The Council adopted a three-stage process for making its determination. The first stage is designed to narrow the universe of non-bank financial companies by establishing certain size or other quantitative thresholds. The second stage applies the analytic framework (i) size, (ii) interconnectedness, (iii) substitutability, (iv) leverage, (v) liquidity risk and maturity mismatch, and (vi) existing regulatory scrutiny to determine whether company could pose a risk to U.S. financial stability. The third stage will utilize qualitative and quantitative information obtained directly from the companies through the Office of Financial Research.

The quantitative thresholds a company would need to get past the stage 1 review are as follows:

Total Consolidated Assets. $50 billion.

Credit Default Swaps Outstanding. $30 billion in gross notional credit default swaps (‘‘CDS’’) outstanding for which a nonbank financial company is the reference entity. Gross notional value equals the sum of CDS contracts bought (or equivalently sold). If the amount of CDS sold on a particular nonbank financial company is greater than $30 billion, this indicates that a large number of institutions may be exposed to that nonbank financial company and that if the nonbank financial company fails, a significant number of financial market participants may be affected. This threshold was selected based on an analysis of the distribution of outstanding CDS data for nonbank financial companies included in a list of the top 1,000 CDS reference entities.

Derivative Liabilities. The Council intends to apply a threshold of $3.5 billion of derivative liabilities. Derivative liabilities equal the fair value of derivative contracts in a negative position. For nonbank financial companies that disclose the effects of master netting agreements and cash collateral held with the same counterparty on a net basis, the Council intends to calculate derivative liabilities after taking into account the effects of these arrangements. This threshold serves as a proxy for interconnectedness, as a nonbank financial company that has a greater level of derivative liabilities would have
higher counterparty exposure throughout the financial system.

Total Debt Outstanding. The Council intends to apply a threshold of $20 billion in total debt outstanding. The Council will define total debt outstanding broadly and  regardless of maturity to include loans (whether secured or unsecured), bonds, repurchase agreements, commercial paper, securities lending arrangements, surplus notes (for insurance companies), and other forms of indebtedness. This threshold serves as a proxy for interconnectedness, as nonbank financial companies with a large amount of outstanding debt are generally more interconnected with the broader financial system, in part because financial institutions hold a large proportion of outstanding debt. An analysis of the distribution of debt outstanding for a sample of nonbank financial companies was performed to determine the $20 billion threshold. Historical testing of this threshold demonstrated that it would have captured many of the nonbank financial companies that encountered material financial distress during the financial crisis in 2007–2008, including Bear Stearns, Countrywide, and Lehman Brothers.

Leverage Ratio. The Council intends to apply a threshold leverage ratio of total consolidated assets (excluding separate accounts) to total equity of 15 to 1. The Council intends to exclude separate accounts from this calculation because separate accounts are not available to claims by general creditors of a nonbank financial company. Measuring leverage in this manner benefits from simplicity, availability and comparability across industries. An analysis of the distribution of the historical leverage ratios of large financial institutions was used to identify the 15 to 1 threshold. Historical testing of this threshold demonstrated that it would have captured the major nonbank financial companies that encountered material financial distress and posed a threat to U.S. financial stability during the financial crisis, including Bear Stearns, Countrywide, IndyMac Bancorp, and Lehman Brothers.

Short-Term Debt Ratio. The Council intends to apply a threshold ratio of total debt outstanding (as defined above) with a maturity of less than 12 months to total consolidated assets (excluding separate accounts) of 10 percent. An analysis of the historical distribution of the short-term debt ratios of large financial institutions was used to determine the 10 percent threshold. Historical testing of this threshold demonstrated that it would have captured a number of the nonbank financial companies that faced short-term funding issues during the financial crisis, including Bear Stearns and Lehman Brothers.

The Council is required to notify the non-bank financial companies in writing of their designation as systemically important and the companies may request an opportunity for a written or oral hearing before the Council to contest the designation. If the Council makes a final determination with respect to a nonbank financial company, the company may, not later than 30 days after the date of receipt of the notice of final determination bring an action in the United States district court for the judicial district in which the home office of such nonbank financial company is located, or in the United States District Court for the District of Columbia, for an order requiring that the final determination be rescinded. Judicial review is quite limited, however, in that the review of such an action shall be limited to whether the final determination was arbitrary and capricious.

