U.S. Circuit Court Overturns Leon Ruling: Industry Implications
On March 21st, the U.S. Circuit Court of Appeals reversed District Court Judge Richard Leon’s ruling that the Federal Reserve violated the Durbin Amendment of the Dodd-Frank Act in establishing the interchange fee cap for debit transactions, and in implementing the transaction routing provisions. The resolution of the legal battles (for now) will provide regulatory clarity for all, but the implications for key stakeholders will vary. These implications include:
Investment in Issuing: Prior to the Leon decision, debit issuing had returned to its historic position as a growth business. While revenue for regulated issuers remained well below pre-Durbin levels, banks enjoyed year-over-year growth driven by consumer usage, which increased steadily at 8% to 10% annually. Even at regulated rates, debit is clearly the most attractive DDA-based payment form. As such, with the uncertainty created by the Leon ruling eliminated, debit issuers will likely return to a growth agenda given the enduring consumer affinity for the product.
Acceleration of EMV: Debit EMV, already challenged by the requirement of multiple unaffiliated networks residing on a single chip, was virtually frozen by the possibility that two signature and two PIN networks would be required. Further, the potentially steep reductions in regulated debit interchange suggested by Leon caused most issuers to suspend even minor investments in debit, not to mention EMV. Overturning Judge Leon’s ruling, along with recent agreements among MasterCard, Visa, and several PIN debit networks to cross-license applications, sets the stage for accelerated issuance of EMV-enabled debit cards.
Focus on Fraud: Fraud losses are the third largest expense for debit issuers, following network fees and processing costs. In the wake of highly publicized data breaches at major retailers, reducing transaction fraud has grown from an internal control issue to a public relations mandate. EMV only addresses certain fraud types, and tokenization efforts are still in their infancy, but failing to act to reduce fraud invites scrutiny from both consumer advocates and regulators.
Operational Relief: Irrespective of the progress of EMV deployment in the U.S., the “2-by-2” model favored by the merchants would have placed enormous operational burdens on issuers, networks, and processors. Existing debit network infrastructure did not contemplate a regulatory requirement to route multiple signature brands. Similarly, back office work flows are typically designed around the network employed for the original transaction; merging those functions would be a tremendous undertaking. Avoiding that investment is a benefit for virtually all stakeholders.
Revenue enhancement: While current interchange rates will remain intact, issuers will continue efforts to replace the revenue lost via Reg II. That revenue will generally come from three sources: new products, migration to existing higher-revenue products, and volume growth. GPR prepaid has emerged as a competitive requirement for all banks, either as a DDA alternative or as a companion product. Migrating spend to Durbin-exempt prepaid or to credit is not a panacea, but can be effective with key customer segments. Most important, however, will be sustained growth in DDAs and associated debit cards, still favored by large segments of customers for their security and control, and targeted by issuers with a variety of creative account and fee structures.
The debit business was facing months, if not years, of paralysis pending final determination of Judge Leon’s ruling, and any required drafting and implementing of new regulations. The appellate court’s overturning that ruling eliminates a significant portion of the uncertainty facing the industry, and clears the way for a renewed growth agenda among issuers.
For more information, please contact Lee Manfred, Partner, firstname.lastname@example.org or Frank Verhaegen, Associate, email@example.com. They are members of our Deposit Access Practice, specializing in Debit and Prepaid.
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