Durbin Amendment Aftershock

Payments Industry Grapples with Proposed Regulation II

The Federal Reserve Board’s proposed Regulation II will limit debit interchange for card issuers with assets of $10 billion or more, and regulate other aspects of the U.S. debit card market. Published in December 2010, proposed Regulation II – or new Section 920 of the Electronic Funds Transfer Act – is the Federal Reserve’s attempt to implement the statutory text of the Durbin Amendment, but the proposal introduces considerable uncertainty about key aspects of the debit market.

To gather information about debit payments in advance of drafting its rules, the Federal Reserve conducted a survey of financial institutions with sufficient assets to be regulated under the proposed rules. Of the issuers that responded, 80 percent reported having combined authorization, clearing and settlement costs (as interpreted by the FRB) of 12¢ per transaction or less. The FRB said they did not receive data with sufficient statistical significance to lead them to treat PIN and signature debit differently in the proposed rules.

Inherent Uncertainties

Proposed Regulation II includes uncertainties in all three of its major provisions.

Interchange Fee Restrictions
Regarding interchange fees, it outlines two alternatives, either of which, if chosen, would take effect July 21, 2011. Alternative 1 provides for a “safe harbor” interchange rate of $0.07 per transaction for regulated institutions. If an issuer’s average variable cost exceeds $0.07, the issuer may receive a per-transaction fee equal to its average variable cost up to $0.12 per transaction. Alternative 2 caps interchange for regulated institutions at $0.12 per transaction.
Network Exclusivity Restrictions
In the area of network participation, the proposed rules outline two alternatives that would apply to all debit card issuers, regardless of asset size. In Alternative A, each debit card must participate in two unaffiliated debit networks (typically one signature network and one PIN network, but potentially two signature networks or two PIN networks). In Alternative B, debit cards must participate in two unaffiliated networks for each authorization type (PIN and signature).

The exclusivity restrictions would take effect October 1, 2011, if Alternative A is chosen, as would a provision giving merchants the right to direct the routing of debit transactions. If Alternative B is selected, the exclusivity restrictions will not take effect until January 1, 2013.

“Alternative B would be a radical departure from how cards work today, particularly on the signature side,” said PULSE President Dave Schneider in a January PULSE Academy session on Regulation II. “The infrastructure to support multiple signature networks doesn’t exist today,” he added.

During the same session, Duncan Douglass, a partner at law firm Alston & Bird, stressed that the final version of the rule could reflect a choice between the options presented, or it could include entirely different provisions.
Fraud Prevention Adjustment
The FRB sought comments on how to implement a provision of the Durbin Amendment that would permit regulated institutions to receive additional compensation for fraud prevention efforts that meet standards yet to be determined.

The Board estimates that industry-wide fraud losses to all parties from debit card transactions were $1.36 billion in 2009, composed of $1.15 billion in signature debit losses and $200 million in PIN debit losses. Signature debit fraud rates were 3.75 times those for PIN, says the FRB, averaging 13.1 and 3.5 basis points of dollar volume, respectively.

“The Fed appears inclined to create a fraud prevention adjustment,” said Douglass. What that adjustment will look like, and when it might take effect, are still unknown at this time, he says.

Future Direction

PULSE is continuing to analyze the proposed rules, and their potential impact on both regulated and exempt debit card issuers. Schneider believes the rules will have far-reaching effects, even on smaller issuers who technically are not subject to the interchange restrictions.

“Merchants and acquirer processors will have much more influence on how debit transactions get routed in the future,” he said. “I expect they will use that influence in an effort to drive down interchange for unregulated issuers.

“At this time, issuers should be working to make sure they fully understand their debit program costs,” Schneider continued. “Look at which components of your cost structure you might be able to reduce. Identify cost-saving opportunities now. Also, look at your customer base carefully around levels of profitability to your institution, and assess what changes you should make in each segment.”

For more information on the proposed regulation, its likely impact on financial institutions and how your institution can prepare, visit the PULSE Durbin Amendment Resource Center at www.pulsenetwork.com/debitregs.

Durbin Amendment Resource Center

Website Offers Information and Analysis on Debit Regulation

The Durbin Amendment Resource Center, accessible from the home page of the PULSE website, is offered as an exclusive benefit to our participants. The site is your source for amendment-related news, white papers, webinar replay links and expert analysis from PULSE and other industry leaders. It provides insight and guidance for use during the development and implementation of the Durbin Amendment regulations.

The site is continually updated as new information and resources become available. For the latest developments, go to www.pulsenetwork.com/debitregs.