Federal Reserve Board Proposal to Implement the Durbin Amendment
On Dec. 16, 2010, the Board of Governors of the Federal Reserve (“Board”) approved proposed rules (“Proposal”) to implement §920 of the Electronic Fund Transfer Act (“EFTA”), as enacted by §1075 of the Dodd-Frank Wall Street Reform and Consumer Protection Act—generally referred to as the “Durbin Amendment.”
Analysts have indicated that the Proposal could reduce debit interchange fees by as much as ninety percent (90%) and that industry-wide debit card-related revenue could suffer an estimated $15 billion reduction. The Wall Street response to the Proposal was swift; the stock prices of VISA and MasterCard shares fell approximately 10% on the day the Proposal was announced, and American Express shares subsequently dipped more than 4% following the Board's announcement.
Comments on the Proposal will be due by Feb. 22, 2011. The Proposal provides for the Board to issue final rules by April 21, 2011. The provisions regarding interchange transaction fees would take effect July 21, 2011. The Board is soliciting comments on numerous issues, including the effective date for the provisions regarding restrictions on the number of networks over which a debit card transaction may be routed (“network exclusivity”). It is significant to note that Governor Tarullo, during the Board meeting in which the Proposal was approved, stated that the Board should be even more open than usual to comments it receives on the Proposal. This certainly reflects the Board’s knowledge as to the significant economic impact the Proposal will have if adopted in its present form.
This advisory briefly summarizes the Proposal including: key definitions; interchange fee standards; adjustments for fraud prevention activities; exemptions from the standards; remedies; standards regarding network exclusivity and routing; and other matters, including the TCF Bank litigation.
The full text of the Proposal may be accessed here, and the full text of the Dodd-Frank Act may be accessed here.
The Proposal sets forth a number of key definitions. In the attached Addendum we highlight those with particular significance, as well as those where definitions have been revised from those appearing in the EFTA or in other federal laws or regulations. We have taken significant parts of the Addendum directly from the Supplementary Information provided with the Proposal. The Board requests comment on all of the terms and definitions that have been provided. In particular, the Board requests comment on any terms used in the Proposal that a commenter believes are not sufficiently clear.
Interchange fee standards
EFTA §920(a)(3) requires the Board to determine standards for assessing what issuers may receive or charge with respect to a debit card transaction. The fees are required to be “reasonable and proportional to the cost incurred by the issuer with respect to a particular transaction” (emphasis added), and rules setting forth this standard are to be in place and effective on July 21, 2011. In making this determination, the statute directs the Board to distinguish between incremental costs incurred by issuers in the authorization, clearing, and settlement process of electronic debit card transactions and other costs which are not specific to the authorization, clearing, and settlement process for these transactions. Institutions of not more than $10 billion in assets, including assets of affiliates, are exempt, as are government-administered programs and certain reloadable prepaid card programs.
Prior to publishing its proposed rule, staff of the Federal Reserve conducted a survey of issuers, merchant acquirers, and payment card networks, asking numerous questions related to how pricing of interchange transaction fees are established. Questions sought to determine the basis on which interchange fees are established, issuers’ costs of processing transactions, current and historical interchange fees, fraud losses and fraud-prevention activities, network exclusivity arrangements, and transaction routing restrictions. In addition, staff interviewed issuers, merchants, acquirers, processors, and consumer representatives and reviewed written submissions presented by other interested parties. The surveys indicated that the median per-transaction total processing cost, which the Board characterized as costs related to authorization, clearance, and settlement of a transaction, was 11.9 cents for all types of debit and prepaid card transactions, while the median variable processing cost was 7.1 cents. The survey also indicated that median network processing fees were 4.0 cents. Survey respondents reported, however, that the average interchange fee charged was 44 cents, or 1.14 percent of the transaction amount.
As stated above, the Board has proposed that the only costs it should consider in determining which are allowable as “reasonable and proportional” are those that specifically relate to the authorization, clearing, and settlement process. Other costs, such as those incurred for credit card transactions, or common overhead charges not specific to debit card transaction authorization, clearing, and settlement, will not be allowable. This Board determination was one reached by a strict, literal reading of the statute. The Board, however, is requesting comment as to whether switch fees, paid by issuers to payment card networks, should be included in allowable costs.
