On July 31, 2013 U.S. District Judge Richard Leon sided with retailers and rejected the debit interchange rate cap set by Federal Reserve under the Durbin Amendment in 2011. The court ruling was hailed as a victory for the many retailers and national associations that had complained that the cap on the interchange rate was previously set too high.
On August 14, 2013 in the first hearing since the July 31 decision, Judge Leon gave the Federal Reserve another week to come up with a position on interim fee reductions and a timeline for getting new lower fees permanently in place. However, merchants shouldn’t celebrate or expect debit card interchange rate reductions just yet.
The Durbin Amendment
The Dodd-Frank Wall Street Reform Act in 2010 contained the so-called Durbin Amendment, which required large financial institutions to cap their debit card interchange rates. The interchange rate is the portion of a merchant’s processing fee that goes back to the financial institution that issued the card used by the customer to buy goods and services.
Initially, the cap was believed to be set around $0.12. However, the Federal Reserve’s final ruling expanded the items included as cost to the banks. Therefore, when the debit card interchange rate cap was implemented in 2011 it had a maximum cap of 0.05 percent plus $0.22, almost twice as much as what was initially expected. Again, the cap only applies to debit cards issued by larger financial institutions.
Although beneficial to most merchants, the Durbin Amendment and its implementation were flawed from the beginning. First, it only required larger financial institutions to reduce the interchange rates on the debit cards they issued. It never required merchant account providers to actually pass on the lower rates to their merchants. To date, many merchants have never seen a penny of the debit interchange rate reduction implemented in 2011. Second, the capped interchange rate actually became punitive for merchants with lower average ticket sales. A debit card sale of $15 or less can actually cost a merchant more now than before the Durbin Amendment was implemented.
Despite the flaws, the lower debit card interchange rate has been beneficial for most U.S. merchants. In fact, processing costs to U.S. merchants were down in 2012 from the year prior. The decrease was certainly due to the Durbin Amendment as well as more merchant awareness and strong competition among providers.
Impact of the Recent Decision
Judge Leon’s decision could result in the current debit card interchange rates being cut by more than 50 percent. The interchange rates could potentially revert to around the 12 cents per transaction level that was initially proposed back in 2010.
This would be good news for merchants and especially merchants with lower average sale transactions. However, don’t expect Judge Leon’s decision to be implemented quickly or to be implemented without arguments from the banking community or perhaps the Federal Reserve. For now, it appears that lower interchange rates will not come to fruition before 2014 and the whole rate issue is still in flux.
The current Durbin Amendment cap on debit card interchange rates currently remains in effect and more hearings and meetings are scheduled to determine any changes to the current interchange rates.
Also, be cautious of sales presentations and savings analyses. I have already come across one salesperson who is telling merchants that the Durbin Amendment has been overthrown and that tiered pricing is a better value. “Interchange plus” pricing is still the best plan for merchants. However, also understand that Interchange Plus pricing does not automatically mean fair pricing. See my article April 2013 article “Merchants on Interchange Plus Pricing Continue to Overpay.” Most of the merchants I consult with are already on Interchange Plus pricing.
Visa Base II and MasterCard Kilobyte Fees
On a separate subject, I have had inquiries about providers implementing a “Visa Base II” fee and a “MasterCard Kilobyte” fee. Merchants have asked if these are legitimate pass-through fees. The answer is “Yes.” Visa and MasterCard charge providers a fee to route the transactions on their system. However, these fees should only be around 0.25 cents (one-quarter of a cent) per transaction. Many providers just include these fees in their own per-transaction fee so merchants do not see these fees on their statement. However, some providers are separating these fees out because they can be a substantial cost to them considering they may be routing billions of transaction per year.
Merchants need to be cognizant of the real cost of around 0.25 cents. I have seen these fees inflated to as much as 3.5 cents by certain providers.
- For now, nothing has changed regarding debit card interchange rates.
- Debit card interchange rates may be lowered in 2014, but probably not without argument from the banking industry and perhaps the Federal Reserve.
- Visa Base II and MasterCard Kilobyte fees should only be around 0.25 cents per transaction.