June 2011 Document Title : DURBIN AMENDMENT NEGOTIATION ANALYSIS: DEBIT CARD FEES NEGOTIATIONS IN LIGHT OF ANCHORING, REFERENCE POINTS, AND FRAMING

By Dan Rosenblum ( June 2011 at NYU Stern School of Business for EMBA Negotiations Class. Web published May 2012 as work in progress regarding Dodd-Frank/Durbin and digital data processing)

Executive Summary

The Durbin Amendment to the Dodd Frank Act proposes to cap debit interchange fees charged by banks to merchants at 12 cents to process the transaction- to go into effect July 21 2011. Currently banks charge merchants a formula that averages 1.14 percent of the purchase price, or 44 cents, to process the data/transaction. Interchange fees presently total about $ 16 billion annually. $ 12 billion in annual fees is at stake. The desired goal to the Durbin Amendment negotiation under consideration is efficiency in commercial data processing. However, the desired outcome of efficiency in commercial data processing does not lie on the spectrum of 12 cents to 44 cents as determined amongst the parties at the table. When the negotiation is framed not as determining an appropriate price between 12 and 44 cents, but rather as analyzing and reconsidering limitations under the bank data processing statutes referred to below, the goal of efficient data processing is obtainable.

NEGOTIATION DESCRIPTION

Negotiation Parties / Relevant Personalities

Senator Durbin's Amendment requires that the Federal Reserve ensure debit interchange fees are "reasonable and proportional" to the actual cost of processing a debit card transaction with the goal of cutting transaction costs for retailers/merchants such as Wal-Mart, Home Depot, and Amazon as well as every location in the US that accepts debit cards. Banks and card companies such as Visa and MasterCard stand to lose what the retailers save- $12 billion. The banking industry, and technology companies like Apple, Microsoft, Google, and Facebook argue that reduced fees will bring increased fraudulent transactions and reduced security mechanisms which otherwise protect data and prevent fraud . Recently Senator Jon Tester of Montana introduced a bill in Congress to delay implementation of the Durbin Amendment for two years to allow for appropriate evaluation of the impact the Amendment will have. U.s. House Rep. Shelley Moore Capito of West Virginia also introduced a bill to delay the Durbin amendment. In its original proposal to comply with the amendment, the Federal Reserve introduced the 12-cent cap, but did also leave room for adjustments for security mechanism and fraud loss adjustments. The Fed proposed two varieties of adjustments- in one the banks would need utilize specific technology, in the other the banks could employ reasonable fraud prevention mechanisms. The size of the adjustment is unclear. Federal Reserve Chairman Ben Bernanke recently noted that U.S. debit-card transactions climbed from about 8 billion in 2000 to 38 billion in 2009. Bernanke recently tried to have a court throw out a bank lawsuit challenging the legality of the Durbin Amendment. Even the Office of the Comptroller of the Currency has weighed in on this negotiation, issuing a statement encouraging banks to develop and implement sound fraud prevention technologies. Jamie Dimon, chadirman and CEO of JPMorgan Chase & Co., says the amendment is "idiotic," “counterproductive,” and “price fixing at its worst.” [1] [2] [3] [4]

RELEVANT ORGANIZATIONAL & SOCIO-ECONOMIC / CONTEXTUAL FACTORS

Kahneman, in Reference Points, Anchors, Norms, and Mixed Feelings defines 'reference points' in terms of a relationship to a valuation of losses and gains. One set of 'anchors' in the instant debate is the general association of a network access card with credit and the wallet for money transfer alone- it is easy for consumers to form reference points to a valuation of financial losses and gains which frame the negotiation for the general public.[5]

