On June 30, 2010, the House of Representatives approved the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Financial Reform Act, a comprehensive and expansive set of financial reforms widely thought to be the toughest changes to financial regulation in the United States since the Great Depression.  The Senate approved the Financial Reform Act on July 15, 2010, and President Obama signed it into law on July 21, 2010.

Amongst the 2300+ pages of the Financial Reform Act is a small section that may have a large impact on players in the payments industry.  Among other things, the provision, called the Durbin Amendment after the Senator who proposed it, gives the Federal Reserve the ability to control a heretofore lucrative revenue stream for issuing banks—the interchange fee.  This Update highlights the salient features of the Financial Reform Act as they relate to these interchange fees.

Certain Debit Card Issuers' Fees Must Be "Reasonable and Proportional" Under the Financial Reform Act; Credit Card Issuers Escape this Regulation For Now

Currently, merchants pay an average of 1-2% of the total transaction amount in debit interchange fees.  Merchants with larger volumes are able to negotiate a smaller fee.  Under Section 1075 of the Financial Reform Act, interchange transaction fees charged by certain debit card issuers on electronic debit transactions must be "reasonable and proportional to the cost incurred by the issuer with respect to the transaction."  Regulations clarifying this standard are still to come.  Among other items, these regulations must take into account the incremental cost to an issuer for processing a particular electronic debit transaction (as opposed to general processing costs) and costs incurred by the issuer for fraud prevention efforts on that issuer's electronic debit transactions.

Significant Categories of Issuers and Cards Are Exempt From Compliance.  Perhaps the most interesting aspect of this legislation concerns which issuers and programs are not required to comply with this portion of Section 1075. The debit card issuers that are exempt from these new limits on interchange transaction fees are:

• Issuers with less than $10,000,000,000 in assets;
  
  
• Government-administered payment programs involving debit and general‑use prepaid cards; and
  
  
• Certain reloadable, open-loop, prepaid cards or payment devices (that are not marketed as gift cards).

Exemption May Be Lost.  Cards and payment programs falling under the second two categories that continue to charge overdraft fees or a fee for the first withdrawal per month from an ATM within the card issuer's ATM network more than one year following the enactment of the Financial Reform Act will lose their exemption from the requirements of Section 1075.

Credit Card Issuers May Be Subject to Similar Restrictions in the Future.  Although credit card interchange fees seem to have escaped regulation at this point, insiders say they believe that is because of the perceived blow credit card issuers suffered from the Credit Card Act of 2009; they expect that once that furor fades into the background, they expect Senator Durbin or others will propose an amendment to apply the "reasonable and proportional" standard to credit card interchange fees as well.  That seems to be the trend, as Senator Durbin has already proposed additional interchange-related amendments to other bills now making their way through Congress.

Merchants Gain Flexibility to Define Their Own Card Acceptance Policies

Card Issuers Are Limited in Their Ability to Regulate How Businesses Accept Cards.  Section 1075 of the Financial Reform Act gives merchants more flexibility by imposing new limitations on the ability of payment card networks (i.e., the servicers that process credit and debit transactions) and issuers to regulate a business's choice of which payment card networks to use and the incentives it offers.

• Payment Card Networks Cannot Restrict Customer Incentives.  Payment card networks may no longer restrict a business from offering discounts or in-kind incentives for its customers' use of cash, checks, debit cards or credit cards, so long as the business (i) makes these incentives available to all issuers and payment card networks, (ii) offers the incentives to all prospective buyers, and (iii) discloses the incentives clearly and conspicuously (if required by federal or applicable state law).
  
  
• Issuers Cannot Direct the Choice of Payment Card Network.  Debit card issuers and payment card networks can no longer require a business to exclusively use only certain payment card networks affiliated with a certain issuer, nor can these issuers or networks otherwise limit or restrict the number of payment card networks used by a business to process transactions.  The choice of payment card network now lies with the individual businesses that accept debit cards.

Businesses and Institutions May Set Minimum and Maximum Spending Limits for Credit Card Transactions.  Section 1075 of the Financial Reform Act grants businesses, federal agencies and higher education institutions that accept credit cards the right to set certain spending limits.

• Minimum Purchase for Card Use Is Allowed. Businesses can set a minimum spending requirement (currently up to a maximum of $10.00) for the acceptance of credit cards so long as that spending requirement applies to all issuers and payment card networks.
  
  
• Certain Institutions May Set Maximum Spending Limits.  Federal agencies and colleges and universities can set a maximum spending limit for acceptance of credit cards so long as that maximum spending limit applies to all issuers and payment card networks.

Given the restraints imposed by the card network rules on a merchant's ability to choose how and when it will accept which cards, this freedom being given to merchants is extraordinary and almost certainly a welcome relief from the old system.  Although many smaller merchants have long ignored the payment card network prohibition on setting minimum purchase amounts for card use, this legislation will permit merchants too big to "fly under the radar" to define their own card acceptance policies.

It is worth noting that, although the regulation of interchange fees and prohibitions on exclusivity with regard to routing applies only to debit cards and certain prepaid cards, the ability to set a transaction minimum for card use applies only to credit products.

Winners and Losers Are TBD

Although it seems clear that the introduction of lower interchange fees and fewer restrictions on card acceptance and routing is a solid victory for merchants, industry commentators are split on whether this development should be considered a victory for consumers.  The theory behind the legislation is that the savings experienced by merchants would be passed on to consumers in the form of lower prices, loyalty programs or other incentives.  With rulemaking yet to come, it is too early to assess the ultimate impact of the Durbin Amendment on merchants or consumers, but it is fair to say that many of these provisions are the result of years of intense lobbying by merchant and consumer groups alike.

Additional Information

This Update is only intended to provide a summary of one section of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  You can find other discussions about the Financial Reform Act on our Web site.