The final rule still leaves a great deal of ambiguity for companies seeking to determine whether they will be covered or not. For example, will large insurance companies be covered or will the fact that they are subject to an existing regulatory supervision by state insurance commissioners be sufficient to knock them out in the second stage? The Council noted that it was not adopting any sort of industry-wide exclusion and indicated that the evaluation of any non-bank company would be company-specific.  Likewise, the Council is analyzing the extent to which there are potential threats to U.S. financial stability arising from asset management companies. This analysis is considering what threats exist, if any, and whether such threats can be mitigated by subjecting such companies to Board of Governors supervision and prudential standards, or whether they are better addressed through other regulatory measures.

Related posts:

1. SEC Adopts Rules Allowing Shareholder Access to Company Proxy Materials
2. Senate Adopts Corporate Finance and Executive Compensation Reforms
3. High Rate Area Determination Relief?

The industry is beginning to draw attention to the statutory expiration of this unlimited coverage.  As originally initiated by the FDIC in 2008, the program was intended to stabilize large deposits in a time of crisis within the financial system.  The Dodd-Frank extension of TAG was completely paid for by financial institutions under the general deposit insurance assessment framework.  Community banks have arguably benefitted the most from the unlimited coverage provisions because the corporate, non-profit, and government depositors holding most of the affected accounts may have more concerns (real or imagined) about the continued solvency of small banks than of big banks.  Without the guarantee, smaller banks may have to rely more on pricing in order to retain these depositors, potentially exposing the insurance fund to greater risk. 

By one industry estimate, more than half of all TAG account balances (over $500 billion) are already held by just 19 banks over $100 billion in assets.  According to the FDIC, more than three-quarters ($191.2 billion) of Q4 2011 growth in domestic deposits was attributable to account balances subject to the guarantee.  The 10 largest insured banks accounted for 73.6 percent ($140.7 billion) of the growth in these balances during this period.  As of December 31, 2011, the average institution with less than $1 billion in assets had 15 covered accounts worth an average of $713,000.  Although liquidity is generally less of a concern than it was in 2008, these large depositors are more likely to seek loans and otherwise bank with institutions holding their TAG-size accounts.

The questions, then, are whether the industry and its regulators are unified around this issue and whether legislators will have the stomach to extend the program in an environment where initiatives seens to benefit banks are politically sensitive.  The original FDIC manifestation was optional, with participating banks paying for the coverage.  Although the Dodd-Frank version is universal, again, banks have picked up the tab through the assessment process.  Nonetheless, it is always possible that an extension of the program will be marred as a boon to banks and a burden to taxpayers.  

Notwithstanding the position of former Chairman Sheila Bair and some currently within the agency that the program should only be further extended by Congress, the FDIC stands at the center of the issue and could always extend the program administratively.  FDIC’s 2008 program was authorized under the FDI Act by a determination by the Secretary of the Treasury in consultation with the FDIC and the Federal Reserve that conditions of ”systemic risk” justified an exception to the least-cost-resolution requirements of the Act.  It was extended by the FDIC in 2009 as a continued response to this finding, although at that time the agency also cited as “additional authority” more general statutory language relating to its mission.  We believe there is footing for a similar, transitional extension of the program under this broader authority.  In fact, when the FDIC extended the program in 2010 through the end of that year, it reserved the right to extend the program through 2011 without additional rulemaking.  This was ultimately not necessary in light of Dodd-Frank, and we think an additional regulatory extension is unlikely to occur here without significant advocacy for it.  The Independent Community Bankers of America and the American Bankers Association, for their part, have recently outlined their views on the issue.  

Meanwhile, examiners are beginning to ask how banks are planning for the expiration of the program.  Many institutions are balancing this expiration with Dodd-Frank’s repeal of the prohibition on the payment of interest on business checking accounts (and by extension Regulation Q).  Challenging as this may be in a time of regulatory uncertainty, these considerations should also be evaluated along with Regulation D’s reserve requirements (where restructured accounts may become demand deposits).

Related posts:

1. Unlimited FDIC Insurance for Non-Interest Bearing Transaction Accounts
2. Unlimited Insurance for IOLTA Accounts
3. Enhanced Deposit Insurance Extended Through 2013

The CFPB will use the Manual initially to supervise the more than 100 large banks, thrifts, and credit unions that are subject to the CFPB’s examination authority pursuant to the Dodd-Frank Act (those with total assets over $10 billion, as well as their affiliates). The Bureau’s examiners will also ultimately use the Manual to supervise non-depository consumer financial service companies (e.g., mortgage lenders), with the stated goal of promoting “fair, transparent, and competitive consumer financial markets where consumers can have access to credit and other products and services, and where providers can compete for their business on a level playing field where everyone has to play by the rules.”

