Prepaid Industry Gets Some Relief but General Purpose Reloadable Cards Face Unanticipated Restrictions
At a publicly held board meeting on June 29, 2011, the Federal Reserve Board approved its final interchange rule, entitled Regulation II, “Debit Card Interchange Fees and Routing,” setting the maximum permissible swipe fee an issuer may receive for an electronic debit transactions, adopting routing requirements and applying unanticipated new restrictions to General Purpose Reloadable (GPR) cards to take advantage of the interchange cap exemption. In addition—to the relief of the banking industry—the Fed announced that the rules on pricing requirements will go into effect on Oct. 1, 2011, as opposed to July 21 as dictated by the Durbin Amendment.
Under the final rule, issuers are permitted to charge a base fee of 21 cents (representing 80 percent of an issuer’s average transaction cost), plus five basis points on the full value of the transaction to cover fraud losses (representing the average per-transaction fraud loss of the median issuer). The fraud loss recoupment (referred to by the Fed as an “ad valorem” or “according to value” charge) came as a surprise to most and is viewed as a big win for the banking industry. The Fed also issued an interim final rule that would allow issuers to charge an additional fraud prevention adjustment of one cent if the bank meets, and certifies compliance of, certain security standards. The Fed requested comments on whether the one-cent cap should be adjusted.
In addition, the Fed approved rules governing routing and exclusivity, requiring issuers to offer two unaffiliated networks for routing debit transactions.
Perhaps the biggest surprise in the final rule is that GPR cards will not benefit from the interchange cap exclusion if they allow funds to be accessed through means other than the card.
Open Board Meeting
At the board meeting, Chairman Ben Bernanke stated that the interchange rule has been one of its most challenging rulemakings under the Dodd-Frank Act to date. The Fed had to consider myriad players impacted by debit interchange, as demonstrated by the more than 11,000 comment letters the Fed received.
After Bernanke’s introductory remarks, Mark Manuszak, Federal Reserve Board staff member and economist, discussed the standards established for assessing whether the amount of an interchange transaction fee is “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” After mentioning the comments received by merchants versus issuers and networks, he stated that the staff concluded that a broader range of costs should be included as the basis for the interchange fee standard. Thus, the “allowable costs” should include not only the incremental cost of authorizing, clearing and settling the transaction but also certain other costs that affect an electronic debit transaction, such as network processing fees and costs associated with connectivity, equipment, software and transaction monitoring. Most significantly, Manuszak said that a portion of fraud losses should be incorporated in this assessment through the ad valorem component.
Manuszak also discussed network exclusivity and the routing of debit card transactions, stating that the final rule adopts the first alternative in the proposed rules, requiring two unaffiliated network options per card (versus per authentication method). He explained that under the final rule issuers and networks remain prohibited from inhibiting a merchant’s ability to direct the routing of debit card transactions over any network. Manuszak added that the network exclusivity rules become effective on Oct. 1, 2011, for networks and April 1, 2012, for issuers—except with respect to nonreloadable and reloadable general-use prepaid cards, which will have a postponed effective date of April 1, 2013 to allow time for technological developments. As a result, nonreloadable general-use prepaid cards sold prior to the effective date are not subject to the prohibition on network exclusivity. Furthermore, GPR cards sold prior to the effective date are not subject to the prohibition on network exclusivity unless and until they are reloaded—if the card is reloaded prior to April 1, 2013, the card must be in compliance by May 1, 2013; if the card is reloaded after April 1, 2013, then it must be compliant 30 days after the date of reloading.
Following Manuszak’s summary, Fed members posed various questions to the staff, including how the rule is expected to affect consumers to influence innovation, and how the staff assessed the impact of interchange regulation in other countries. Of particular note, the staff addressed how issuers with under $10 billion in assets would be impacted by the final rule. At one point, Daniel Tarullo recommended the Fed take steps to enforce the statutory exemption for small issuers. Bernanke followed by announcing plans to monitor the developments in the debit card market, including collecting and publishing data related to interchange rates charged by each network both covered and exempt issuers.
Finally, the members of the Board (consisting of Bernanke, Vice Chair Janet Yellen, Elizabeth Duke, Tarullo and Sarah Bloom Raskin) cast their votes, with all except Duke approving the final rule. In a brief comment in opposition to the final rule, Duke targeted prepaid cards, and called upon the Consumer Financial Protection Agency to ensure that more consumer protections be established over such cards.
Treatment of Prepaid Cards
The final rule still exempts reloadable prepaid cards not marketed/labeled as a gift card. These cards, however, are eligible for the exemption only if they are the only means of accessing the underlying funds or unless all remaining funds are provided to the cardholder in a single transaction. Thus, as stated in the Official Board Commentary, “reloadable cards that provide access to the funds underlying the card through check, ACH, wire transfer or other method (unless these other means of access were used solely for a one-time cash-out of the remaining balance on the card) would not meet the [exemption].” It appears that the restriction on ACH access relates solely to the cardholder’s ability to access the funds and will not impact on cards that have funds automatically loaded via ACH by an employer, governmental entity, etc.
The rule provides that general-use prepaid cards with underlying funds held in an omnibus account (and not separate accounts held by or for the benefit of individual cardholders) are still eligible for the exemption. In addition, the rule still prohibits reloadable prepaid cards from imposing overdraft fees or a fee for the first in-network ATM withdrawal per calendar month.
Furthermore, the Official Board Commentary adds a new comment on “hybrid cards,” i.e., cards that offer both combined credit and debit features. By way of example, the commentary states that if a card permits a cardholder to initiate a transaction that debits an account or funds underlying a prepaid card, then the card may be considered a debit card.
Representatives from merchant groups, such as the National Retail Federation and the Retail Industry Leaders Association, have already criticized the final rule, stating that the elevated caps are not “reasonable and proportional” and accusing the Fed of caving in to pressure from big banks and credit card companies.
The banking industry, on the other hand, expressed appreciation for the Fed’s willingness to mitigate the proposed rules’ detrimental impacts, while still voicing concern over government price controls. While the final rule permits a maximum interchange fee of 24 cents for the average $40 debit card transaction (doubling the initially proposed cap of 12 cents per transaction), American Bankers Association President Frank Keating acknowledged that the rule still represents a 45 percent loss in revenue for banks.
Among the prepaid industry, greatest concern has been raised about the impact of the new restriction on GPR cards that are exempt from the lower interchange rate. The final rule does not permit GPR cards to benefit from the exclusion if they allow funds to be accessed through means other than the card. The practical impact will be to eliminate convenience checks, remittance and bill payment services from many GPR products that are relied upon by the underbanked and underserved, making it more difficult and expensive for such cardholders to access basic financial services.