Evan Schuman's StorefrontBacktalk

Attorney Mark D. Rasch is the former head of the U.S. Justice Department’s computer crime unit and today is a lawyer in Bethesda, Md., specializing in privacy and security law.

On July 31, a federal court in Washington sent shock waves through the merchant, banking, and credit/debit card industry by overturning the Federal Reserve’s rules implementing limitations on the interchange fees banks can charge merchants for processing signature- and PIN-based debit cards. In doing so, the Judge ruled that the Fed had not reduced these fees enough to comply with the wording and the intent of Congress. While this is good news for merchants and bad news for banks, how much the good news is worth depends on how much a debit card transaction costs. And just as important is who gets to decide what a “cost” is.

At issue in the case was the Federal Reserve’s “Final Rule” implementing the so-called “Durbin Amendment” to the Dodd-Frank financial reform act.

The purpose of the law was to reduce the interchange and other fees charged by banks to merchants for processing debit cards, while permitting the banks to recover their actual direct costs associated with such processing. But the Fed permitted banks to add into what they could recover a host of fees that had nothing to do with processing a specific transaction, but represented “unassociated” costs (overhead, lawyers, etc.)

As a result of the Fed’s interpretation of the statute, interchange fees to merchants, which were proposed to be from 7 to 12 cents per transaction, rose to 21 cents per transaction plus an ad valorem fee of .05 percent.

That’s big bucks. How much of those big bucks merchants have to pay was determined by Congress—or it was until the Fed and bank lobbyists got involved. While the statute was intended to shift these costs (fees) from merchants to banks, the Fed rule didn’t quite do that, and fueled ever increasing fees (although it did reduce the fees charged by banks to merchants, it didn’t reduce them as much as Congress intended, at least according to the court).

In a typical debit card transaction, whether it’s processed like a credit card transaction with a signature or using a PIN at a terminal, the acquiring bank charges merchants an interchange transaction fee for accepting the debit card. The network also charges acquirers and issuers a “switch fee” or “network fee.”

These, together with an additional markup, are used to compute the “merchant discount”—which is not a discount to the merchant, but a reduction in the money the merchant receives after the fees are taken out. In layman’s terms, this is the “vig” or the “juice”—the fee extracted from merchants for the benefit of doing business. (A mafia informer once told me that it’s called the “juice” because, after all, you have to “squeeze” to get the “juice.”)

When PIN-based debit cards were first introduced, they reduced costs for both banks and merchants. No longer did merchants have to handle, process, deposit and authenticate checks, or run the risk that cash would have the problem of “shrinkage.” This was an easy way for merchants to effectively directly remove money from a customer’s bank account. The risk of default was low, as was the cost of processing. Merchants had to install new PIN-based

POS terminals, but many banks and acquirers helped to subsidize these costs by setting the interchange fees at “par” (no fee) or even reverse fees as a subsidy.

But then debit cards took off.