The CFPB Examination Framework and Philosophy

While only certain entities will be subject to CFPB examination, the Manual outlines an examination approach that is illustrative of the Bureau’s bend on matters over which it has rulemaking authority. This is particular true of its view of its authority over matters it considers unfair, deceptive or abusive acts or practices (UDAAP).

Like other bank regulators, the CFPB will prepare for examinations by gathering and reviewing a wide array of regulatory and public data about an institution:  state and/or prudential regulator reports of examination and correspondence, enforcement actions, state licensing and registration information, complaint data, call reports, HMDA LARs, HAMP data, fair lending analyses, SEC or other securities-related filings, the institution’s website and advertising, and, among other things, “newspaper articles, web postings, or blogs that raise examination related issues.” The CFPB will then contact the institution about the examination and prepare its customized Information Request.

The CPFB’s “Risk Assessment” is a living document—a profile of a particular institution that will be maintained and used to guide its examination and supervision generally. As stated in the Manual (emphasis added):

CFPB’s Risk Assessment is designed to evaluate on a consistent basis the extent of risk to consumers arising from the activities of a supervised entity or particular lines of business within it and to identify the sources of that risk. “Risk to consumers” for the purpose of the CFPB Risk Assessment is the potential for consumers to suffer economic loss or other legally-cognizable injury (e.g., invasion of privacy) from a violation of Federal consumer financial law. The risk assessment includes factors related particularly to the potential for unfair, deceptive or abusive practices, or discrimination. Two sets of factors interact to result in a finding that the overall risk in a business or entity is low, moderate, or high. The first set of factors relate to the inherent risk in the particular line of business or the entity overall. The second set of factors is the quality of controls that manage and mitigate that risk. The Risk Assessment also includes a judgment, based on current or recent information, about the expected change in the overall risk: decreasing, increasing, or unchanged.

The Risk Assessment provides the basis for an institution’s “Supervision Plan”—the Bureau’s custom approach to supervising a particular depository institution and its affiliates and for allocating supervision resources. A sample Risk Assessment is provided beginning on page four of the Manual’s Part III.

As with any other bank regulatory examination, the examination process would conclude with an exit meeting with management, the assignment of a rating, and the production of a Report of Examination (“ROE”). Prior to delivery of the ROE, the CFPB will submit its draft report to the entity’s prudential bank regulator, if any. If the report concerns other types of regulated entities, opportunities for comment by state regulators will depend on whether CFPB is conducting joint or coordinated examinations with the relevant state regulators.

The CFPB will also require a meeting with a supervised entity’s board of directors or principals when or more of the following circumstances are present:

• The proposed compliance rating is “3,” “4,” or “5”;
• An informal supervisory agreement or formal enforcement action is recommended; or
• The supervised entity’s management, board, or principals requests such a meeting.

Unfair, Deceptive or Abusive Acts or Practices

One section of the Manual provides new insight into the CFPB’s intended use of its authority under Dodd-Frank to prohibit what it considers to be an “unfair, deceptive or abusive act or practice.” Under the Dodd-Frank Act, it is unlawful for any provider of consumer financial products or services to engage in any unfair, deceptive or abusive act or practice. The Act also provides CFPB with rulemaking authority and, with respect to entities within its jurisdiction, enforcement authority to prevent unfair, deceptive, or abusive acts or practices in connection with the provision of consumer financial product or services or offers to do so.

While standards for what is “unfair” or “deceptive” are somewhat established, the CFPB’s ability under Dodd-Frank to regulate practices it considers “abusive” is new territory. Under the Act, an act or practice is not “abusive” unless it:

1. Materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or
2. Takes unreasonable advantage of –
   a. A lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;
   b. The inability of the consumer to protect its interests in selecting or using a consumer financial product or service; or
   c. The reasonable reliance by the consumer on a covered person to act in the interests of the consumer.

Unlike its overview of the “unfair” and “deceptive” legal standards, the Manual does not—and arguably could not yet—provide examples of enforcement activity based on practices that are “abusive.” The Manual does, however suggest an approach to the new standard:

Based on the results of the risk assessment of the entity, examiners should review for potential unfair, deceptive, or abusive acts or practices, taking into account an entity’s marketing programs, product and service mix, customer base, and other factors, as appropriate. Even if the risk assessment has not identified potential unfair, deceptive, or abusive acts or practices, examiners should be alert throughout an examination for situations that warrant review.

