Joint Trades Comment on Reg II Prohibition on Circumvention, Evasion and Net Compensation

Dear Ms. Misback:

The Clearing House Association L.L.C.,[1] the Bank Policy Institute,[2] and the Consumer Bankers
Association[3] (collectively, the “Associations”) respectfully submit this comment letter to the Board of Governors of the Federal Reserve System in response to the notice of proposed rulemaking regarding modifications to Regulation II[4] and the Official Board Commentary on Regulation II related to debit card interchange fees.[5]

Introduction

The Board proposes to amend Regulation II and the Commentary to reduce the interchange fee
cap, to adopt a new methodology for determining the base component of the interchange fee cap, to provide for automatic adjustments to the interchange fee cap on a biennial basis in the future, and to make certain other conforming and clarifying changes to Regulation II. The Board does not, however, propose to meaningfully amend Regulation II’s prohibitions on circumvention, evasion, and net compensation.

Much has changed since the Board first issued Regulation II in 2011.[6] Debit card transactions
have continued to grow at a rapid pace,[7] and large participants in the financial technology (“fintech”) industry have continued to grow and partner with small exempt financial institutions, frequently leveraging those small financial institutions to issue debit and prepaid cards in connection with the fintech companies’ financial services programs.[8] The legal agreements may be complex between the fintech and the exempt partner bank and nominally provide the bank with certain authorities or responsibilities related to the card program, but ultimately, in practice, the fintech has effective control over all material aspects of the debit or prepaid card program.[9] As the U.S. Department of the Treasury has noted in detail,[10] certain fintech companies are engaging in regulatory arbitrage by selecting small, exempt financial institutions as card issuers and structuring their card issuing programs to take advantage of the small issuer exemption to avoid the interchange fee limitations under EFTA and Regulation II.[11] Indeed, the Treasury concluded that “[s]uch use of the Durbin Amendment exemption warrants further examination.”[12]

To read the full comment letter, please click here, or click on the download button below.


[1] The Clearing House Association L.L.C., the country’s oldest banking trade association, is a nonpartisan organization that provides informed advocacy and thought leadership on critical payments-related issues. Its sister company, The Clearing House Payments Company L.L.C., owns and operates core payments system infrastructure in the U.S., clearing and settling more than $2 trillion each day. See, The Clearing House’s web page at www.theclearinghouse.org.

[2] The Bank Policy Institute is a nonpartisan public policy, research and advocacy group that represents universal banks, regional banks, and the major foreign banks doing business in the United States. The Institute produces academic research and analysis on regulatory and monetary policy topics, analyzes and comments on proposed regulations, and represents the financial services industry with respect to cybersecurity, fraud, and other information security issues.

[3] The Consumer Bankers Association is the only national trade association focused exclusively on retail banking. Established in 1919, the association is a leading voice in the banking industry and Washington, representing members who employ nearly two million Americans, extend roughly $3 trillion in consumer loans, and provide $270 billion in small business loans. See the Consumer Bankers Association’s web page at consumerbankers.com.

[4] Section 1075 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111-203, 124 Stat. 1376 (2010)) amends the Electronic Fund Transfer Act (15 U.S.C. 1693 et seq.) (the “EFTA”) to add Section 920 to the EFTA. Section 920(a)(2) of EFTA, codified at 15 U.S.C. 1693o-2 (the “Durbin Amendment”) requires debit interchange transaction fees to be an amount that is “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” The Durbin Amendment is implemented through Regulation II (12 C.F.R. Part 235).

[5] See Debit Card Interchange Fees and Routing, 88 Fed. Reg. 78100 (Nov. 14, 2023).

[6] See Debit Cards Interchange Fees and Routing, 76 Fed. Reg. 43478 (July 20, 2011).

[7] The value of core noncash payments in the United States (including debit card payments) grew faster between 2018 and 2021 than in any previous Federal Reserve Payment Study measurement period since 2000, with the number of non-prepaid debit card payments increasing the most of all card types. (The Federal Reserve Payments Study: 2022 Triennial Initial Data Release, p. 1, https://www.federalreserve.gov/paymentsystems/fr-payments-study.htm.)

[8] See “Banking as a service: The role of banks in powering the fintech industry,” https://www.spglobal.com/marketintelligence/en/news-insights/research/banking-as-a-service-the-role-of-banks-in-powering-the-fintech-industry (accessed Feb. 1, 2024)) (noting that “there are more than 50 financial institutions that support fintechs on an as-a-service basis . . . [which banks] often have less than $10 billion in assets.”)

[9] For example, these arrangements often give a significant share of all interchange to the fintech, require the fintech to incur losses for customer fraud, transaction errors, and chargebacks, and assign control of the customer relationship to the fintech, from customer acquisition to customer service. (See, for example, Marqeta, Inc. Form 10-K (2023), https://investors.marqeta.com/static-files/4068a8e7-2689-4462-b802-9f6acb512e74. “Under this agreement we are entitled to receive 100% of the Interchange Fees for processing our customers’ card transactions.”)

[10] U.S Department of the Treasury Report to the White House Competition Council, Assessing the Impact of New Entrant Non-bank Firms on Competition in Consumer Finance Markets, November 2022, page 82, https://home.treasury.gov/system/files/136/Assessing-the-Impact-of-New-Entrant-Nonbank-Firms.pdf (noting that non-banks are able to commit regulatory arbitrage by taking advantage of Regulation II’s small issuer exemption to “scale up their operations to be larger than the $10 billion threshold.”)

[11] Section 920(a)(2) of EFTA requires the amount of any interchange fee that an issuer of debit cards receives or charges to be reasonable and proportional to the cost incurred by the issuer with respect to the transaction. As proposed by the Board in the proposed rule, Sections 235.3 and 235.4 of Regulation II would give effect to section 920(a)(2) of EFTA. See Debit Card Interchange Fees and Routing, supra note 5.

[12] Supra note 10.