On July 31st, the Federal Reserve's rule on debit card fees charged to merchants when cardholders use either a signature debit (check card) or a PIN debit card was overturned. Stating the rate caps initially set under the Durbin Amendment were too high, a U.S. District Judge ordered the Fed to lower the Interchange fees on debit cards further. In his ruling, the Judge said that the Fed was only allowed to consider the incremental cost of processing each individual transaction and not the fixed costs like equipment or other costs like fraud prevention. This leaves the Fed to recalculate the incremental cost of processing a debit transaction for the entire industry. Many experts are predicting a return to the initialing proposed 7 cents to 12 cents per transaction level.

While the Fed has 60 days to appeal his ruling, the Judge has given them until August 21st to decide how much time will be needed to rewrite the rules, pushing them for a final interim rule to be in place by the end of the month.

The pressure is on to change from merchant Interchange to cardholder fees.

A 2013 Debit Issuer Study conducted prior to the Judge’s ruling suggests that both regulated and exempt banks were fundamentally changing their debit businesses in response to the early 2011 reduction in Interchange revenue. The study found the most common adjustment was product and pricing structures on checking accounts, directing customers to bank accounts that generated more revenue, have higher minimum balances or have lower costs. The expected impact of more severe caps on debit fees will likely be that more banks will look at fees for debit card use, reducing debit card benefits and placing greater fraud controls by limiting debit card transaction size, frequency and restricting where the card can be used.

While bank customers have grown accustomed to getting many products for free, one of the central arguments on debit pricing is who should pay for the service. Many argue that charging cardholders to use their card is a more efficient way to set market prices. For example, Canada has zero Interchange fees on its single national debit card network and consumers there either maintain $1,000 minimum balance or pay for debit card privileges.

Many believe that banks will look to creatively work around caps, steering consumers to credit and prepaid cards which are not subject to government price controls. Using mobile devices to make payments at the POS could help issuers shift consumers to select charge instead of debit products through the use of incentives and liability protections (and using automated bill pay to make credit transactions look like debit transactions to the cardholder).

Greater network routing rules pose significant operational consequences.

In a 58-page ruling, the Judge also ordered that the Fed rewrite its network routing rules requiring merchants to be presented with multiple unaffiliated PIN debit networks and multiple unaffiliated signature debit networks for each transaction. The current Fed ruling allows for a debit card to be limited to one network choice for signature transactions and one network choice for PIN transactions. This change will mean that each bank issuer will need to put in place agreements that support competing systems with multiple debit networks in order to process a single debit card transaction, effectively increasing the costs of providing debit services while at the same time being restricted by price controls that don’t fully cover all the incremental costs of delivering cardholder services. The debit networks themselves are already changing there pricing approach to the market as a result. Star, Jeanie and Pulse PIN debit networks have all announced a new $6.00 annual merchant participation fee, regardless of the number of transactions you route to them.

After years of planning to roll out more secure and globally accepted EMV chip card payments to replace legacy mag-stripe card technology in the U.S., the big question now is how to support EMV while also adhering to more complex merchant routing choice obligations imposed by the Judge’s ruling.

EMV chips are better suited than mag-stripe cards to handle routing instructions delivering transactions to a merchant’s network choice, but implementing a common standard that all the competing payment parties can agree on won’t happen overnight. EMV will require merchants to upgrade their POS systems and the 2015 liability shift of moving fraud losses to merchants who do not support EMV chip acceptance, designed to encourage merchant adoption, may be delayed as the operational hurdles of more routing options gets resolved.

What does all this mean for small businesses?

What continues to be lost in this ongoing story is if merchants are getting the Fed regulated debit savings. Square and similar flat rate pricing plans along with many of your largest brand name banks and processors don’t pass Fed regulated pricing on to all merchants (or only pass a portion of the savings), thus keeping the difference for themselves. Processors and merchant service providers are not required to pass on the lower Fed regulated debit Interchange rates – and because of this, most small businesses are still, two years later, not realizing the benefits of this legislation.

We’ve been preaching the concept of “Interchange qualification management” for 14 years now. And we’ve posted many articles discussing what steps merchants should take to ensure they see the benefits from lower debit Interchange.

Senate Adopts Amendment to Regulate Interchange; What should merchants do now?
What should merchants do now that the Senate has adopted an amendment to regulate Interchange rates and fees?

Interchange pricing is the key to merchant savings
Check your October 2011 statement to see if you are getting the Fed regulated debit rates.

Small Businesses are Missing Out on Debit Interchange Savings
The only way a business can be sure you are getting ALL of the savings passed through is through the Interchange pass through pricing model.

All merchants who are not on an Interchange pass through billing plan should take action now to renegotiate their pricing arrangements. Merchants should also continue to reterminalize their businesses as needed, particularly moving off dial up terminal communication methods. However, use caution when it comes to any pressure to replace units solely to support EMV. Tablet POS solutions might be a better upgrade investment at this point while waiting for the dust to settle on how new debit network routing rules will be implemented within EMV.