In determining allowable costs, the Board proposes that the “average variable cost” should be used. This approach will exclude fixed costs (i.e., those costs that will not vary with changes in output) that cannot be identified with a particular transaction. Allowable costs will be those that are attributable to the issuer’s role in authorization, settlement, and clearance and that vary with the number of transactions sent to an issuer each calendar year. The issuer’s allowable costs for each transaction would be the sum of the allowable costs of all electronic debit transactions during the calendar year divided by the number of electronic debit transactions on which the issuer received or charged an interchange transaction fee in that year.
The Board has determined that it will assess the “reasonableness” of interchange fees by considering whether they are fair and proper in relation to an individual issuer’s costs as well as costs incurred by all issuers of covered debit cards (i.e., those not otherwise exempt from the Final Rule). In this regard, the Board proposes to not require identical cost-to-fee ratios for all issuers but, rather, recommends a safe harbor and cap be established so that any fee received by an issuer that is below the safe harbor or cap amount will be deemed proportional.
The Board is proposing two alternative standards for comment, only one of which it intends to finalize in the Final Rule. The first, Alternative 1, uses a combination of three approaches—(i) issuer-specific standards, (ii) a cap, and (iii) a safe harbor. The second approach, Alternative 2, only provides for a cap.
Alternative 1 (§235.3(a))
Alternative 1 permits each issuer to determine the maximum amount of interchange fee it may receive for a debit card transaction by calculating its variable costs for authorization, clearing, and settlement services for electronic debit transactions. This approach also provides a safe harbor of 7 cents per transaction for those issuers that do not want to go through the process of calculating their specific variable costs. Alternative 1 permits issuers with costs in excess of the safe harbor to recover their variable costs for authorization, clearance, and settlement up to a cap that the Board proposes at 12 cents per transaction. The Board indicates that setting a cap ensures that no issuer may charge an interchange fee at an unreasonably high level and that, without the cap, issuers would not have an incentive to keep costs low.
Specifically, the calculation would permit issuers to charge the greater of:
- Seven (7) cents per transaction; or
- Allowable costs (as described above) incurred by the issuer for electronic debit card transactions during the calendar year preceding the start of the implementation period, divided by the number of electronic debit transactions on which the issuer charged or received an interchange transaction fee during that calendar year, but not more than twelve (12) cents per transaction.
Except for the initial implementation period, the implementation period will be Oct. 1 of any calendar year through Sept. 30 of the following calendar year. As a transitional rule, for the period of July 21, 2011 through Sept. 30, 2012, an issuer will comply with the requirements of receiving or charging only reasonable and proportional interchange fees if it receives or charges no more than 7 cents per transaction, or allowable costs (as previously defined) incurred during the 2009 calendar year, divided by the number of electronic debit transactions on which the issuer received or charged an interchange transaction fee during 2009, but no higher than 12 cents per transaction.
Alternative 2 (§235.3(a))
Alternative 2 has the same 12 cent-per-transaction cap as Alternative 1, but eliminates any necessity for issuers to calculate their variable costs for authorization, clearing, and settlement. Simply stated, any interchange settlement fee of 12 cents or less will be deemed reasonable. Of course, any settlement fee in excess of the cap will not be deemed reasonable and, therefore, may not be charged.
Under each Alterative, the cap would be re-evaluated every two years. In addition, the safe harbor proposed in Alternative 1 would also be re-evaluated on the same two-year cycle.
§920 provides the Board with the authority to prohibit circumvention or evasion of the Final Rule. The Board has proposed to prohibit issuers from receiving net compensation from payment networks related to debit card transactions. The Board understands that networks often reward issuers for the transaction volumes that are processed on the networks. Such rewards, whether in the form of per-transaction rebates or incentive payments, will not be permitted, to the extent such payments exceed the total amount of fees paid by an issuer to a network.
The Board identified several ways in which the new standards could be implemented. The option chosen will have important implications for issuers’ ability to set higher fees for riskier transactions and offset them with lower fees for less risky transactions. First, the new standards could work as a strict cap on interchange fees charged for any transaction. Second, issuers could comply with the rule as long as the average of their interchange fees charged over a specified time period meet the standard. The third possible approach would focus on compliance at the network level instead of at the level of each issuer. Under that approach, issuers would be in compliance with the standard as long as, on average, over a specified timeframe, all covered issuers on a particular network meet the standard given that network’s mix of transactions. The first option would provide more certainty, while the second two options would allow for much greater flexibility for issuers. The first option, setting a hard price cap, is already embodied in the proposed rule. The Board requests comment, however, on whether the second or third option would be appropriate and about whether and how it should adopt standards under those approaches with respect to the allowable amount of variation from the benchmark.
