Stakeholders Respond to Proposed Revision of U.S. Debit Interchange Fee Cap

For the first time since 2011, the Federal Reserve has proposed a revision to the maximum interchange fees charged on covered debit card transactions in the U.S. The proposal follows a decade of reported reductions in the underlying authorization, clearing and settlement (ACS) costs of issuing banks.¹ With the open comment period on the Fed’s proposal now closed, CMSPI’s Insights team breaks down four of the most commonly cited challenges to the rate revisions.

Understanding the Proposal

When Regulation II came into force in 2011, the maximum interchange fee that could be charged on a covered domestic debit transaction was set at 21 cents plus 5 basis points (bps) of the transaction’s value. This fee represented the ACS costs of the 80th percentile issuer in the market at the time. Since then, ACS costs have fallen more than 50%, from 8 cents per transaction in 2009 to less than 4 cents per transaction in 2021.²

The newly proposed rate combines a 14.4 cents base and a 4 basis point ad valorem component.³ The proposed base component aims to achieve at least cost recovery for 98.5% of covered issuers’ ACS costs, while the ad valorem component aims to cover median issuer fraud losses.⁴ There is also a fraud adjustment that issuers can charge if they meet certain compliance requirements. This is currently set at 1 cent and is proposed to be raised to 1.3 cents.⁵

During the public comment period, four core challenges to the proposal emerged. Here, we break down each in the context of public payments data.

Argument 1: Consumer Harm

According to CMSPI’s analysis of public comments, the most common argument against lowering the debit cap was that the corresponding loss in bank revenue would force banks to cut services provided to consumers. Moreover, the savings merchants would receive from lower fees would come at the expense of banking customers, especially those of lower income. Several comments suggested that operating a debit program at a loss would be a critical blow to wider banks’ stability and sustainability.

Other Perspectives

According to analysis of average profit margins by industry from NYU Stern, as of January 2024 banks had net margins of 30.89%, compared to regional banks at 29.67%, and financial services providers at 15.44% (Figure 1).⁶ In comparison, industries such as general retail and grocery were found to have average net margins of 3.09% and 1.18%, respectively.⁷ In economics, low margins are typically associated with higher levels of competitive tension and therefore consumer pass-through,⁸ discussed further in Argument 2.

Argument 2: Merchant Pass-through

How merchants pass savings to consumers was also brought to the forefront of the comment section and wider conversations. Many issuer comments pointed to “windfall” profits of retailers as a reason for maintaining the current rate cap.

Other Perspectives

In 2021, the European Commission produced a research report evaluating the impacts of EU-wide interchange caps set in 2015, which are nearly 60% lower than U.S. debit caps when evaluated at standard average transaction value of $50. They found that their intervention saved consumers hundreds of millions of euros annually, and that merchants passed on an estimated 66-72% of cost decreases to consumers.⁹ A U.S. study similarly found that merchants passed on interchange savings 69% of interchange savings resulting from the Durbin Amendment, amounting to billions of dollars in consumer benefit.¹⁰

Argument 3: Small Bank Impact

Another key debate topic centered around the trickle-down impact of regulation on small banks and credit unions. Regulation II currently exempts issuers with under $10 billion in assets from the debit interchange rate cap. Smaller institutions commented that, despite this, impacts of the rate cap on ‘covered’ issuers may affect the revenue exempt issuers can earn.

Other Perspectives

Federal Reserve data on the interchange revenue of exempt issuers shows that interchange fees on a cost per transaction basis have increased by nearly 20% since 2011, rising from $0.43 in 2012 to $0.52 in 2022.¹¹ In contrast, the regulated rate for larger issuers has remained at $0.21 plus $0.01 per transaction and 5 basis points of the transaction value since introduction in 2011. Furthermore, an analysis of smaller regulated banks shows that debit interchange typically represents less than 2% of their reported net income in 2023.¹²

Argument 4: Fraud Losses

Lost revenue due to a lowered interchange cap was also mentioned within the context of fraud risk and loss. Commentators cited the growing investment required to combat payments fraud and protect consumers as a potential reason for retaining the current debit cap.

Other Perspectives

According to data from the Federal Reserve, between 2011 and 2021 merchant fraud losses as a share of transaction value at covered issuers increased by 174%, while cardholders experienced a 2,286% increase, and issuers an increase of 25% (Figure 2). This breakdown indicates that in 2021 a more significant share of fraud losses is being borne by other (non-issuer) parties involved in a debit transaction than in 2011 when data was first collected.^13,14

Intervention in Payments

At the end of 2022, payments revenues were estimated to have reached $1.6 – 2.2 trillion.¹⁵¹⁶ As the industry innovates rapidly, policymakers are increasingly introducing, revising, and closing gaps in regulation to protect merchants and consumers. At the same time, merchants are leveraging granular data analysis to ensure that the updates that do come are passed through accurately. With the comment period on Regulation II now closed, the Federal Reserve will review the comments provided and determine the final structure of the revised debit rate, as well as ongoing revisions.