appendix 1.
Interchange fees for debit card transactions are capped at 21 cents plus an ad valorem component of 5 basis points of the transaction value. The 21 cents plus 5 basis points serves as a de facto “safe harbor” — a debit card transaction interchange fee that does not exceed this threshold is conclusively reasonable and proportional. In addition, under an interim final rule issued concurrently with the final rule, an additional 1 cent per transaction “fraud prevention adjustment” to the interchange fee is available to those issuers that comply with certain standards outlined by the Federal Reserve Board.
- The 21-cents-per-transaction figure is substantially higher than the 12-cents-per-transaction cap included in the proposed rule, primarily due to the Federal Reserve Board’s inclusion of a much broader base of allowable costs under the final rule than had been considered under the proposed rule. The interchange fee caps under both the final rule and proposed rule were pegged to the 80th percentile of issuer allowable costs based on the Federal Reserve Board’s survey of covered issuers.
- The 5-basis-point ad valorem component adjusts for fraud losses, based on the average per-transaction fraud losses of the median issuer, as indicated in data from the Federal Reserve Board survey of covered issuers.
- The available fraud prevention adjustment of 1 cent per transaction represents the median fraud-prevention cost of 1.8 cents per transaction, as determined by the Federal Reserve Board survey of covered issuers, less the median fraud-monitoring cost of 0.7 cents per transaction (which was already included in calculating the 21-cent interchange fee cap figure), rounded to the nearest cent.
The interchange fee limitations apply unless one of three specific exemptions is met: small issuer, government programs or reloadable general-use prepaid cards.
- Small Issuer: Any debit card issuer with total worldwide assets (including assets of affiliates) of less than $10 billion as of the end of the previous calendar year.
- Government Programs: Debit card transactions made pursuant to a government-administered payment program, even when the administration of such program is outsourced to a private third-party contractor.
- Reloadable General-Use Prepaid Cards: Reloadable general-use prepaid cards, excluding open-loop gift cards that meet certain criteria; provided, however, that this exemption applies only if the prepaid card is the sole means of accessing the funds underlying the card for a payment transaction. Due to this additional requirement, many reloadable general-use prepaid cards and many health benefit cards (HSA, FSA, etc.) in the marketplace today, which would have qualified for this exemption as included in the proposed rule, may be subject to the interchange fee limitations under the final rule if they allow noncard methods of accessing prepaid funds (e.g., ACH access and check-writing).
- As of July 21, 2012, the Government Programs and Reloadable General-Use Prepaid Card exemptions are not applicable if the issuer of such cards charges either (1) an overdraft fee or (2) a withdrawal fee on the first withdrawal in any given month at an ATM in the issuer’s designated ATM network.
The prohibitions on network exclusivity and merchant routing restrictions (a) require an issuer to enable at least two unaffiliated networks on each debit card (“Alternative A” from the proposed rule), (b) prohibit networks from entering into exclusivity arrangements and (c) restrict the ability of issuers or networks to mandate transaction routing requirements. Unlike the interchange fee limitations, there are no available exemptions.
- In adopting network exclusivity prohibition Alternative A from the proposed rule, the Federal Reserve Board has prohibited issuers and networks from limiting available routing options for debit card transactions to fewer than two unaffiliated networks per debit card. Accordingly, all debit cards will need to participate in at least two unaffiliated networks so that transactions initiated using those debit cards will have at least two independent routing channels. The two unaffiliated networks could be one PIN network and one signature network (the most common configuration), two signature networks or two PIN networks (in each case so long as the two networks are not affiliated). Recall that Alternative B from the proposed rule, if adopted, would have required issuers to enable at least two unaffiliated networks per method of authorization on each debit card.
- Even where an issuer has enabled two unaffiliated networks on its debit cards, the final rule prohibits networks from limiting the number of additional networks an issuer may enable on its debit cards.
- The prohibition on routing restrictions also eliminates the ability of an issuer or a network to require routing based on the card issuer’s or network’s preferences, and within certain limits, gives merchants control over debit card transaction routing, including via predetermined routing tables.
- These rules have general applicability and are not subject to any exemptions, including those available for small issuers, government programs and reloadable general-use prepaid cards that apply to the interchange fee limitations.
ATM transactions and three-party networks are not subject to the final rule.
- The Federal Reserve Board observed that ATM transactions are not electronic debit transactions for purposes of the rule because (a) cash withdrawals are not “payments” (i.e., exchanges of money for goods or services) and, accordingly, a network providing only ATM services is not a payment card network, and (b) because ATM transaction interchange fees do not compensate an issuer.
- In opting to exclude three-party networks (when the system operator is acting as both network and debit card issuer) from the final rule, the Federal Reserve Board concluded that such three-party networks do not constitute “networks” that “route” transactions.
The final rule sets varying effective dates for the interchange fee limitations and the prohibition on network exclusivity and merchant routing restrictions.
- The interchange fee limitations (including the “fraud-prevention adjustment” established under the interim final rule) are effective October 1, 2011.
- The prohibition on network exclusivity arrangements has rolling effective dates, as follows:
October 1, 2011, for payment card networks;
April 1, 2012, for most debit card issuers; April 1, 2013, for certain heath and other benefit cards subject to IRS rules; and
April 1, 2013, for general-use prepaid cards that have been reloaded (or 30 days after being reloaded, if the first reload occurs on or after April 1, 2013).
- The prohibition on merchant routing restrictions is effective October 1, 2011.
The final rule will have an impact across all sectors of the payments industry, including issuers, networks, merchant acquirers, merchants and technology providers.