Appeals court upholds swipe fee decision, Fed must rewrite rule

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• Key insight: The Fed could be compelled to lower the cap banks are allowed to charge merchants to process debit card transactions.
• Expert quote: "The clearest sign of regulatory drift was the flat 21-cent cap because it applied to every transaction, no matter its cost." — David Straus, judge, Eight Circuit Court of Appeals

The Federal Reserve might have to go back to the drawing board for its rule setting a cap on the fees banks can charge for processing debit card transactions.

On Monday, the U.S. Court of Appeals for the Eighth Circuit confirmed a lower court ruling from last year that invalidated Regulation II, the Fed policy that implemented the swipe fee cap as defined by so-called Durbin Amendment to the Dodd-Frank Act of 2010. 

It was not immediately clear whether the Fed would appeal the ruling to the Supreme Court or if it would attempt to implement a new framework that more closely reflects per-transaction costs associated with debit interchange processing.

Writing for the appeals court, Judge David Straus said the Fed violated the law by factoring fixed costs into the calculation of its cap, which set a flat limit of 21 cents per transaction. He noted that the Durbin Amendment specifically called for a limit that reflects the "incremental costs" incurred from each individual swipe. 

"Among the non-transaction-specific costs it included were fixed costs related to authorization, clearance, and settlement; network processing fees; transaction-monitoring costs for fraud prevention; and fraud losses," Straus wrote. "The clearest sign of regulatory drift was the flat 21-cent cap because it applied to every transaction, no matter its cost."

The opinion stems from a 2021 lawsuit filed against the Fed by Corner Post, a North Dakota truck stop, over the interchange fee cap. Corner Post was joined by a legion of other retail businesses, industry groups and Sen. Dick Durbin, D-Ill., — the author of the eponymous amendment — who filed supporting briefs.

The Merchants Payments Coalition, a Washington, D.C.-based organization representing retailers, supermarkets, convenience stores, gasoline stations and online merchants quickly lauded the court's decision.

"Today's decision confirms what merchants have said for more than a decade: The Fed let the nation's biggest banks charge far more than the law allows," said Doug Kantor, a member of the group's executive committee and general counsel for the National Association of Convenience Stores. "Two courts have now agreed that the current rate lets banks collect billions of dollars a year more from stores and their customers than the law ever meant for them to have — far more than it takes to cover their costs and earn a healthy profit. Rather than keep defending an illegal rule, the Fed should promptly replace it with one that complies with the law and takes some of the upward pressure off the prices shoppers pay every day."

The Fed established the 21-cent transaction cap in 2011 through its Regulation II, which applied to banks with at least $10 billion in assets. The framework also allows a 1 cent charge to support fraud prevention and a 0.05% set-aside for fraud loss recovery. 

Corner Post's victory in district court last year was preceded by two major rulings at the Supreme Court from the summer of 2024. The first was Loper Bright Enterprises v. Raimondo, which dismantled the so-called Chevron Doctrine of courts granting regulatory agencies broad deference to implement ambiguous statutory requirements. 

The second was Corner Post's own case against the Federal Reserve Board, in which the high court determined that the six-year statute of limitations on challenging a federal agency rule did not begin when a rule was implemented, but rather when the plaintiff was injured by it. In this instance, the ruling enabled the truck stop to challenge the merits of decade-old rule — just in time, it turned out, to capitalize on the Supreme Court's shift away from agency deference.

In an analyst note, Brian Gardner, chief Washington policy strategist at the investment bank Stiefel, said he expects banking industry groups to petition the Supreme Court to review the decision sometime in the coming weeks. 

In the meantime, the Fed is expected to begin working on implementing at least an interim rule to replace its current Reg II framework, according to a note from the investment firm Keefe, Bruyette & Woods, which noted that the Fed's 2023 proposal to reform the framework could form the basis of the Fed's new approach.

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In 2023, under the leadership of then-Fed Vice Chair for Supervision Michael Barr, the Fed proposed implementing a 14.4-cent cap augmented by a 0.04% fraud loss recovery set-aside and a 1.3-cent adjustment for fraud prevention. At the time, the Fed noted that a $50 transaction would be capped at 17.7 cents, down from 24.5 cents under the current rule, a decrease of nearly 28%.

Yet, some analysts are warning that a revised framework that factors out all fixed costs entirely could result in a materially lower cap for the country's largest banks.

"Our view is that a compliant Durbin debit interchange fee cap could be less than five cents per transaction for the largest banks," TD Cowen Managing Director Jaret Seiberg wrote in a note on Monday. "This represents a sizable reduction from the rate today, which is 21 cents plus 5 basis points per transaction."