Regulator skepticism starts fresh fight on interchange fees

"It is possible that exemption may not be effective in the marketplace," Bernanke said.

Federal Deposit Insurance Corporation Chairwoman Sheila Bair echoed Bernanke's concern.

"It remains to be seen whether [small banks] can be protected by this," she told the panel. "I'm skeptical."

Bair went on to say it was possible that banks would have to raise fees to make up for lost revenue, and suggested the impact of the provision has not been "dealt with as thoroughly as it might have been."

Across Capitol Hill, Fed Governor Sarah Bloom Raskin made clear to a House Financial Services subcommittee that the debate on interchange fees was far from over. At a hearing devoted to the subject, Raskin, citing the "novelty and unusual complexity" of the issues at stake, said the Fed was "reserving judgment" on what the final rule, due in April, will look like.

The comments set off a fresh push from banking groups, which are calling for a repeal of the provision. Merchants worked to defuse the comments, suggesting the regulators were mistaken on the law.

At the heart of the debate is a controversial provision of the Dodd-Frank financial reform law dubbed the Durbin amendment. Backed primarily by Sen. Dick Durbin (D-Ill.), the provision requires the Fed to place limits on the fees banks charge retailers for swiping debit cards. The measure has pitted retailers and banks against each other for months, with billions in revenue at stake.

Durbin quickly responded to Bernanke's comments, telling him in a letter that he was disappointed the chairman had "echoed the financial industry's talking points."

"The U.S. banking industry is a $13 trillion industry … [and] has always fiercely opposed any reform to the current interchange fee system," he wrote. "I urge you and the Federal Reserve to recognize these tactics for what they are, and to carry out the implementation of interchange reform as Congress intended — on the basis of facts and not the financial industry’s fictions."

The Fed proposed rules limiting the fees in December. Its proposal, which would limit fees to seven to 12 cents per transaction, would represent a drop of 73 percent from the current 44-cent average.

Banks have harshly criticized the provision, arguing it amounts to governmental price-fixing and will force new banking fees on consumers to make up for the lost revenue.

On the other side of the debate are retailers, who contend that interchange fees no longer cover the costs of managing a debit-card network, and now simply serve to pad banks' profit margins. By capping the fees, they will be able to pass savings on to consumers, they maintain.

Banking groups pushing to curtail the limits appeared to have the support of a bipartisan group of senators Wednesday, as the interchange rules faced harsh criticism from several panel members.

Sen. Bob Corker (R-Tenn.) said it was "an impossibility" that smaller banks would not be adversely affected by the rules.

"There's no question that smaller institutions are going to be impacted in a big way," he said.

Sen. Mike Johanns (R-Neb.) said the Fed's proposed rules "stunned everybody."

"I don't think anyone ever expected something this dramatic, this draconian," he said, going on to suggest that there is no proof retailers will pass on savings from the reduced fees to consumers, as merchants groups have asserted.

"We can't guarantee that a single consumer will get any benefit from that legislation," he said.

Sen. Jon Tester (D-Mont.) said he was "very concerned" about the interchange proposal and what it might mean for small community banks.

"It would seem to me that there's going to be undue harm done to smaller banks," he said.

The National Association of Federal Credit Unions said Bernanke's comments serve as a "clear indication that the interchange fee cap was ill-conceived and will have a profoundly negative impact on credit unions and their 92 million members."

Merchants immediately pushed back against the chairman's comments, suggesting he was mistaken in saying stores might turn down cards with higher fees.

"He [Bernanke] doesn't seem to have a clear understanding of how the ‘Honor All Card’ rule works in the marketplace," said Brian Dodge, senior vice president for the Retail Industry Leaders Association.

Rather, he maintained that the two major debit-card networks, run by Visa and MasterCard, both have policies that state that merchants cannot pick and choose which cards they will accept.

And on a practical note, Dodge pointed out that for many types of transactions, such as when the customer swipes a card himself, the cashier does not have an opportunity to identify the card, making discrimination unlikely.

While the financial services industry has asked the Fed to delay its rulemaking for two years to further study the impact of the provision, any repeal of the provision would require legislation. Despite the bipartisan concern about the provision, no bill repealing the Durbin amendment has been introduced yet in the new Congress.