Adjustments for fraud prevention activities
§920 authorizes the Board to allow for an adjustment to permitted interchange fees if the adjustment is reasonably necessary to allow for an issuer’s fraud prevention costs in relation to debit card transactions and the issuer complies with Board-established fraud prevention standards. (Under the Proposal, fraud losses may not be considered a fraud prevention cost.) The statute requires the Board to consider several factors when establishing standards for receiving fraud prevention-related cost adjustments and gives the Board flexibility in considering other factors as well. The specific factors the Board is to consider, with respect to electronic debit card transactions, are: (i) the nature, type, and occurrence of fraud, (ii) the extent to which the occurrence of fraud depends on whether the authorization is based on signature, PIN, or other means, (iii) available and economic means to reduce fraud, (iv) fraud prevention and data security costs expended by each party, (v) the cost of fraud incurred by each party, (vi) the extent to which interchange transaction fees have reduced or increased incentives for parties to reduce fraud, and (vii) such other factors the Board deems appropriate. Any such standards must require issuers to take effective steps to reduce the occurrence and cost of fraud, as well as taking into account amounts received from other network participants due to fraud. These costs would include those for implementing cost-effective fraud prevention technologies.
The Board has determined that it does not have sufficient information at this time to propose how adjustments to debit card interchange transaction fees for fraud prevention costs should be made. Instead, the Board is seeking comment on two general approaches, including setting forth a series of related questions.
First approach—catalyst for spurring major innovation
The first approach would use adjustments to the interchange rate to spur major innovations in reducing industry-wide fraud losses. The Board would need to identify material technology innovation(s) that would reduce debit card fraud in a cost-effective manner and determine the cost of issuers’ implementation of the new technology. In a memo to the Board dated Dec. 13, 2010, the staff indicated that this approach could result in issuers being locked into specific technologies “that are not as effective in reducing fraud, or not as cost effective, as other technologies that are not identified in the standards.” Additionally, the staff indicated that significant challenges would remain in measuring effectiveness and understanding the cost of implementing new technologies in order to properly set the cost adjustment.
Second approach—encouraging issuers to engage in existing or new fraud prevention activities
The second approach would use the adjustment of interchange rates to encourage issuers to continue with existing fraud prevention activities and/or to participate in new fraud prevention activities. The standards would be more general than in the other approach where the Board would specify technologies to be used in order to obtain the adjustment. In this approach, standards might require issuers to maintain cost-effective fraud prevention programs but not describe specific measures. The adjustment would reimburse issuers for some/all of the costs associated with current fraud prevention activities, including research and development costs. The Board could recommend a cap under this approach. Also, the staff indicated that this approach could lead to the potential unintended consequence of issuers not having an incentive to control costs or to shift to more effective activities. The Board, in §235.4 of the Proposal, is seeking responses to the following questions:
- “Should the Board adopt technology-specific standards or non-prescriptive standards that an issuer must meet in order to be eligible to receive an adjustment to its interchange fee? What are the benefits and drawbacks of each approach? Are there other approaches to establishing the adjustment standards that the Board should consider?
- If the Board adopts technology-specific standards, what technology or technologies should be required? What types of debit-card fraud would each technology be effective at substantially reducing? How should the Board assess the likely effectiveness of each fraud-prevention technology and its cost effectiveness? How could the standards be developed to encourage innovation in future technologies that are not specifically mentioned?
- If the Board adopts non-prescriptive standards, how should they be set? What type of framework should be used to determine whether a fraud-prevention activity of an issuer is effective at reducing fraud and is cost-effective? Should the fraud-prevention activities that would be subject to reimbursement in the adjustment include activities that are not specific to debit-card transactions (or to card transactions more broadly)? For example, should know-your-customer due diligence performed at account opening be subject to reimbursement under the adjustment? If so, why? Are there industry-standard definitions for the types of fraud-prevention and data-security activities that could be reimbursed through the adjustment? How should the standard differ for signature- and PIN-based debit card programs?
- Should the Board consider adopting an adjustment for fraud-prevention costs for only PIN-based debit card transactions, but not signature-based debit card transactions, at least for an initial adjustment, particularly given the lower incidence of fraud and lower chargeback rate for PIN-debit transactions? To what extent would an adjustment applied to only PIN-based debit card transactions (1) satisfy the criteria set forth in the statute for establishing issuer fraud-prevention standards, and (2) give appropriate weight to the factors for consideration set forth in the statute?