As the Durbin negotiation takes place one ‘norm’ is a general association of a debit/credit card carried in a wallet for use with a secure data process as a cash substitute alone- secure financial data alone. The card is a network access card, its major characteristics are: a physical item; 16 digits, plus other code identifiers; perhaps a magnetic strip, etc, plus generally a signature. Some sort of similar (if not identical) card or system or direct substitute is an essential element of such a secure data processing endeavor. While it is the most basic of sound fraud prevention technologies, the “credit card” or “debit card” is the most basic of digital data processing sound fraud prevention technologies in the marketplace being utilized for financial data processing alone. To be certain, when one banking institution develops a secure processing technology to compete for a share of the 36 billion data processing services market, that bank does not share that technology with competitors, nor is it expected to do; sharing such R & D technologies is counter-intuitive in any commercial market. The technology developed involved lots of R & D, and is tailored to the data processed, looks to minimize hardware and software costs, increase functionality, etc. Not only will the bank not share with direct competitors, but, the developer of such technology will not give away their technology to non-competitors in other markets. The developer of the sound, fraud prevention technology will protect their proprietary innovation using intellectual property. The product released and used is cutting edge, developed using resources available given the market of 36 billion instances anticipated to use the technology this year alone, with an increase next year. It is also based upon the infrastructure presently available and dedicated to the chore- bandwidth available, chip processing speed, dominant operating system, etc. All this, with a limitation that acts as a disincentive to apply these mechanisms to non-financial data processing.

Insofar as additional structural analysis, there is a fallacy in the implicit negotiation. The bargaining zone of 12 to 44 cents is irrelevant to the underlying interests of each party, affecting any integrative potential between the parties. The major point of my analysis is that the negotiation needs to be re-anchored. The Federal Reserve Board and other players should not seek to determine the appropriate fee for debit/credit card swipes, but, rather, how banks’ proprietary network systems should be permitted to process non-financial data on secure networks, utilizing the same technologies the OCC refers to above in its Durbin commentary.

The impasse in these negotiations is best contemplated by considering how the negotiation has been defined, anchored, and framed. The present impasse is as a result of the fact that the essential element requiring modification by the parties will not be affected during the instant negotiations. All sides desire an integrative solution- but it will not presently be achieved. The desired outcome is known and is driving the negotiation; but the desirable outcome is not an option on the table.

FRAMEWORK FOCUS: THE BANK PERSPECTIVE:

While the stance on issues for a good portion of players is described above, the banking industry must always be mindful of banking regulation- which regulation helps to drive firm agenda. Bank regulation driving firm commercial agenda is compelling when compared to other industry commercial agenda. Given the bank’s allegiance to specific regulation in the banking industry, I here consider the bank perspective. Interwoven in this complex negotiation context are the extent regulations themselves. Underlying the Durbin Negotiation Process are strategies relevant to such regulation, defining timing, fairness issues, and biases.

The root elements which should be under consideration are Section 4(c)(8) of The Bank Holding Company Act, Title 12: Banks and Banking Part 225—Bank Holding Companies And Change In Bank Control (Regulation Y) § 225.28 List of permissible nonbanking activities. Section 4(c)(8) of The Bank Holding Company Act permits a bank holding company to engage, directly or through a subsidiary, in activities that the Board has determined by order or regulation to be “so closely related to banking or managing or controlling banks as to be a proper incident thereto.” ( 12 U.S.C. § 1843(c)(8)).

The present relationship between bank holding companies and national consumer driven commercial digital data processing should be considered in terms of 12 CFR 225.21, not choosing a price for financial data. Bank holding company owned digital networks could perform digital network services more efficiently in an environment permitting non-financial data processing on the bank holding company owned digital networks. There is a return on the R & D for sound fraud prevention technologies which is not being realized given current regulations.

Bank Holding Companies are permitted to engage in data processing as per 12 CFR 228.14. The Board’s 1982 Citicorp Order, which effectively enacted 12 CFR 228.14, specifically stated that

[I]t is appropriate that all reasonable efforts should be taken to assure compliance with the Board’s finding that only the processing and transmission of banking, financial, and economic data is permissible. A limitation on the types of data for which processing and transmission services are offered does not appear excessive, since the technology to effect such limitation exists.( 68 Fed. Res. Bull. 505 (1982))

The Board's Citicorp Order evolved to Title 12: Banks and Banking Part 225—Bank Holding Companies And Change In Bank Control (Regulation Y) § 225.28 (b) (14) Data processing. Section (i)A stipulates that the data to be processed must be financial, banking or economic; and any non financial processing must be limited to 49 percent of the company's total annual revenues derived from data processing. A decade/15 years ago bankers would argue that the behemoth (Citigroup, etc.) could seemingly process unlimited data given the 50% rule- bank operations far exceeded data transfer- but that is a fallacious interpretation because the more efficient processor might be a wholly owned subsidiary devoted to 100% non-financial processing, which endeavor cannot even be contemplated under the 50% rule.

