WASHINGTON — Although banks failed in their attempt to convince Congress to delay an interchange fee cap for debit cards, the financial services industry is not giving up, just changing venues.
Bankers have now shifted their focus to convincing the Federal Reserve Board to raise the proposed 12-cent cap and a looming court battle over the central bank's right to enact such limits in the first place.
"The fight is not over, regardless of the [legislative] outcome," said Oliver Ireland, a partner at Morrison & Foerster.
Still, the 54 to 45 vote in the Senate — six members shy of the 60 necessary to enact a bill to delay the fee cap — was a massive blow to the banking industry. Lobbyists from both bankers and retailers had fought for weeks over a bill by Sen. Jon Tester, D-Mont., to delay the interchange rule by another year, with the financial services industry appearing to gain significant momentum.
What remains unclear is what the Fed will do now. It proposed a 12-cent-per-transaction cap in December, but industry representatives have argued the central bank did not properly account for the industry's costs in developing and maintaining debit payment systems.
With a final rule due out "within days," according to Sen. Richard Durbin, D-Ill., the author of the interchange fee limit in Dodd-Frank, many analysts expect the Fed to increase the cap.
"The cap will be raised," said Brian Gardner, a political analyst at Keefe, Bruyette & Woods Inc. "The December proposal was a floor. How much will it be raised? That's a crapshoot."
Many industry estimates have suggested the cap could be raised as high as 20 cents-per-transaction. While a significant improvement from a mandated 12-cent cap, that would still be far short of the industry's average charge of 44 cents.
The industry may make a renewed push to alter the Fed rule, but most said it is already a done deal.
"People may still talk to the Fed about this and try to convince them, but my guess is the rule is close to final form," said Gardner.
But there are other issues than just the size of the cap. The Fed's proposal also would prohibit institutions of all sizes from imposing network-exclusivity and merchant-routing restrictions on businesses.
"There is still the issue as to what the Fed is going to do with respect to how many networks have to be on the card and when that goes into effect," said Gil Schwartz, a partner at Schwartz & Ballen LLP and a former lawyer for the central bank.
Ed Mills, research analyst and vice president of financial policy research at FBR Capital Markets & Co., said where exactly companies will focus their attention in the Fed rule will depend in part on their size.
"For Visa and MasterCard, the entire focus is on network exclusivity. For the issuers, the entire focus is on the final interchange rate. For the small issuers it will be on what if anything the Fed will do to make the small-bank exemption work," he said.
Under the law, banks with less than $10 billion of assets are technically exempt from the interchange fee cap. But bankers have argued a two-tiered structure won't work, and small banks will be forced to abide by the cap. Federal regulators, including Fed Chairman Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair, agreed the interchange fee limit could hurt community banks. Industry representatives are hoping the central bank could revamp the exemption to make it more workable, but it's unclear how much leeway Fed officials have.
Once the final rule is out, it seems likely that bankers will continue to push the Fed to change it, even while retailers attempt to keep it intact.
"This is such a heated battle that neither side will let up until well past what other people would consider the end date — either past the final regulations coming out or the compliance date," said Mills.
But banks also have another place to seek relief from the interchange fee limits — the courts. The end of the legislative battle will likely renew focus on the lawsuit brought by TCF Financial Corp.
The $18 billion-asset company based in Minnesota is fighting the Fed's rule in the U.S. District Court for South Dakota, arguing it would violate the bank's due-process rights and - assuming the small-bank exemption works — put institutions like TCF at an unfair advantage. In April, a judge denied the government's effort to have the case dismissed.
Mills said one challenge facing the Fed is that if it successfully can making pricing for small banks distinct from that of large banks — therefore satisfying the intent of Dodd-Frank and many of the industry's concerns — that would hurt the Fed's prospects in court.
"The Catch-22 for the Fed has been the lawsuit contends there is a violation of equal protection because TCF contends small banks will get more," said Mills. "The Fed's position has been that they won't. But to whatever extent the final rules come down, if the small bank exemption is done in a way that works in the regulation, that's likely to bolster the focus on the TCF case and potentially bolster their argument."
Banks had hoped Congress would resolve the issue for them, or at least mitigate it. Right up until the vote was held on Wednesday, it was unclear which way it would go.
Sens. Jon Tester, D-Mont., and Bob Corker, R-Tenn., made changes to their legislation on Tuesday in an effort to gain the necessary 60 votes. Under the revised bill, the Fed would have had to suspend its current rulemaking and study the issue with other agencies for an additional six months, followed by six more months to produce a rule. The bill would have forced the Fed to consider a broader range of a bank's costs related to card processing when setting the cap.
The gambit appeared to work, with bankers arguing that momentum was on their side in the hours leading up to the vote. By Wednesday morning, sources had said bankers had nailed down at least 57 votes to support the measure, and were hopeful others could be persuaded to join.
Tester focused his arguments on the small bank exemption, noting that Bernanke had said some institutions could fail if the rule goes into effect without significant changes.
"Everyone agrees that if the Fed's rules go into effect, it's very likely that small banks and credit unions will suffer," Tester said on the floor of the Senate.
But in the end, Tester received only 54 votes in favor of a delay, as retailers and Durbin pushed back hard in an effort to keep the fee limit in place. Durbin, the Senate's majority whip and one of the most powerful lawmakers in the chamber, said the current interchange fee structure hurt small businesses, and dismissed arguments that bankers would be damaged by the change.
"The merchants and the retailers have no voice in the amount of that fee — no voice whatsoever," Durbin said.