- Should the adjustment include only the costs of fraud-prevention activities that benefit merchants by, for example, reducing fraud losses that would be eligible for chargeback to the merchants? If not, why should merchants bear the cost of activities that do not directly benefit them? If the adjustment were limited in this manner, is there a risk that networks would change their rules to make more types of fraudulent transactions subject to chargeback?
- To what extent, if at all, would issuers scale back their fraud-prevention and data-security activities if the cost of those activities were not reimbursed through an adjustment to the interchange fee?
- How should allowable costs that would be recovered through an adjustment be measured? Do covered issuers’ cost accounting systems track costs at a sufficiently detailed level to determine the costs associated with individual fraud-prevention or data-security activities? How would the Board determine the allowable costs for prospective investments in major new technologies?
- Should the Board adopt the same implementation approach for the adjustment that it adopts for the interchange fee standard, that is, either (1) an issuer-specific adjustment, with a safe harbor and cap, or (2) a cap?
- How frequently should the Board review and update, if necessary, the adjustment standards?
- EFTA §920 requires that, in setting the adjustment for fraud-prevention costs and the standards that an issuer must meet to be eligible to receive the adjustment, the Board should consider the fraud-prevention and data-security costs of each party to the transaction and the cost of fraudulent transactions absorbed by each party to the transaction. How should the Board factor these considerations into its rule? How can the Board effectively measure fraud-prevention and data-security costs of the 8 million merchants that accept debit cards in the United States?”
Exemptions from the standards
The Proposal, consistent with the EFTA, generally exempts interchange transaction fees charged by small issuers or charged in connection with government-administered programs and certain reloadable prepaid cards from §§235.3, 235.4 and 235.6 (i.e., the proposed fee restrictions and the related provisions on fraud adjustment and circumvention), but not from §§235.7 and 235.8 (i.e., the network exclusivity and routing restrictions and reporting requirements (see “Standards regarding network exclusivity and routing” below)). A debit transaction is exempt from the fee restrictions so long as it qualifies for at least one exemption, though it may qualify for more than one. To judge whether an issuer’s transactions are exempt, a payment card network only needs to satisfy itself that the issuer's transactions qualify for at least one of the exemptions.
An interchange transaction fee is exempt if (i) the issuer holds the account that is debited and (ii) the issuer, together with its affiliates, has assets of less than $10 billion as of the end of the previous calendar year. An issuer would qualify for this exemption if its total worldwide banking and nonbanking assets, including assets of affiliates, are less than $10 billion. The Board requests comment on whether the rule should establish a consistent certification process and reporting period for an issuer to notify a payment card network and other parties that the issuer qualifies for the small issuer exemption. The Board suggests, as an example, that an issuer would be required to notify the payment card network within 90 days of the end of the preceding calendar year in order to be eligible for an exemption for the next rate period. The Board also requests comment on whether payment card networks should be permitted to develop their own processes for making this determination.
An interchange transaction fee is exempt if charged or received for using a debit or general-use prepaid card that has been provided pursuant to a federal, state, or local government-administered payment program. The exemption applies only if the debit or general-use prepaid card may be used solely to transfer or debit funds, monetary value, or other assets that have been provided pursuant to the government program. A program is “government-administered” whether operated by a government agency directly or by a third-party service provider acting on behalf of the agency. Additionally, a program may be “government-administered” even if a government agency is not the source of funds for the program it administers (e.g., child support programs administered by state governments). (In addition to this exemption in the Proposal, §1075(b) of the Dodd-Frank Act exempts electronic benefit transfer or reimbursement systems established under the Food and Nutrition Act of 2008, the Farm Security and Rural Investment Act of 2002, and the Child Nutrition Act of 1966 from any of the restrictions in the Proposal.) As with the exemption for small issuers, the Board requests comment on whether the rule should establish a certification process for an issuer to notify a payment card network and other parties that the issuer qualifies for this exemption, or whether it should permit payment card networks to develop their own processes. Additionally, if the Board chooses to establish a certification process, it requests comment on how to structure the process, including the time periods for reporting and what information may be needed to identify accounts to which the exemption applies (e.g., certain cards issued under a government-administered payment program may be distinguished by the BIN or BIN range).