To move forward competitively, effectively, and efficiently in negotiating fees associated with processing data the negotiation needs to be re-framed. First, in the landscape of data processing, it needs to be recognized that financial data processing commands fee based revenues as quantified above whereas non-financial data generally does not. The economics of Internet Commerce are defined by transactional fees for financial data processing, but advertising revenues for non-financial data processing. The root of this fact is an essential element of any negotiation seeking the goal of competitive, effective, efficient data processing (and associated fees).Presently, however, the negotiation needs to be reframed in light of the framework here focused on if the desired result is efficient data transfer. The players are at the table; the desired outcome of efficiency in commercial data processing is driving the negotiation. But the negotiation is framed around the fees alone that can be charged for financial data processing, with anchors at approximately 12 cents and 44 cents. However, the desired outcome of efficiency in commercial data processing does not lie on the spectrum of 12 cents to 44 cents as determined amongst the parties at the table.

REFLECTION / RECOMMENDATIONS FOR FUTURE

When the negotiation is framed not as determining an appropriate price between 12 and 44 cents, but rather as analyzing and reconsidering extant regulations and limitations under the bank data processing statutes hereto referred, the goal of efficient data processing is obtainable. The US economy is not presently fully harnessing and fully realizing the extraordinary benefits associated with internet technologies in the 21st Century.

In 2011 a limitation to permit the companies which collect revenues for providing the service of processing upwards of 38 billion secure data transfers a year only to process financial data and to place limitations/disincetives on non-financial data processed is counterproductive and stymies innovation in internet technologies commercial network development. If, by regulation, Bank Holding Companies continue to be permitted to engage in financial data processing as per 12 CFR 228.14, then Bank Holding Companies should be permitted to engage in processing and transmission of non-financial data in a regulated environment designed to capture the benefits of internet technologies to the benefit of the US economy. If not, innovation will suffer, extant technologies will go underutilized, value will be lost to owners of Trademarked and Copyrighted materials, and consumers will be underserved. The Durbin Amendment to the Dodd Frank Act simply will have the Federal Reserve pick a number between 12 and 44 because the negotiation is improperly framed and poorly anchored. Until banks can function unfettered- or with regulations specific to the data processing industry bearing in mind the this matter of the important relationship between secure financial data processing and secure non-financial data processing, the industry is suffering, with potential economic benefits for the economy in general remaining unrealized.

Sources/Citations:

[1] Will Durbin Rule Make Data Less Secure? Cheyenne Hopkins. American Banker. New York, N.Y.: Apr 29, 2011. Vol. 176 pg. 1) ( Phil Mattingly . Google, Facebook Group Asks Delay of Debit-Card Fee Rules (Apr 12, 2011) available at http://www.bloomberg.com/news/print/2011-04-12/google-facebook-group-asks-delay-of-debit-card-swipe-fee-rules.html

[2] Tracy Kitten. The Durbin Amendment and Fraud.Insiders Say Interchange Issue Could Hurt Fight Against Fraud (April 26, 2011) available at http://www.bankinfosecurity.com/articles.php?art_id=3579&opg=1

[3] Tracy Kitten. The Durbin Amendment and Fraud.Insiders Say Interchange Issue Could Hurt Fight Against Fraud (April 26, 2011) available at http://www.bankinfosecurity.com/articles.php?art_id=3579&opg=1

[4] Tamara Keith. Banks, Retailers In Lobbying Race Over Debit Fees. NPR MorningEdition. (May 10, 2011) available at http://www.npr.org/2011/05/10/136147726/banks-retailers-in-lobbying-race-over-debit-fees)

[5] Daniel Kahneman. Reference Points, Anchors, Norms, and Mixed Feelings. University of California, Berkeley

[6] Federal Reserve Docket OP-1158, 12 USC 1972

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