Big banks on defense after Fed sides with retailers on debit swipe fees

For nearly a decade, the Federal Reserve avoided choosing sides in the protracted, high-stakes dispute between banks and retailers over debit card fees.

But after the Fed last week embraced one of the main arguments made by merchants, many observers believe that more bad news is coming for large and midsize banks.

The Fed is required by law to cap the interchange fees that banks with more than $10 billion in assets can collect when consumers use their debit cards at retailers. Since 2011, the limit has been set at 21 cents, plus 0.05% of the transaction. The central bank has long ignored pleas from both sectors to make changes. But now, in light of a decade-long decline in the banks’ processing costs, the Fed faces growing pressure to lower the price ceiling.

“I don’t think the Fed can do anything other than lower the interchange cap. That’s the mandate in the regulation — the interchange rate has to be representative of the costs associated with debit transactions, and costs have certainly come down,” said Sarah Grotta, a debit payments expert at Mercator Advisory Group.

Between 2009 and 2019, the cost of processing debit card transactions at banks with more than $10 billion of assets has fallen by nearly 50%, according to the Fed. The average cost, excluding fraud losses, fell from about 7.7 cents to 3.9 cents, the central bank said in a report issued Friday.

The same day, the Fed proposed a new rule that would resolve a related issue in a manner that is favorable by retailers. Under the proposal, banks that issue debit cards would be required to offer merchants the choice of at least two unaffiliated networks over which to route e-commerce transactions.

Merchants have long had such a choice on transactions where shoppers swipe their debit cards in physical stores. But banks have been much more spotty about providing routing options for online purchases, which retailers contend has raised their costs.

In other parts of the U.S. debit card market, the rules on routing choice have facilitated competition that did not previously exist, according to Callum Godwin, chief economist at CMSPI, a payments consulting firm that works exclusively with retailers. “The one place we haven’t seen that is in online debt,” he said.

Sen. Richard Durbin, D-Ill., who authored the section of the Dodd-Frank Act that required the Fed to impose both price caps and routing choice, last year urged the central bank to focus attention on the fast-growing e-commerce market. The interchange cap, commonly known as the Durbin amendment, applies to banks with more than $10 billion of assets.

In 2019, banks that accounted for approximately half of all debit-card transactions did not offer routing choice in any situations where the consumer paid remotely, according to a survey conducted by the Fed.

“We are moving to a cashless society. Whenever someone is paying with a card online, exorbitant fees are involved,” said Leon Buck, vice president of government relations in banking and financial services at the National Retail Federation. “We want the opportunity, as retailers, to have routing choice.”

Bank industry groups responded harshly to the Fed’s proposal. In a joint statement, they implied that Visa and Mastercard, which own the networks over which most remote debit-card transactions get routed, offer better security measures than the smaller networks that stand to benefit from the Fed’s proposal.

“By reopening the rules surrounding debit card transactions, the Fed could put the convenience, safety and security that Americans have come to expect when they use their debit card at risk,” read the statement, which was issued by the American Bankers Association and four other groups that represent banks and credit unions.

But several observers indicated that they do not expect the banks will be successful in their efforts to convince the Fed to change…