Federal Reserve Proposes Changes to Debit Interchange Cap

The Federal Reserve is proposing changes to the debit interchange cap and calculation methods, as well as proposing a new process to update these figures more frequently going forward. The changes would apply directly to financial institutions with $10 billion or more in total assets, though will have indirect, downstream effects on debit card issuers of all sizes.

Under the current rule, the cap on each interchange fee is the sum of (i) 21 cents (the “base component”), (ii) 5 basis points multiplied by the value of the transaction (the “ad valorem component”), and (iii) for a debit card issuer that meets certain fraud-prevention standards, a “fraud-prevention adjustment” of 1 cent per transaction. Together, these three components comprise the “interchange fee cap.”

Under the proposal, the base component would decrease from 21.0 to 14.4 cents, the ad valorem component would decrease from 5.0 basis points (multiplied by the value of the transaction) to 4.0 basis points (multiplied by the value of the transaction), and the fraud-prevention adjustment would increase from 1.0 cents to 1.3 cents.

As an example, the maximum permissible interchange fee for a $50 debit card transaction would be 17.7 cents under the proposal, down from 24.5 cents under the current rule.

The proposed rule also includes a structure to update the components for the interchange fee cap every two years going forward, without public comment. The updates would be based on data from the Fed's biennial survey of covered issuers

At the Fed's meeting today, most of the governors expressed their support for the rule, and indicated they looked forward to reviewing comments from the public. Governor Michelle Bowman did not support the rule. In her remarks, she raised a number of concerns, including unintended consequences on both smaller financial institutions and low-income consumers, impact on the banking system as a whole, regressive methodology, incomplete data, and more.

Another notable moment in the hearing came when Fed staff were asked about potential impacts on community banks and financial institutions under the $10 billion asset cap. They stated:

• "The experience since the current cap was established in 2011 provides some evidence about whether that exemption for small issuers has been effective…
• "The interchange fees, on average, for community banks and small depository institutions did not decline following implementation of the current cap, and in fact have risen somewhat in recent years…
• "All of this suggests to us that the small issuer exemption has, in fact, been effective in practice, and we see no reason that would change under the proposed revisions. That having been said, we recognize that this is a complex market with a lot of potential, complicated effects on the different parties in the market, and so the proposal does seek comment on the effects the revisions might have, including on smaller depository institutions.

In contrast to this position, a recent study by Cornerstone Advisors found that all debit issuers - including those under the $10 billion asset threshold - had significant negative revenue impacts. The study notes that exempt banks and credit unions "have seen revenue cut by almost a third for single-message transactions, which represent the majority of debit transactions for an issuer…Exempt debit transaction revenue declined by 29% on single-message networks."

Once published in the Federal Register, the proposed rule will be open for comments for 90 days. Here at the League, we are reviewing the details of the proposed rule and will be commenting. We expect strong opposition from stakeholders across the financial services industry.

You can view today's hearing here, read the proposed rule, and more here.