Certain reloadable prepaid cards
Interchange fees are also exempt if charged in connection with certain reloadable “general-use prepaid cards.” In order to qualify for the exemption, the card must satisfy the following criteria:
- A qualifying prepaid card may not be issued or approved for use to access or debit any account held for the benefit of the cardholder. In a proposed comment, the Board clarifies that prepaid card programs structured such that funds underlying each card are held in separate accounts for each cardholder’s benefit do not qualify for the exemption because such accounts are too similar to ordinary debit cards. To the extent the account is structured as an omnibus account to hold the funds, with a series of “subaccounts” or other recordkeeping means to track amounts attributable to each cardholder, the card will qualify for the exemption.
- A qualifying card must also be “reloadable and not marketed or labeled as a gift card or gift certificate.” A proposed comment would specify that a card is “reloadable” if its terms and conditions allow the cardholder to add value to the card after the initial issuance. The exemptions would also apply, however, to fees charged or received for transactions involving non-reloadable temporary cards issued solely in connection with qualifying reloadable general-user prepaid cards. The Board reasons that such temporary cards should benefit from the exemption because otherwise issuers would be deprived of a useful means of limiting fraud and facilitating compliance with customer identification program requirements under the Bank Secrecy Act. The Board borrows from its previous gift card rule to clarify the meaning of “marketed or labeled as a gift card or gift certificate,” deeming cards gift cards if they were promoted as such, a standard that would include cards that were primarily marketed for another purpose. The Board noted that cards marketed as cheaper alternatives to bank accounts, for example, could be considered gift cards if advertising also promoted them using words such as “gift” or “present.” Displaying a holiday or congratulatory message on packaging or promotional materials could also be enough to make the card a gift card under the new rule. Proposed comments would allow covered entities to prevent their products from being considered gift cards by maintaining policies and procedures reasonably designed to avoid such marketing.
The Board notes that payment card networks and others will need a process for identifying accounts accessed in connection with government-administered programs or reloadable general-use prepaid cards. The Board therefore seeks comment on whether it should establish a certification process or if the industry should develop its own process.
Sunset for certain government-administered and reloadable general-use prepaid card exemptions
After July 21, 2012, the above exemptions relating to government-administered programs and reloadable general-use prepaid cards will not apply if either of the following is charged for use of the card: (i) an overdraft fee or (ii) a fee charged by the issuer for the first withdrawal each month from an ATM that is part of the issuer’s network. The overdraft fee includes any fee charged for a shortage of funds or a transaction processed for an amount exceeding the account balance but does not include a fee or charge for transferring funds from another asset account to cover a shortfall in the account accessed by the card.
Standards regarding network exclusivity and routing
One of the significant requirements of new §920 is the requirement that the Board prevent issuers and networks from restricting to one network (and its affiliates) the routing of debit card transactions. As with the methods for calculating allowable costs, the Board has proposed two alternatives for comment. Under Alternative A, the non-exclusivity requirement would be satisfied if the debit card transaction can be routed on at least two unaffiliated networks. Consideration need not be given to the authorization method utilized (i.e., PIN or signature). A debit card that could be used on one network for signature-based transactions and another (unaffiliated network) for PIN-based transactions would satisfy the requirements of this Alternative. It is apparent that this option would avoid significant incremental compliance costs and would not require material changes to current network infrastructure.
Under Alternative B, the non-exclusivity requirement would be satisfied if the debit card is enabled with at least two unaffiliated networks for each type of authorization method (i.e., currently signature- and PIN-based). The Board recognizes that this option would facilitate merchant choice in routing transactions but would entail a substantial increase in costs. Existing network infrastructure does not accommodate such choice with signature-based transactions.
Additionally, while merchants would be able to direct the routing of debit card transactions, the choice of network would be limited to those that are enabled on the applicable debit card.
The Board notes that its proposed rules apply most readily to point of sale transactions and transactions carried over four-party networks, although by the Board’s terms the rules will apply to any transactions that debit an account. Given the challenges of implementing the rules with respect to ATM transactions and networks and three-party systems, the Board solicits comments on the application of the rules to such transactions.
The EFTA provides for only administrative enforcement of the provisions in the Proposal. The provisions of the Proposal are to be enforced under EFTA §918 (15 U.S.C. 1693o), which enumerates the administrative agencies that are permitted to enforce its requirements. However, unlike other provisions in EFTA, the requirements of §920, and, accordingly, of §§235.2, 3, 4, 6, 7 and 8, are not subject to civil or criminal liability.