Needless to say, the list of materials subject to CFPB review and transaction testing in a UDAAP analysis is comprehensive. More significantly, the template Risk Assessment provided in the Manual illustrates the CFPB’s potential reach. Many items on the Assessment’s “risk checklist” are qualitative and/or highly subjective:

“Products are bundled in a way that may obscure relative costs.”

“The terms of the product are subject to change at the discretion of the entity, and the entity has frequently made changes in the terms.”

“Complex products are marketed to consumers not likely to benefit from them or who may be likely to be harmed by them.”

CFPB architect Elizabeth Warren has said that the Bureau’s focus will be on improving disclosures, not prohibiting products. In the first iteration of the Bureau’s Examination Manual, there is room for both approaches. Describing an element of the test for “unfairness,” that the injury caused by an allegedly harmful product was “not reasonably avoidable,” the Manual states (emphasis added):

A key question is not whether a consumer could have made a better choice. Rather, the question is whether an act or practice hinders a consumer’s decision-making. For example, not having access to important information could prevent consumers from comparing available alternatives, choosing those that are most desirable to them, and avoiding those that are inadequate or unsatisfactory. In addition, if almost all market participants engage in a practice, a consumer’s incentive to search elsewhere for better terms is reduced, and the practice may not be reasonably avoidable.

Related posts:

1. The CFPB Busily Restating Regulations
2. Senate Publishes Text of Regulation Reform Bill
3. Treasury Publishes Second Report to Congress

The specific focus of this fourth round of testing is comparison shopping.  Consumers and the lending industry have been asked to compare two different types of loan products using the same version of the form.  The CFPB states that it wants to be sure that the disclosure actually helps consumers to understand the features of competing loan products, from the overall loan amount to estimates of tax and insurance costs.

The CFPB’s efforts in this area have generally met with approval from all interested parties.  The proposed form is more clear, concise and informative than either the existing TILA or RESPA disclosures.  For example, all of the useless “seller’s column” and “buyer’s column” information on the RESPA good faith estimate has been eliminated in favor of total dollar amounts for the services the consumer can shop for and for the services the consumer cannot shop for.  Implementing the new requirements will require systems changes, but we might finally arrive at a disclosure that eliminates useless information, reconciles the differences between TILA and RESPA, and that is easier to explain to borrowers.

Past efforts to reconcile TILA and RESPA disclosures were hampered by the fact that the Federal Reserve had primary regulatory authority for TILA and the Department of Housing and Urban Development had primary authority for RESPA.  The Dodd-Frank Act removed this roadblock by transferring these powers to the Bureau.

Regulatory changes will be needed in order for the model form to satisfy both TILA and RESPA requirements.  The Dodd-Frank Act directs the Bureau to propose rules and a model form for public comment by July 12, 2012 (one year after the designated transfer date).  The Bureau is well on its way toward producing the disclosure form for formal comment.

Related posts:

1. Mortgage Reforms under the Dodd-Frank Act
2. Making Home Affordable Programs – Updates for Mortgage Holders and Servicers
3. Senior Official Tips the OCC’s Hand On Loan Loss Reserve, Concentrations, and Capital Standards

Related posts:

1. Dodd-Frank Reform Bill Broadens Affiliate and Insider Transaction Rules to Include Additional Financial Products
2. Questions (and Answers!) on the new TARP Executive Compensation Rules
3. Durbin Amendment Webinar

The Durbin Amendment:

What Does the Final Ruling Mean for Prepaid?

You can register for free online. Attendees are encouraged to submit in advance and without attribution, any questions they would like addressed during the webinar.  Please enter your questions when you register.

The Webinar will be presented by Judie Rinearson (Bryan Cave – New York), Linda Odom (Bryan Cave – Washington, D.C.) and Courtney Stolz (Bryan Cave – Washington, D.C.).

CLE credit for this webinar will be available for attendees in California, Georgia, Illinois, New York and Virginia.

