What Changes to the Regulated Interchange Cap Could Mean

In the 1989 film “Honey, I Shrunk the Kids,” a scientist creates a ray gun machine that can shrink and enlarge objects, but he is unable to get it to work — at least to the best of his knowledge. A baseball through the window of his home lab leads to the accidental shrinking of his son and daughter and the two boys who live next door. After discovering the mess in his lab, the scientist unknowingly sweeps up the kids and puts them out with the trash, forcing them to fight for their lives as they try to make it across the backyard to get home, where even ants are larger than them.The banking industry is grappling with its own fears about the unintended consequences of shrinking something. Following a proposal by the Federal Reserve to shrink the regulated interchange cap under its Regulation II, financial institutions are worrying that such a change could ultimately lead to further consolidation within the banking industry. Potential Change The Federal Reserve issued a proposal that would reduce the maximum interchange fee that debit card issuers can charge merchants for transactions made using debit cards. Under the proposal, the base component fee would drop to 14.4 cents, from 21 cents; the ad valorem component would fall to 4bp (multiplied by the value of the transaction), from 5bp; the fraud-prevention adjustment would rise to 1.3 cents per debit card transaction, up from 1 cent. While such reductions would, no doubt, be good for merchants and retailers, the change could have significant ramifications. According to research commissioned by the Consumer Bankers Association, lower fees would ultimately prove harmful for consumers because many financial institutions would be forced to eliminate free bank accounts, and monthly maintenance fees would rise by 42% to counteract the reduction in interchange revenue. That would translate to consumers paying an additional $1.3B to $2B in bank fees. Meanwhile, the 30% reduction of interchange fees that smaller financial institutions currently receive could be enough to force further consolidation within the banking industry, as industry experts predict that roughly one-third of debit card issuers would be unable to cover their costs. Merchants vs. Card IssuersMerchants, who stand to gain the most from the proposed changes, are not fully satisfied with the Fed’s proposal. They remain insistent that the fees would still be too high, based on the methodology the Fed is advocating. The National Retail Federation penned a press release in May that stated that while a change is long overdue in how the cap is calculated, the new method would be to the disadvantage of merchants and consumers and won’t accommodate the upcoming changes in the payments industry.Unsurprisingly, the Fed’s proposal has not been well received by the banking industry, and multiple organizations have pushed back against it. More than 50 state bankers’ associations, along with the American Bankers Association, the DC Bankers Association, and the Puerto Rico Bankers Association, sent a joint letter expressing their opposition to the proposal, calling it misguided. “We remain gravely concerned that the Federal Reserve is moving forward — in response to intense pressure from the very largest retailers and an expansive misinterpretation of the statute — with an unnecessary and poorly considered rule that will have far reaching impacts,” said the associations. Their letter also notes that the Fed’s proposal is based on incomplete and flawed data from 2021 that was skewed by payment behavior related to the COVID-19 pandemic and that it failed to factor in debit routing changes made in July 2023. In light of the heavy commentary on the topic, the Fed even extended the deadline for commentary, receiving 2.5K responses from October 2023 to May 2024. There is also political resistance to the proposal. On June 18, 2024, Sen. Ted Budd introduced the “Secure Payments Act,” which would force the Fed to pause its interchange fee proposal until it completes an extensive study on the impact that reducing the fee would have on costs to consumers and the broader economy. “Indiscriminately imposing government price caps on debit card services makes it harder for people to open bank accounts and forces banks to end popular perks like free checking,” said Sen. Budd. The bill was also introduced in the House of Representatives by Rep. Blaine Luetkemeyer. The same day the legislation was introduced, the American Bankers Association and four other industry associations cosigned a letter in support of the Secure Payments Act. If the Fed’s proposal to lower the regulated interchange cap goes through as planned, in June 2025, the impact on financial institutions could be wide-reaching. As of right now, there is no documented response from the Fed to the Secure Payments Act introduced in June. We will keep a close watch on this issue and let you know of any significant developments.