Visa, MasterCard Model Threatened by Debit Proposal

Fed Issues Rules to Cut Debit-Card Fees
The Federal Reserve Board proposed new rules to curb debit-card fees, offering alternative plans that are likely to aid retailers and cut profit for U.S. lenders who reaped about $15 billion from such charges last year. Photographer: Norm Betts/Bloomberg

Visa Inc. and MasterCard Inc. may face permanent damage to the fastest-growing part of their business after the Federal Reserve proposed rules that could cut debit-card transaction fees by 84 percent.

“It is negative all around,” wrote Scott Valentin, an analyst at FBR Capital Markets, in a note to clients. “This significantly impacts the business model for the networks.”

Visa and MasterCard, the world’s biggest payment networks, plunged more than 10 percent in New York trading yesterday after the Fed proposed capping so-called interchange fees at 12 cents each. Currently, the networks charge merchants an average of 1 percent of the purchase price, regardless of cost, and pass that money to banks that issue cards.

The change, if approved by the Fed after a public comment period, would wipe out most of the $16.2 billion in revenue that debit cards generated last year for U.S. lenders, including Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co.

“These credit-card giants and banks are imposing fees that are in no relation to the actual cost of processing, and the retailers and merchants have no way to bargain or even resist these increases,” U.S. Senator Richard Durbin, the Illinois Democrat who pushed for the caps, said in an interview. “This new law brings the Federal Reserve into the picture and changes that dynamic.”

Visa fell 29 cents to $66.90 at 4:15 p.m. in New York Stock Exchange composite trading, after yesterday’s 13 percent decline, the most in two years. MasterCard dropped $2.23, or 1 percent, to $221.26, after plunging 10 percent yesterday.

More Competition

The average debit interchange fee last year was 44 cents per transaction, or 1.14 percent of the purchase price, according to a draft of the proposed rules. The Fed staff outlined plans that recommend setting interchange at 7 cents or 12 cents, a reduction of 73 percent to 84 percent. Initial Wall Street estimates yesterday pegged the cut as high as 90 percent.

The proposed reductions would align U.S. interchange rates more closely with other countries, including Australia and the 27 nations of the European Union. Visa Europe Ltd., operator of the Continent’s biggest payments network, agreed to cut the fees to 0.2 percent as part of a deal to end EU antitrust action, the European Commission said last week. MasterCard agreed to the same rate last year.

Network Choices

The Fed hasn’t yet decided how to implement a rule that would require banks to let merchants choose from at least two independent debit networks for routing transactions, a change that could create more competition for MasterCard and San Francisco-based Visa.

MasterCard said the Fed didn’t consider “the full range of costs” tied to debit programs and that the rules would shift costs from merchants to their customers.

“Consumers, not banks or payments networks, are the biggest losers as a result of this regulation,” said Noah Hanft, general counsel for Purchase, New York-based MasterCard, in a statement. “This type of price control is misguided and anticompetitive.”

Visa, which derives about 20 percent of its revenue from U.S. debit, said the rules would create “unintended consequences” for the industry and consumers.

Actual Costs

“The Federal Reserve’s proposal includes artificial caps on debit interchange that do not realistically reflect the value of card acceptance and do not reflect the actual costs of running a secure, reliable and efficient debit network,” Will Valentine, a spokesman for Visa, said in a statement.

While Visa and MasterCard don’t keep interchange fees, the caps may prompt banks that do to renegotiate their service contracts, the payments networks’ biggest revenue source.

The caps are based on information collected from debit-card issuers, networks and merchants about costs, the Fed staff wrote in a memo that Vice Chairman Janet Yellen prepared for the board. This approach means the Fed is unlikely to shift much when it writes the final rule, Jaret Seiberg, a financial-services policy analyst with MF Global in Washington, said in a research note.

“Substantive changes will require new evidence, which is unlikely given the amount of work the Fed has spent on this project,” Seiberg said.


The Retail Industry Leaders Association, which represents companies including Wal-Mart Stores Inc., Home Depot Inc. and Target Corp., said the Fed’s proposal validates the claims of merchants that the payments market is broken.

The Fed’s proposal “is a step forward for the effort to bring relief to merchants and consumers,” said Brian Dodge, a RILA spokesman.

Bankers will push lawmakers to change or eliminate the Durbin provisions they passed in July as part of the Dodd-Frank financial overhaul legislation, according to Kenneth Clayton, senior vice president and general counsel for card policy at the American Bankers Association.

“Congress needs to revisit the issue,” Clayton said. “An implementation delay would be welcome.”

To compensate for the lost profit, banks may eliminate rewards on debit cards and charge some customers for using them, said John McDonald, an analyst with Sanford C. Bernstein & Co., in a Dec. 15 note to clients. Fees on deposit accounts may rise and banks could promote other products that aren’t covered by the regulations, such as charge cards that require consumers to pay their bills in full each month, he wrote.

Cards or Cash

Debit cards have become an increasingly popular substitute for cash as credit-card issuers cut off accounts and curbed lending amid the financial crisis and recession.

U.S. consumer spending with debit cards climbed 8 percent last year to $1.45 trillion, while credit purchases plunged 10 percent, according to the Nilson Report, an industry newsletter. Total debit transactions climbed 13 percent to 38.6 billion, while those for credit dropped 4 percent to 22.36 billion.

The law allows the central bank to consider fraud costs incurred by lenders in determining appropriate interchange rates. The Fed staff said in its memo that it lacked enough information to make a recommendation to the board on that issue and would seek input during the public comment period, which ends Feb. 22.

Fraud Prevention

“The largest cost for most of our institutions in providing these services are fraud costs and fraud prevention costs,” said Bill Cheney, chief executive officer of the Credit Union National Association.

While the law exempts banks with assets of less than $10 billion, including most community banks and credit unions, those institutions remain concerned that Visa and MasterCard may ultimately lower interchange rates for everyone, Cheney said.

“Setting a cap ensures that no issuer is able to receive an interchange fee at an unreasonably high level,” Yellen said in the memo outlining the proposals.


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