For national banks, federal savings associations, federal branches, and federal agencies of foreign banks, and member banks of the Federal Reserve System, enforcement is effected through §8 of the Federal Deposit Insurance Act (“FDIA”). The appropriate federal banking agency, as defined in §3(q) of the FDIA (12 USC 1813(q)), will control enforcement actions.
If a banking entity in the list above violates a provision in the Proposal, such violation would be deemed to be a violation of a requirement imposed under the FDIA. Additionally, the applicable agency may exercise, for the purpose of enforcing compliance with the provisions of the Proposal, any other authority conferred on it by law.
If enforcement authority is not specifically granted to another government agency, the Federal Trade Commission (“FTC”) and the Bureau of Consumer Financial Protection will share authority to enforce the provisions of the Proposal. If the FTC enforces the proposal, a violation of the provisions in the Proposal is deemed a violation of a requirement imposed under the FTC Act. All of the functions and powers of the FTC under the FTC Act are available to enforce compliance by any person subject to its jurisdiction, regardless of whether that person otherwise meets the jurisdictional tests under the FTC Act.
TCF bank litigation
There is pending litigation in the U.S. District Court for South Dakota which is attempting to overturn the Durbin Amendment (“Amendment”) provisions as being unconstitutional. TCF National Bank, a national bank with more than $18 billion in total assets, is seeking an injunction preventing the Board from enforcing provisions of the Amendment.
In broad introductory statements in its complaint, TCF claims the Amendment “irrationally, prejudicially, and illegally interferes with TCF’s activities.” Further, TCF claims the Amendment places “unconstitutional limitations on the ability of TCF and similarly situated banks to recover their costs for providing a service crucial to bank depository customers today.” TCF specifies that there is no legislative history to the Amendment other than Senator Durbin's comments that the Amendment was “aimed at reducing fees charged by credit card issuers and debit network operators” and that the Amendment "is entirely disconnected from that goal.” And, perhaps, the most fundamental statement made is “there is no obligation under the Amendment to pass cost savings on to consumers.”
The legal claims made by TCF include the following:
- A substantive due process violation in that the Amendment prohibits the opportunity to charge debit interchange fees that allow TCF to recover all of its costs plus a reasonable return;
- An unlawful regulatory taking in that the Amendment “frustrates TCF's ability to compete on even ground with the exempt banks, savings and loans, and credit unions and ... singles out a small number of banks, including TCF, to bear a substantial competitive and financial burden,” and
- A denial of equal protection in that the Amendment exempts debit card issuers which, together with their affiliates, have assets of less than $10 billion.
As of this date, no decisions have been reached by the Court and TCF’s motion for a preliminary injunction is scheduled for a hearing on April 4, 2011.
Winning any case that alleges a federal statute is unconstitutional is always difficult. That said, the claims by TCF in the complaint are not overstated and it should have a fair chance of success. It will be interesting to see which, if any, banks or trade associations are prepared to assist or provide amicus briefs.
The Proposal is an unusual Board issuance, combining aggressive price controls with tentative treatment of fraud prevention and network exclusivity. Admittedly, the Durbin Amendment confronts the Board with considerable analytical and political problems—not only the requirement to set prices, which goes against the general consumer protection philosophy of ensuring full disclosure, but also the fact that the Durbin Amendment was enacted in a political environment that has changed substantially over the past seven months, with renewed quantitative easing, the election of a Republican House majority and other developments.
The Proposal was controversial even before the Board issued it—13 Senators and, separately, Chairman Frank wrote to Chairman Bernanke cautioning him about it—and has been no less controversial since it was issued. As a result, the Proposal may undergo material changes before the Board adopts it in final form.
If the interchange transaction fee limits are adopted as proposed, they could have a substantial impact on the debit card industry. For example, issuers may institute new cardholder-facing rules, such as higher fees, especially for cardholders with low balances or who use their cards infrequently. Issuers may also institute new merchant-facing rules, such as eliminating the guarantee of debit funds or charging for services such as same-day settlement on an unbundled basis. Analysts have warned of many other unintended consequences of the Proposal.
Future advisories will summarize the final rules, as well as these and other resulting changes to the debit card industry.
Addendum: Relevant Definitions
A. Account. §235.2(a). EFTA §920(c) defines the term debit card in reference to a card, or other payment code or device, that is used to debit an asset account (regardless of the purpose for which the account is established) . . . .but it does not define the terms ”asset account” or “account.” EFTA §903(2) defines the term “account” to mean “a demand deposit, savings deposit, or other asset account” (other than an occasional or incidental credit balance in an open end credit plan), as described in regulations of the Board established primarily for personal, family, or household purposes, but such term does not include an account held by a financial institution pursuant to a bona fide trust agreement.
