Banks that issue debit cards should brace for challenges if the Federal Reserve moves ahead with a plan to amend certain regulations for card-not-present transactions.
The Fed has proposed clarifications to the Durbin Amendment’s Regulation II, including a requirement that card-not-present transactions must be capable of being processed across at least two competing networks.
While the agency has suggested that the change would be “non-substantive” in terms of new obligations and compliance, there are concerns that, with no further clarifications, the implications for issuers could be very substantive from contractual, financial and compliance perspectives.
When Reg II was created, the Fed believed the market for card-not-present transactions was not mature enough to have solutions to back two unaffiliated networks for online transactions. While some domestic debit networks now support card-not-present transactions, the business case for enablement is murky, and certain issuers have elected not to opt-in. The Fed has said it feels such practices are inconsistent with Reg II and must be addressed with this clarification.
What are the concerns for issuers?
Practicality is a big consideration. Depending on how the Fed interprets the two-network requirement, the proposal has raised questions around the compliance obligations that issuers will need to monitor. How can issuers ensure that every merchant accepts both of their card payment networks? Does an issuer need to support all merchants even if one is considered high risk? How will innovation be handled if only one network supports an emerging capability?
The proposal could prove to bedevil community banks. If card-not-present volume shifts from national card networks to regional networks, smaller issuers could run the risk of failing to meet certain contractual obligations and commitments with their networks. That could eventually contribute to more consolidation among smaller banks.
While the current conversation is limited to Durbin’s requirement that issuers make at least two network options available for all debit transactions, industry advocates used the comment window to revisit broader interchange grievances.
Retail associations and merchants want the Fed to step in and mandate that two networks be enabled as early as the holiday season. They also want the Fed to reexamine the regulated interchange rate, arguing that issuer costs have declined by almost 50% since the ceiling was set in 2011, with no adjustments having been made.
Issuers and associations like the American Bankers Association and the National Association of Federally-Insured Credit Unions caution that the proposal could have unintended consequences for safety and security and a financial impact like the original Reg II rollout. They have strongly suggested that the Fed take more time to analyze the potential implications for issuers and consumers.
When Reg II was created, the Fed believed the market for card-not-present transactions was not mature enough to have solutions to back two unaffiliated networks for online transactions. While some domestic debit networks now support card-not-present transactions, the business case for enablement is murky, and certain issuers have elected not to opt-in.
Though debit interchange rates are not part of the proposal, the Fed left the door open, stating it will continue to review the regulation and may propose more revisions. And Sen. Durbin brought up the topic of credit interchange in the Judiciary Committee earlier this year as he seeks bipartisan support for further refinements to Reg II, including a potential expansion to credit transactions.
How should bankers respond?
The comment period ended August 11, so the most proactive thing bankers can do now is prepare for any worst-case scenarios.
Issuers should watch and plan for the proposed changes by taking inventory of their existing relationships and evaluating the implications of change occurring as early as next year.
New contractual relationships should be carefully considered, including commercial terms, given the uncertainty. Issuers should actively engage their government relations areas and make this issue a priority at the local and national levels while working with their associations.
About the Authors
Co-author Keith Ash, Senior Vice President at SRM, has 25 years of payments expertise across issuer, network, and process roles. Before joining SRM, Keith spent 14 years at MasterCard leading new business and account management initiatives. Keith can be reached via email at kash@srmcorp.com.
Co-author Myron Schwarcz, EVP at SRM, has two decades of experience in the banking industry, advising leading financial institutions on their strategic initiatives. Further inquiries of Myron may be made via email at
mschwarcz@srmcorp.com.