Judith Rinearson leads Bryan Cave’s Stored Value and Prepaid Card Services Group and is a recognized authority in the areas of payment systems, electronic payments, stored value, travelers checks and check processing. She has more than 19 years of experience in the financial services industry, particularly in the areas of non-bank money services and payment products. She currently chairs the Government Relations Working Group for the NBPCA and the Payment Card Fraud Task Force for the ABA’s Cyberspace Law Committee. She also serves as counsel to the recently established Retail Gift Card Association.

Linda Odom concentrates her practice in technology, contracts and intellectual property matters with significant experience in the area of new financial service products. She has assisted prepaid clients in developing and structuring complex card and mobile prepaid payment products and has negotiated agreements with program managers, processors, bank issuers and acquirers. Linda has been working in the technology-based financial services area since 1996 when she negotiated the agreements to form the technology platform for NetBank, the world’s second Internet-only bank.

Courtney Stolz concentrates her practice on banking, electronic commerce, and privacy. Her clients include internet banks, as well as other premier financial services providers that rely on Internet or other non-traditional delivery channels. She advises on the legal requirements imposed under the money transmitter licensing laws, check casher laws, the Bank Secrecy Act, the Anti-Money Laundering Act and laws related to gift cards, prepaid cards, bill payment services and other funds transfers.

Related posts:

1. New "Durbin" Interchange and Routing Final Regulations Issued
2. Bryan Cave and BKD Present Webinar on Consumer Financial Protection Bureau
3. Bryan Cave Attorneys Present BAI Regulatory Reform Webinar Series

This rule renumbers and issues these former OTS regulations as new OCC regulations, with nomenclature and other technical amendments to reflect OCC supervision of federal savings associations. These newly issued OCC regulations will supersede OTS regulations for purposes of OCC supervision of federal savings associations, as provided by the Act.

This interim final rule is part of a larger OCC review of OCC and OTS regulations to determine what changes are needed for the transition to OCC supervision of federal savings associations. As a continuation of this review, the OCC will consider more comprehensive substantive amendments to these regulations, as appropriate, later this year.

Related posts:

1. FDIC Issues Final Brokered Deposit and Interest Rate Restriction Regulations
2. Interim Final Rule Regarding Executive Compensation Limitations Published
3. FDIC Issues Interim Rule to Implement the Temporary Liquidity Guarantee Program

• Preemption standard for national banks and federal thrifts is altered
• Codification of the requirement that a bank holding company act as a “source of strength” for any subsidiary that is a depository institution
• Federal Reserve is authorized to issue orders and regulations relating to the capital requirements of holding companies
• Heightened capital requirements for interstate acquisitions
• New restrictions on insider asset sales and lending
• Truth in Lending Act exemption threshold for certain credit transactions and consumer leases is increased from $25,000 to $50,000 (i.e., TILA coverage is increased)
• Repeal of Regulation Q and the underlying statute (permitting payment of interest on demand deposit accounts)
• Increase in next-day availability requirement for deposit items not themselves subject to next-day availability under the Expedited Funds Availability Act from first $100 to first $200
• Required credit score disclosure under the Fair Credit Reporting Act where adverse action is based in whole or part on a consumer report

We will continue to follow rulemaking and enforcement of the Act and provide updates linked to our dedicated Dodd-Frank page.  Regulators (and Barney Frank) are celebrating the law’s milestone today by testifying before the U.S. Senate on how the Act has improved supervision.  Stay tuned.

Related posts:

1. OCC Issues NPRM on Dodd-Frank Implementation, Preemption
2. OCC Opines that Federal Preemption Still Exists, Despite Dodd-Frank
3. Regulators Respond to Dodd-Frank

Under the final rules, issuers are permitted to charge a base fee of 21 cents plus 5 basis points (.05%) multiplied by the full value of the transaction, to cover fraud losses.  In addition, a 1 cent per transaction fraud prevention adjustment was also proposed, for those issuers who meet eligibility requirements (such as having fraud prevention and data security policies and procedures in place, which must be updated and certified on an annual basis.)  The fraud prevention adjustment rules are new, and are open for comment through September 30, 2011.

Under the new rules, a covered $50 debit or prepaid transaction would have a total possible interchange fee of  = 23.5¢ [21¢ + 2.5¢ ($50 x .05  /100) + 1¢], and a $500 transaction would have a total possible interchange fee of  = 47¢  [21 ¢ + 25¢ ($500 x.05 /100) + 1¢].   While this is a significant improvement over the original suggested cap of 12¢, it still represents a substantial decrease in interchange revenues for both prepaid and debit card issuers.