Similar to EFTA §903(2), proposed §235.2(a) defines “account” to include a transaction account (which includes a demand deposit account), savings, or other asset account. The proposed definition differs from EFTA §903(2) because EFTA §920(c) does not restrict the term debit card to those cards, or other payment codes or devices, that debit accounts established for a particular purpose. Accordingly, the proposed definition includes both an account established primarily for personal, family, or household purposes and an account established for business purposes. Additionally, the proposed definition includes an account held by a financial institution under a bona fide trust arrangement. These distinctions are clarified in proposed comment 2(a)-1.
The proposed definition is limited to accounts that are located in the United States. Debit card transactions that debit an account not located within the U.S. will be excluded from the limitations found within the proposal.
B. Acquirer. (§235.2(b). The Board is proposing to define “acquirer” to mean only those entities that acquire (or buy) the electronic debit transactions from the merchant. Proposed §235.2(b) defines “acquirer” as a person that contracts directly or indirectly with a merchant to receive and provide settlement for the merchant’s electronic debit transactions over a payment card network. The proposed definition limits the term to entities serving a financial institution function with respect to the merchant, as distinguished from a processor function, by stipulating that the entity receive and provide settlement for the merchant’s transactions.
C. Cardholder. (§235.2(d). Proposed §235.2(d) defines the term “cardholder” as the person to whom a debit card is issued. Proposed comment 2(d) clarifies that if an issuer issues a debit card for use to debit a transaction, savings, or other similar asset account, the cardholder usually will be the account holder. In some business accounts, especially, there may be multiple persons who have been issued debit cards and are authorized to use those debit cards to debit the same account. Each employee issued a card would be considered a cardholder. In the case of a prepaid card, the cardholder is the person that purchased the card or a person who received the card from the purchaser. See proposed comment 2(d)-1.
D. Debit card and general-use prepaid card. §§235.2(f) and 235.2(i). EFTA §920(c)(2) defines “debit card” as any card, or other payment code or device issued or approved for use through a payment card network to debit an asset account (regardless of the purpose for which the account is established), whether authorization is based on signature, PIN, or other means. The term includes a general-use prepaid card, as previously defined by the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (“Credit CARD Act”). The statute excludes paper checks from the definition.
Proposed §235.2(f) defines “debit card” and generally tracks the definition in the EFTA. Thus, proposed §235.2(f)(1) generally defines the term as any card, or other payment code or device, issued or approved for use through a payment card network to debit an account, regardless of whether authorization is signature-based, PIN-based, or other means. The term applies regardless of whether the issuer holds the underlying account. This part generally applies to any card, payment code, or device, even if it is not issued as a physical card form. Similarly, the term “debit card” would include a device with a chip that links the device to funds held in an account, such as a mobile phone or sticker containing a contactless chip, that enables the cardholder to debit an account.
E. Deferred and decoupled debit cards. These types of cards are addressed in proposed comments 2(f)-2 and -3. The Board believes these card products fall within the statutory definition of “debit card.” Deferred debit transactions do not immediately post to a cardholder’s account when the transaction is received by the account-holding institution for settlement. The funds in the account are held and made unavailable for other transactions for a specified period of time, perhaps until the end of the day or month. Upon expiration of the time period, the cardholder’s account is debited for the amount of all transactions made using the card which were submitted for settlement during that period. Deferred debit cards would be considered debit cards for purposes of the requirements of this part. See proposed comment 2(f)-2.
Decoupled debit cards are addressed in proposed comment 2(f)-3. In decoupled debit card transactions, the issuer is not the institution that holds the underlying account that will be debited. Transactions are not posted directly to the cardholder’s account when presented for settlement with the card issuer. The issuer sends an ACH debit instruction to the account-holding institution in the amount of the transaction in order to obtain the funds. The Board has determined that decoupled debit cards should be treated as subject to the requirements of this part. The Board solicits comment on whether additional guidance is necessary to clarify that deferred and decoupled debit, or any similar products, qualify as debit cards for purposes of this rule.
