A Judge’s Debit Card Ruling May Shape Credit Card Issuer Strategies Moving Forward

A U.S. District Court ruling requiring debit card interchange fees to match each issuer’s actual cost per transaction rocked the payment industry last week. 

Although the ruling by U.S. District Court Judge Daniel M. Traynor for the District of North Dakota only applies to debit cards, credit card issuers should take notice because the decision stands to bring changes to their growth plans. Many financial institutions issue both credit and debit cards, so strategies for one often influence the other.

The Durbin Amendment instructs the Federal Reserve to oversee debit card interchange rates to ensure they are “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.”

In accordance with the amendment, the Federal Reserve has placed a cap on debit interchange since 2011 that limits it to 21 cents plus 0.05% of a transaction’s cost. 

But Traynor says the Fed surpassed its authority by permitting issuers to recoup costs, including those for fraud prevention, in interchange fees. 

His ruling stated in part that “Congress did not hide an ‘easter egg’ of a third cost category in the Durbin Amendment, particularly when those additional costs would benefit banks at the expense of merchants and consumers.”

Issuers could face substantial losses in interchange revenue if the ruling stands.

Traynor issued a hold on his ruling, which means that existing directives that regulate interchange on debit card transactions will remain in effect for the time being. But industry stakeholders may look back at this period as the calm before the storm.

“This ruling is going to have a seismic impact and radically reduce profits for large debit issuers, because their cost per transaction is pretty close to zero,” Eric Grover, Principal at Intrepid Ventures, told Digital Transactions. “If the ruling sticks, tens of billions of dollars in interchange revenue will evaporate.”

Grover said he is in favor of Traynor’s ruling because the Fed did not, in his opinion, implement the law accurately.

“Congress, not the Fed, is the policymaker,” he said. “The Fed’s job was to implement Congress’s intent as expressed in the text of the statute.”

Traynor’s ruling could may cause dominoes to fall in the payments arena. Today, banks can use the money they make from debit card interchange fees to help finance such offerings as free checking and savings accounts.

Banks can also use interchange revenue to fund card rewards programs. If debit revenue falls, financial institutions may choose to peel back rewards offerings and discontinue free checking and savings account products.

Ken Musante, President of Napa Payments and Consulting, told us a few scenarios may unfold because the ruling “doesn’t impact the card network fees or the interchange collected by banks under $10 billion.” 

“Large banks will institute monthly fees for the privilege of obtaining a debit card or require compensating balances,” Musante said.

Affected institutions should review their debit card portfolios and determine how many customers have account balances substantial enough that the bank would want to keep their business even without charging them monthly maintenance fees.

That practice will give them a starting point to better understand whether imposing monthly fees on debit accounts is a move the financial institution would be comfortable making.

After all, banks will need to perform a balancing act if the judge’s ruling sticks. They’ll want to protect revenues as fully as possible while avoiding rocking the boat for customers who maintain profitable accounts. 

Industry participants other than traditional financial institutions that issue cards may also feel the effects of this ruling. Musante added that it could also impact fintechs that “will specifically pursue banks under $10 billion for BaaS offerings.”

But don’t expect every change that results from the ruling to take place immediately. Musante told us they “will happen slowly at first.”

That means affected banks have time to get their refined strategies in order, but they would be wise to move quickly.

Court decisions don’t always produce clear-cut winners and losers, but this one appears to have done just that.

Large banks that offer debit cards may not have taken news of Traynor’s ruling well, but merchants celebrated.

The Merchant Payments Coalition represents businesses and other stakeholders that seek a card system that is more competitive and fair to both consumers and merchants. 

Doug Kantor, Executive Committee Member of the coalition and General Counsel for the National Association of Convenience Stores, called the ruling a “well-reasoned decision” in a press release from the Merchant Payments Coalition responding to Traynor’s action.

“This case shows that banks have swiped a windfall of billions of dollars per year in debit fees from Main Street that go far beyond normal, competitive profit margins,” Kantor said. “The Federal Reserve should quickly rewrite its rules to cure this problem and reduce the inflationary pressure these fees impose on the entire U.S. economy.”

Capital One gained access to one of the U.S.’s largest card networks with its recent acquisition of Discover.

Capital One may have greeted the ruling with enthusiasm, according to Julian Morris, a Senior Scholar at the International Center for Law & Economics. 

The bank holding company completed its acquisition of Discover in May and gained access to one of the largest card networks in the U.S. with the purchase. Merchants accept the Discover network at 70 million access points.

“This creates an even bigger opportunity for Capital One, which can shift its customers to Discover’s three-party debit network, thereby avoiding the Durbin Amendment altogether and enabling it to both offer premium debit products and enhance its offerings to lower income customers,” Morris told us.

While Capital One basks in the fortuitous timing of its acquisition of Discover, other large financial institutions may turn to a different payment vehicle to boost revenues in light of Traynor’s ruling.

Morris told us “banks will be further incentivized to encourage customers to use and switch to credit cards” if Traynor’s decision stands.