Last week was a pivotal time for issuers of debit cards, with the Federal Reserve Board (FRB) releasing a final rule and an interim final rule implementing the Durbin Amendment, and the U.S. Eighth Circuit Court of Appeals rejecting TCF National Bank’s challenge to the Amendment on the very same day.

For debit card issuers, the final rule and interim final rule likely represent as favorable a result as possible under the Amendment, while the Eighth Circuit decision will come as a real disappointment.

From the standpoint of debit card issuers, the final FRB rule significantly improves the proposed rule, discussed in a prior legal alert, in critical respects:

  • The final rule allows covered issuers to recover an interchange fee on each transaction equal to the sum of: (1) 21 cents; plus (2) five basis points (0.05 percent) times the transaction amount; plus (3) for issuers who comply with specified fraud prevention requirements, an additional penny, for a total of 24.5 cents on a $50 transaction. This more than doubles the maximum transaction fee of 12 cents permitted under the proposed rule. Nevertheless, the final rule will still result in a very substantial reduction in interchange revenues for covered debit card issuers.
  • Regarding the requirement that debit cards must be functional on at least two unaffiliated payment card networks, the final rule requires that a qualifying network must not be restricted in geographic reach or by type of merchant or transaction. The authorization method used by each network is disregarded. Thus, it suffices if a card allows signature transactions on one payment card network and PIN transactions on an unaffiliated payment card network. In the proposal, the FRB asked for comment on whether it should require a signature-based card to function on two unaffiliated signature networks (and a PIN-based card to function on two unaffiliated PIN networks).
  • The rule provides that it generally becomes effective on October 1, 2011, although parts of Section 235.7 (limitations on payment card restrictions) become effective at later dates. Although the Durbin Amendment originally contemplated a July 21, 2011, effective date on interchange fee limits, it also contemplated a final FRB rule by April 21, 2011. In light of the FRB’s failure to meet this deadline, the FRB determined that a three-month implementation period should still be allowed.

TCF had argued in its lawsuit that the rates allowed under the Durbin Amendment were confiscatory and accordingly violated the Takings and Due Process clauses of the Fifth Amendment to the U.S. Constitution. The Eighth Circuit held that, in the present posture of the case—a facial challenge to the Amendment—the district court properly denied TCF’s motion for a preliminary injunction. The court did not rule out the possibility of a subsequent claim by TCF that would challenge the Amendment, as applied to TCF. Any such challenge would likely await the announcement by Visa of the interchange pricing it will adopt. In the meantime, TCF has dismissed its lawsuit without prejudice to its right to resurrect as-applied claims in the future.

Both the FRB and the Eighth Circuit separately expressed concern that the Durbin Amendment’s interchange fee exemption for small issuers (those that, together with their affiliates, have less than $10 billion of assets) might provide no practical protection for small issuers. Indeed, the Eighth Circuit quoted from FRB Chairman Ben S. Bernanke’s recent testimony before a Senate committee: “By the statute, the smaller institutions will be exempt from these restrictions, but there is the possibility … that either because merchants wouldn’t accept the more expensive cards or because networks would not be willing to have a two-tiered pricing system … that in practice they would not be exempt from the lower interchange fee.” The Eighth Circuit added that, in light of evidence that “Visa is currently bound to offer all financial institutions the same interchange rate … the record is not clear that smaller banks will have a competitive advantage.”

Visa has previously announced that it intends to establish two-tier interchange pricing for large and small debit card issuers, whereas MasterCard has not announced its plans. It remains to be seen what prices the networks will establish, just as it remains to be seen how issuers, merchant acquirers, retailers, and Congress will react to the next shoes that drop. We will be following developments closely.