Among the more controversial aspects of the Final Rules were:

• The decision not to require payment networks to implement a two-tier system that would ensure that exempt entities, such as banks with less than $10 billion in assets, will receive the benefits of their exemptions.   Instead, the Board will be surveying and publishing average interchange rates for exempt and non-exempt banks, in order to monitor the effectiveness of the small bank exemption.
• The decision to exclude “three-party systems” in which the same entity is the Issuer and the Acquirer for the debit or prepaid card. Also excluded are ATM and ACH payment transactions.
• The full exemption for all products using a bona fide trust arrangement that meets Internal Revenue Code requirements -  which benefits many HSA/HRA card issuers.
• The additional requirement for exempt reloadable general-use prepaid cards to be the sole means for the cardholder to access the funds.  Thus, while an exempt reloadable prepaid card may be loaded via ACH, the cardholder cannot use ACH or convenience checks to make payments from the prepaid card account – without the issuer losing the exemption.
• The requirement that the payment networks develop policies and procedures to determine which entities are eligible for exemptions.
• The decision to include within the scope of the regulations both business and personal accounts, as well as prepaid cards that rely on “selective authorization” such as University cards and Mall cards.

The Board also approved rules governing routing and exclusivity, requiring issuers to offer two unaffiliated networks for routing debit transactions on each debit or prepaid product. The cards must have either one signature network and unaffiliated one PIN network, or a two unaffiliated PIN networks or two unaffiliated signature networks.

The new Interchange Rules go into effect on October 1st, 2011, as opposed to July 21 as originally dictated by the Durbin Amendment.  Most of the Routing Rules go into effection on April 1, 2012, although some provisions (relating to prepaid cards and HSA/HRA cards go into effect on April 1, 2013.

Related posts:

1. Final Interchange Rules Approved
2. Modified Interchange Provision Incorporated in Final Financial Regulatory Reform Bill
3. Senate Defeats Bill to Delay Interchange Fee Caps

At a publicly held board meeting on June 29, 2011, the Federal Reserve Board approved its final interchange rule, entitled Regulation II, “Debit Card Interchange Fees and Routing,” setting the maximum permissible swipe fee an issuer may receive for an electronic debit transactions, adopting routing requirements and applying unanticipated new restrictions to General Purpose Reloadable (GPR) cards to take advantage of the interchange cap exemption. In addition—to the relief of the banking industry—the Fed announced that the rules on pricing requirements will go into effect on Oct. 1, 2011, as opposed to July 21 as dictated by the Durbin Amendment.

Under the final rule, issuers are permitted to charge a base fee of 21 cents (representing 80 percent of an issuer’s average transaction cost), plus five basis points on the full value of the transaction to cover fraud losses (representing the average per-transaction fraud loss of the median issuer). The fraud loss recoupment (referred to by the Fed as an “ad valorem” or “according to value” charge) came as a surprise to most and is viewed as a big win for the banking industry. The Fed also issued an interim final rule that would allow issuers to charge an additional fraud prevention adjustment of one cent if the bank meets, and certifies compliance of, certain security standards. The Fed requested comments on whether the one-cent cap should be adjusted.

In addition, the Fed approved rules governing routing and exclusivity, requiring issuers to offer two unaffiliated networks for routing debit transactions.

Perhaps the biggest surprise in the final rule is that GPR cards will not benefit from the interchange cap exclusion if they allow funds to be accessed through means other than the card.

Open Board Meeting

At the board meeting, Chairman Ben Bernanke stated that the interchange rule has been one of its most challenging rulemakings under the Dodd-Frank Act to date. The Fed had to consider myriad players impacted by debit interchange, as demonstrated by the more than 11,000 comment letters the Fed received.

After Bernanke’s introductory remarks, Mark Manuszak, Federal Reserve Board staff member and economist, discussed the standards established for assessing whether the amount of an interchange transaction fee is “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” After mentioning the comments received by merchants versus issuers and networks, he stated that the staff concluded that a broader range of costs should be included as the basis for the interchange fee standard. Thus, the “allowable costs” should include not only the incremental cost of authorizing, clearing and settling the transaction but also certain other costs that affect an electronic debit transaction, such as network processing fees and costs associated with connectivity, equipment, software and transaction monitoring. Most significantly, Manuszak said that a portion of fraud losses should be incorporated in this assessment through the ad valorem component.