F. General-use prepaid cards. (§235.2(i). The statutory definition of “debit card” includes a general-use prepaid card as that term is defined under EFTA §915(a)(2)(A). Proposed §235.2(i) defines “general-use prepaid card” as a card or other payment code or device that is (1) issued on a prepaid basis in a specified amount, whether or not that amount may be increased or reloaded, in exchange for payment; and (2) redeemable upon presentation at multiple, unaffiliated merchants or service providers for goods or services, or usable at ATMs. The proposed definition of “general-use prepaid card” generally tracks the definition as it appears under EFTA §915(a)(2)(A), with modifications to simplify and clarify the definition.
The inclusion of general-use prepaid cards in the definition of “debit card” under EFTA §920(c)(2)(B) refers only to the term “general-use prepaid card” as it is defined in EFTA §915(a)(d)(A). It does not incorporate separate exclusions to that term that are set forth in the gift card provisions of the Credit CARD Act. Proposed comment 2(i)-2 provides that a mall gift card, which is generally intended to be used or redeemed at participating retailers located within the same shopping mall or in the same shopping district, would be considered a general-use prepaid card if it is also network-branded. Network branding would permit the card to be used at any retailer that accepts that card brand, including retailers located outside the mall.
G. Electronic debit transactions. §235.2(h). EFTA §920(c)(5) defines the term “electronic debit transaction” as a transaction in which a person uses a debit card. The Board’s proposed definition in §235.2(h) adds two clarifying provisions. First, proposed §235.2(h) clarifies that the term reflects a transaction in which a person uses a debit card as a form of payment. The statute defines “payment card network,” in part, as a network a person uses to accept a debit card as a form of payment. For clarity, the Board incorporates that requirement into the definition of “electronic debit transaction.” Second, the statutory definition is silent as to whether use of the debit card must occur within the United States. Proposed § 235.2(h) limits electronic debit transactions to those transactions where a person uses a debit card for payment in the United States.
H. Interchange transaction fee. §235.2(j). Proposed §235.2(j) generally incorporates the EFTA §920(c)(8) definition that defines the term as any fee established, charged, or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction. The proposed definition clarifies that interchange transaction fees are paid by merchants or acquirers. See proposed comment 2(j)-1. Proposed comment 2(j)-2 restates the rule that interchange fees are limited to those fees established, charged, or received by a payment card network for the purpose of compensating the issuer, and not for other purposes, such as to compensate the network for its services to acquirers or issuers.
I. Issuer. §235.2(k). Proposed §235.2(k) incorporates the statute’s definition of “issuer” that defines the term as any person who issues a debit card or the agent of such person with respect to the card. Proposed §235.2(k) follows the statutory definition, but removes the phrase “or the agent of such person with respect to the card” as being unnecessary. As agents are held to the same restrictions as their principals, the Board does not believe that removing this clause will have a substantive effect.
J. Three-Party Systems. (§235.2(k)(3). In three-party systems, the network typically provides the debit card or prepaid card directly to the cardholder or through an agent. Generally, the network also has a direct contractual relationship with the cardholder. In such systems, the network is considered an issuer under proposed § 235.2(k) because it provides the card to the cardholder, and may also be the account-holding institution. See proposed comment 2(k)-3. The Board requests comment on all aspects of the issuer definition. The Board specifically requests comment on whether the appropriate entity is deemed to be the issuer in relation to the proposed examples.
K. Merchant. (§235.2(l). The Board is proposing to define a merchant as a person that accepts a debit card as payment for goods or services.
L. Payment card network (§235.2(m). EFTA §920(c)(11) defines the term “payment card network” as (1) an entity that directly, or through licensed members, processors, or agents, provides the proprietary services, infrastructure, and software that route information and data to conduct debit card or credit card transaction authorization, clearance, and settlement, and (2) that a person uses in order to accept as a form of payment a brand of debit card, credit card, or other device that may be used to carry out debit or credit transactions. Proposed §235.2(m) follows this definition, with revisions for clarity. Because the interchange fee restrictions and network exclusivity and merchant routing provisions of the Dodd-Frank Act do not apply to credit card transactions, the Board believes it is appropriate to exclude from the proposed definition the reference to credit cards in the statutory definition to avoid unnecessary confusion. No substantive change is intended. The Board solicits comment as to whether certain non-traditional or emerging payment systems, such as those using mobile phones or PayPal, are covered by the definition of “payment card network.” The Board appears inclined to include them in the definition unless there is a means to distinguish them appropriately from the traditional debit card payment systems.
M. Person. The term “person” is not defined in the EFTA. The proposed definition incorporates the definition of the term in existing Board regulations.