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Fed Interchange Rule: Beyond First Impressions

August 11, 2011

By Chris Daniel, Stan Koppel, Kevin Petrasic & Ky Tran-Trong

Following a protracted, controversial and hard-fought political battle to block or delay its issuance, the Federal Reserve Board (FRB) released the long-awaited Debit Card Interchange Fee and Routing Rule (Interchange Rule) on June 29, 2011. The rule, which is generally scheduled to take effect October 1, 2011, represents a compromise of sorts between the interests of retail merchants that lobbied hard for inclusion of section 1075 of the Dodd-Frank Act (DFA), i.e., the so-called Durbin Amendment, and those of bank issuers and payment card networks that originally opposed inclusion of the Durbin Amendment in the DFA last year and then attempted to delay its effective date this spring.

In issuing the rule, the FRB was effectively caught between a rock and hard place with respect to addressing and accommodating the competing concerns of the amendments sponsor, Senator Durbin, and numerous bipartisan supporters on the Hill, backed by a number of influential players in the retail merchant space community, and similarly vocal, bipartisan Hill opposition to the amendment, including a number of influential members of the Senate Banking Committee, pushed by virtually the entire banking industry, including large banks, regional banks, small community banks and credit unions. Ultimately, the FRB found a way to implement a compromise that almost nobody likes but everybody appears to be able to live with, even if grudgingly so. In navigating between a proposed interchange fee cap viewed by the banking industry as overly restrictive and a "reasonable and proportional" cost recovery cap that is not directly tied to an issuer's specific costs opposed by merchants, the FRB effectively compromised by adopting a threshold stand-alone cap that, although higher than proposed, the banking industry still does not like, but which has also been heavily criticized by the retail merchant industry due to the increase from the proposed baseline fee from the proposal. The ultimate effects on the payments industry of the Interchange Rule, including delivery of promised benefits to merchants and consumers and impact on community banks, are not easy to predict. What is clear, however, is that the Interchange Rule will have immediate practical impacts on all organizations in the value chain of delivery of consumer payment services. These impacts arise not only from the revenue and cost re-distribution between issuers and merchants, but also from substantial infrastructure efforts necessary to implement the two-tier interchange rate structure applicable to covered and exempt issuers and products as well as the network exclusivity and routing provisions.