I. INTRODUCTION
The Federal Reserve Board (FRB) issued its final rule to implement the “Durbin Amendment” (Section 1075) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The final rule sets caps on permissible interchange debit card fees and requires that debit cards provide at least two unaffiliated payment card networks through which merchants may route transactions. While small banks are exempt from the interchange debit card rule, the networks are not obligated to maintain differential pricing. In addition, all banks, including those with assets under $10 billion, must comply with the routing requirements.
II. PERMISSIBLE INTERCHANGE FEE
The final rule provides an interchange fee for non-exempt banks and cards composed of:
Accordingly, for the average $40 transaction, the interchange fee is capped at 24 cents (21 cent base fee, plus 2 cents to cover fraud losses, and 1 cent for fraud prevention). For a $500 transaction, the fee could not exceed 47 cents (21 cent base fee, plus 25 cents to cover fraud losses, and 1 cent for fraud prevention). While the regulation permits networks to charge up to the cap, they are not required to. Thus, for example, the interchange fee might be lower for small dollar transactions.
Costs incorporated into the calculation of the permissible base fee of 21 cents now include:
o network connectivity;
o computer equipment;
o staff to operate and maintain computer equipment;
o network processing fees;
o costs of processing chargebacks and other non-routine transactions; and
o transaction monitoring.
Excluded from the 21 cent base fee cost calculation are:
III. FRAUD PREVENTION ADJUSTMENT
The fraud prevention adjustment allows issuers to receive up to an additional one cent per transaction and adopts a non-prescriptive approach that allows issuers to develop and adopt policies and procedures designed to identify, monitor and respond to fraud risks. To be eligible to receive the fraud prevention adjustment, an issuer must develop and implement policies and procedures reasonably designed to:
To qualify for the fraud prevention adjustment, issuers must review their fraud prevention policies and procedures, and their implementation, at least annually, and update them as necessary in light of (a) their effectiveness in reducing the occurrence of, and costs to all parties from fraudulent electronic debit transactions involving the issuer; (ii) their cost effectiveness; and (iii) changes in the types of fraud, methods used to commit fraud, and available methods for detecting and preventing fraudulent electronic debit transactions that the issuer identifies from (A) its own experience or information; (B) information provided to the issuer by its payment card networks, law enforcement agencies, and fraud monitoring groups in which the issuer participates; and (C) applicable supervisory guidance.
To be eligible to receive or charge a fraud-prevention adjustment, an issuer must annually notify its payment card networks that it complies with the fraud-prevention standards. Finally, if an issuer is substantially noncompliant with the fraud prevention standards, as determined by the issuer or the agency with responsibility for enforcing the issuer’s compliance with Regulation II, the issuer must notify its payment card networks that it is no longer eligible to receive or charge a fraud-prevention adjustment no later than 10 days after the date of the issuer’s determination or notification from the agency and must stop receiving or charging the fraud prevention adjustment no later than 30 days after notifying its networks.
IV. SMALL ISSUER EXEMPTION
The final rule retains an exemption from the fee cap for issuers with total assets of less than $10 billion. The FRB will publish lists annually of the issuers that qualify for the exemption to assist networks in identifying exempt institutions. For purposes of calculating an issuer’s assets, assets of both domestic and overseas affiliates are aggregated with the issuer’s assets. Issuers that cease to qualify for the Small Issuer Exemption are required to become compliant no later than July 1 of the following year. In addition, the Board plans to survey payment card networks annually and publish a list of the average interchange fees each network provides to its covered and exempt issuers.
V. EXCLUSIONS FOR ATMS AND THREE-PARTY NETWORKS
The final rule clarifies that ATM networks and three-party debit networks (e.g., American Express) do not fall within the definition of a “payment card network” and therefore are not subject to either the interchange fee provisions or the network routing requirements.
VI. EXEMPTION FOR PREPAID CARDS
The final rule exempts certain reloadable prepaid cards. The FRB has added a clarification that the exemption only applies if the card “is the only means of access to the underlying funds, except when all remaining funds are provided to the cardholder in a single transaction.” The Supplementary Information advises, “The Board believes that reloadable cards that provide access to the funds underlying the card through check, ACH, wire transfer or other method would not be exempt.”
