Fed Proposes Dramatic Cuts to Debit Card Interchange Fees

a hand holding a debit card - debit card feesThe Federal Reserve Board proposed rules Thursday that may dramatically cut the interchange fees that banks charge merchants for debit card transactions.

The Fed suggested capping the fees at 12 cents a transaction. Currently, banks charge merchants 1% to 2% of the dollar value of the transaction.

Small banks would be exempt, as would issuers of government benefit debit cards and prepaid cards.The proposed changes are likely to be welcomed by merchants and railed against by banks. (The American Bankers Association has already fired off an angry retort.) Stores say they're more or less forced to pay whatever fees the banks set, and it's a lucrative source of income: Fed vice chairman Janet Yellen observed in the meeting that banks earned a whopping $16 billion in interchange fees in 2009.

What does this mean for consumers? Fed rulemakers acknowledged that it's impossible to predict exactly how this will impact cardholders, but there are a couple of likely possibilities: Banks are likely to cut back or eliminate their debit rewards programs, and they may add fees or create less favorable terms for accountholders who have and use debit cards.

While this may sound onerous, itmay not actually be so bad. Right now, all of us -- whether we pay by card, check or good old cash -- bear the brunt of high interchange fees because merchants pass them along to all of us in the form of higher prices. With the new fee rules in place, only the people who want the convenience of using a debit card will pay for it.

It's also worth noting that banks predicted they'd raise fees and cut cardholder benefits when the CARD Act was passed, but in reality, this didn't actually happen. Banks want to keep their customers, so they're going to be forced to be competitive with their rates, terms and reward programs.

The Fed voted to open the proposal up to public comment and set a target date of April 21 by which new rules must be set; banks will then have another three months before it goes into effect on July 21 of next year. The meeting also addressed debit transaction routing, a thornier issue the Fed aims to have a new set of regulations for by July 21, 2011.

The Fed acknowledged that its proposals still let banks profit from interchange fees, since the financial reform legislation that led to this round of rulemaking only specifies that fees have to be "reasonable and proportionate," not that banks can't still earn money from them. However, the structures of both of their suggested options have built-in incentives for banks to conduct their debit transactions more cost-effectively.

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