Five years after the introduction of the Durbin Amendment, which put a cap on the debit fees financial institutions could charge merchants, the Federal Reserve is now explaining part of how it came up with its controversial $0.21-plus-0.05%-per-swipe limit.
The explanation comes at the behest of a U.S. District Court as part of a ruling on a suit in which the National Association of Convenience Stores claimed that, among other things, the Fed used flawed methodology to calculate the fee limit.
According to its eight-page explanation issued yesterday, the Fed is standing by its math.
At the heart of the controversy is the Durbin Amendment's cost-recovery approach to setting the debit interchange cap. It allows the Fed to set interchange fees that are "reasonable and proportional to the cost incurred by the issuer with respect to the transaction." Financial institutions with less than $10 billion in assets are exempt.
Former Fed Chairman Ben Bernanke originally proposed a $0.12 cap in 2010. Today, the fee structure has two components: The standard interchange fee of $0.21 plus $0.05%, and a fraud-prevention adjustment of $0.01 that issuers may receive if they adopt certain activities such as research and development of new fraud-deterrence technologies, card reissuance due to fraudulent activity, data security and card activation.
That two-part structure created a big issue in the NACS case regarding how to classify transaction-monitoring fees. The NACS argued those costs, which issuers incur during authorization to detect fraud or other irregularities, shouldn't be part of the math used to determine the standard interchange fee, because they're actually fraud-prevention tools and aren't specific to particular debit transactions. Though the NACS ultimately lost the case, the court asked the Federal Reserve Board to explain its thought process.
On Monday, the Secretary of the Board Robert DeV. Frierson defended the Fed's position.
"Transactions-monitoring systems, such as neural networks and fraud-risk scoring systems, assist in the authorization process by providing information needed by the issuer in deciding whether the issuer should authorize the transaction before the issuer decides to approve or decline the transaction," Frierson wrote. "In fact, most costs of the authorization process (which are costs Congress required to be considered in determining the interchange fee) assist in preventing some type of fraud."
"Because the statute requires the board to consider incremental authorization costs in setting the interchange fee standard," Frierson added, "the board concluded that that it should consider the costs of all activities that are integral to authorization, even if those costs are also incurred for the dual purpose of helping to prevent fraud."
"The Fed likens the treatment of transaction-monitoring costs to its treatment of costs of equipment, software or labor when calculating the interchange fee standard: the board argues that, because costs of equipment, etc., are necessary to every transaction, they should be included in calculating the interchange fee standard," NAFCU said in a statement.
Ultimately, the Fed's explanation "alters nothing in the way the Fed calculates interchange costs," it added.
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