Manuszak also discussed network exclusivity and the routing of debit card transactions, stating that the final rule adopts the first alternative in the proposed rules, requiring two unaffiliated network options per card (versus per authentication method). He explained that under the final rule issuers and networks remain prohibited from inhibiting a merchant’s ability to direct the routing of debit card transactions over any network. Manuszak added that the network exclusivity rules become effective on Oct. 1, 2011, for networks and April 1, 2012, for issuers—except with respect to nonreloadable and reloadable general-use prepaid cards, which will have a postponed effective date of April 1, 2013 to allow time for technological developments. As a result, nonreloadable general-use prepaid cards sold prior to the effective date are not subject to the prohibition on network exclusivity. Furthermore, GPR cards sold prior to the effective date are not subject to the prohibition on network exclusivity unless and until they are reloaded—if the card is reloaded prior to April 1, 2013, the card must be in compliance by May 1, 2013; if the card is reloaded after April 1, 2013, then it must be compliant 30 days after the date of reloading.

Following Manuszak’s summary, Fed members posed various questions to the staff, including how the rule is expected to affect consumers to influence innovation, and how the staff assessed the impact of interchange regulation in other countries. Of particular note, the staff addressed how issuers with under $10 billion in assets would be impacted by the final rule. At one point, Daniel Tarullo recommended the Fed take steps to enforce the statutory exemption for small issuers. Bernanke followed by announcing plans to monitor the developments in the debit card market, including collecting and publishing data related to interchange rates charged by each network both covered and exempt issuers.

Finally, the members of the Board (consisting of Bernanke, Vice Chair Janet Yellen, Elizabeth Duke, Tarullo and Sarah Bloom Raskin) cast their votes, with all except Duke approving the final rule. In a brief comment in opposition to the final rule, Duke targeted prepaid cards, and called upon the Consumer Financial Protection Agency to ensure that more consumer protections be established over such cards.

Treatment of Prepaid Cards

The final rule still exempts reloadable prepaid cards not marketed/labeled as a gift card. These cards, however, are eligible for the exemption only if they are the only means of accessing the underlying funds or unless all remaining funds are provided to the cardholder in a single transaction. Thus, as stated in the Official Board Commentary, “reloadable cards that provide access to the funds underlying the card through check, ACH, wire transfer or other method (unless these other means of access were used solely for a one-time cash-out of the remaining balance on the card) would not meet the [exemption].” It appears that the restriction on ACH access relates solely to the cardholder’s ability to access the funds and will not impact on cards that have funds automatically loaded via ACH by an employer, governmental entity, etc.

The rule provides that general-use prepaid cards with underlying funds held in an omnibus account (and not separate accounts held by or for the benefit of individual cardholders) are still eligible for the exemption. In addition, the rule still prohibits reloadable prepaid cards from imposing overdraft fees or a fee for the first in-network ATM withdrawal per calendar month.

Furthermore, the Official Board Commentary adds a new comment on “hybrid cards,” i.e., cards that offer both combined credit and debit features. By way of example, the commentary states that if a card permits a cardholder to initiate a transaction that debits an account or funds underlying a prepaid card, then the card may be considered a debit card.

Industry Response

Representatives from merchant groups, such as the National Retail Federation and the Retail Industry Leaders Association, have already criticized the final rule, stating that the elevated caps are not “reasonable and proportional” and accusing the Fed of caving in to pressure from big banks and credit card companies.

The banking industry, on the other hand, expressed appreciation for the Fed’s willingness to mitigate the proposed rules’ detrimental impacts, while still voicing concern over government price controls. While the final rule permits a maximum interchange fee of 24 cents for the average $40 debit card transaction (doubling the initially proposed cap of 12 cents per transaction), American Bankers Association President Frank Keating acknowledged that the rule still represents a 45 percent loss in revenue for banks.

Among the prepaid industry, greatest concern has been raised about the impact of the new restriction on GPR cards that are exempt from the lower interchange rate. The final rule does not permit GPR cards to benefit from the exclusion if they allow funds to be accessed through means other than the card. The practical impact will be to eliminate convenience checks, remittance and bill payment services from many GPR products that are relied upon by the underbanked and underserved, making it more difficult and expensive for such cardholders to access basic financial services.

Related posts:

1. Modified Interchange Provision Incorporated in Final Financial Regulatory Reform Bill
2. Federal Reserve Board Issues Final Gift Card Rules
3. Senate Defeats Bill to Delay Interchange Fee Caps