VII. NETWORK EXCLUSIVITY AND ROUTING REQUIREMENTS
The Dodd-Frank Act requires the FRB to implement requirements to prohibit network exclusivity arrangements on debit cards and ensure merchants have choices in how debit card transactions are routed. Unlike the interchange fee provision, no asset threshold exemption applies to the network exclusivity requirements. In addition, the network exclusivity and routing requirements apply to both debit cards and prepaid cards.
The final rule requires that issuers make two unaffiliated networks available without regard to the method of authentication (PIN or signature). A card issuer may comply with the network exclusivity requirement by enabling the debit card to process transactions through one signature network and one unaffiliated PIN network. Thus, a card issuer that currently processes PIN and signature transactions through affiliated networks will have to enable an unaffiliated PIN network on their debit cards. Card issuers do not have to remove a PIN network affiliated with the signature network so long as the merchant has the option to choose an unaffiliated PIN network. Card issuers will not be required to display added PIN network logos on the debit cards, eliminating reissuance costs. Cards that are only usable with PINs must be enabled with two unaffiliated PIN networks.
The Federal Reserve Board of Governors (FRB) adopted a final rule in October of 2022 that amends Regulation II to specify that the requirement that each debit card transaction must be able to be processed on at least two unaffiliated payment card networks applies to card-not-present transactions, and to clarify the requirement that debit card issuers ensure that at least two unaffiliated networks have been enabled to process a debit card transaction. The final rule is effective on July 1, 2023.
When the Board issued Regulation II in 2011, the market had not yet developed solutions to broadly support multiple networks for card-not-present debit card transactions, such as online purchases. In the ensuing decade, most networks have introduced the technical capabilities to process card-not-present debit card transactions. In those cases where only one network is enabled for card-not-present transactions, merchants do not have an alternative network option that might offer lower fees or better fraud-prevention capabilities.
The final rule underscores that issuers should provide routing choice for card-not-present debit card transactions. The final rule specifies that card-not-present transactions are a particular type of debit card transaction for which issuers must enable at least two unaffiliated networks. The final rule also adds language to emphasize that Regulation II does not require an issuer to ensure that two unaffiliated networks will actually be available to the merchant to process every transaction.
Under the final rule, an issuer must configure each of its debit cards so that card-not-present transactions performed with those cards can be processed on at least two unaffiliated networks. As a practical matter, an issuer will first need to determine whether card-not-present transactions performed with its debit cards can already be processed on at least two unaffiliated networks. If the issuer is not already compliant with the final rule, then the issuer will need to adjust its debit card processing arrangements to meet the final rule’s requirements.
The final rule includes certain changes that make it easier for issuers to determine whether they are already compliant with the prohibition on network exclusivity. Specifically, the final rule retains the approach in current Regulation II that allows issuers to rely on network rules or policies in determining whether the networks enabled by an issuer may be used to satisfy the prohibition on network exclusivity.
Card issuers that currently offer an unaffiliated PIN network on their debit cards will not have to take action to comply with the rule. ATM transactions are not subject to the routing and network exclusivity regulation.
VIII. EFFECTIVE DATES
A. Permissible Interchange Fee/Routing Requirements
The effective date for the interchange fee provisions, as well as the routing restrictions was October 1, 2011.
B. Network Exclusivity Rules
1. Issuers
The network exclusivity rules would be generally effective and compliance would be mandatory on April 1, 2012, with respect to issuers.
2. Payment Card Networks
With respect to payment card networks, however, the final rule makes these provisions effective on October 1, 2011.
3. Government Benefit Cards
The effective date for the network exclusivity rules for certain health and other benefit cards that are subject to certain Internal Revenue Service (IRS) rules (health flexible spending accounts and health reimbursement accounts) are delayed until April 1, 2013.
4. Non-Reloadable General-Use Prepaid Cards
The effective date for the network exclusivity rules for non-reloadable general-use prepaid cards is April 1, 2013.
5. Reloadable General-Use Prepaid Cards
The effective date for the network exclusivity rules for reloadable general-use prepaid cards will be April 1, 2013. As a result, reloadable general-use prepaid cards sold after April 1, 2013, must comply with the rule; reloadable prepaid cards sold before April 1, 2013, would not be subject to the rule unless and until they were reloaded, with the effective date for such cards established as May 1, 2013, (if reloaded prior to April 1, 2013) or 30 days after the date the cards were reloaded (if reloaded after April 1, 2013).