Federal Reserve’s Swipe Fee Rule Struck Down By Judge; Says 21 Cents Per Transaction Inflates Transaction Costs; Retailers Rejoice

It’s back to the drawing board for the Board.

On Wednesday, U.S. District Judge Richard Leon ruled that a 21-cent cap on debit card transactions by the Federal Reserve Board implemented in October 2011 had the opposite effect of what was intended; instead of bringing down fees it raised them.

“The Board has clearly disregarded Congress's statutory intent by inappropriately inflating all debit card transaction fees by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit card transaction,” Leon wrote in his opinion.

The decision means the Federal Reserve must now draw up new rules. Until then, the current standard, a product of the so-called Durbin Amendment in the Dodd-Frank financial reform law of 2010, will remain in place.

Retailers are hoping to see these fees go down as much as possible. “From the very beginning, retailers and restaurants knew the Federal Reserve Board of Governors had grossly misapplied the swipe fee law,” said Mallory Duncan, general counsel for the Washington D.C.-based National Retail Federation. “They failed to heed Congress’ call to set fee standards that were ‘reasonable’ and ‘proportional’ to the actual cost of a transaction.”

The Merchants Payment Coalition, an advocate organization representing small businesses including supermarkets, drug stores, convenience stores and gas stations, applauded the ruling as a victory for consumers and small businesses. “Debit fees on low dollar transactions, which increased under the current rule, will now have to be reasonable as the law requires,” the organization said in an email. Whether this benefits consumers, as retail industry advocates claim, is a subject of debate. Retail advocates contend the competitive marketplace would create pressure on merchants to pass the savings to customers in lower prices. However, considering all the factors that affect the prices of consumer goods and services – inflation, gas prices, the constant flux in the prices of commodities – determining how much a reduction in swipe fees is affecting the price of a cup of coffee at Starbucks is easily debatable.

Groups like the Electronics Payments Coalition argue that the Durbin Amendment has forced more banks to find other ways to make up for the revenue lost from lower swipe fees, such as fees for low bank balances, and that merchants have not lowered the price of goods commensurate with the reduction in their costs of handling debit transactions.

This is the latest in an ongoing struggle between retailers and banks over how much banks should profit off authorizing, clearing and settling debit card transactions.

According to a report in March from the Board of Governors of the Federal Reserve System in 2011, before the 21-cent cap was in effect banks were charging an average of 24 cents for each debit card swipe.

At the same time the median cost to banks for processing each transaction was 11 cents, giving the average bank a gross average profit of 13 cents per transaction. This sweet profit margin was even sweeter for the largest debit-card issuers. Banks with at least $10 billion in assets – such as JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) -- paid an average of 5 cents per transaction, according to the Board.