Regulation II Debate: How the Fed’s 2023 Proposal Threatens Community Banks & Low-Income Consumers

The proposed amendments to Regulation II, advanced in November 2023, seek materially to lower interchange fee caps for large debit card issuers, while adjusting only the fraud-related component upward slightly. The base component’s cut from 21¢ to 14.4¢ and ad valorem from 5 bps to 4 bps would reduce total allowable fees by roughly 30% on average transactions. [6][7] These changes reflect cost data reported in 2021. The proposal also introduces a biennial reset mechanism to tie future caps more tightly to issuer cost experience. [7]

However, industry stakeholders argue that basing policy on 2021 data no longer captures substantial transformations in payments—namely, shifts in routing rules (2022), surges in contactless and mobile wallet usage, and evolving fraud profiles. [2] They anticipate that more recent issuer cost experiences likely diverge from those used in the proposal, particularly inflationary pressures, technology investments, and fraud loss trajectories.

Legally, the future of both the current 2011 Reg II standard and the 2023 proposal is clouded by conflicting court decisions. In Corner Post (ND) issued in August 2025, the court vacated the Reg II rule, finding that the Fed violated the statutory requirement under the Durbin Amendment by imposing a uniform cap instead of issuer- and transaction-specific standards. [4] In contrast, in Linney’s Pizza (KY) decided September 2025, a different district court upheld the rule, finding that the 2011 regulation reasonably balances competing interests. [5] The appellate path remains uncertain, leaving foundational legal questions unresolved and any rulemaking subject to challenge.

Given the legal divergence and data concerns, trade groups argue the Fed should formally withdraw the 2023 Proposed Rule to reduce regulatory uncertainty for issuers, networks, and merchants. While the Fed has reportedly deferred finalizing the rule until after legal clarity emerges, withdrawing—or at least suspending—the proposal could provide market participants with greater predictability while newer data and court decisions mature. [2][1]

Strategically, banking institutions (especially community-level issuers) must brace for tighter revenue on debit transactions if the rule proceeds as proposed. Margin compression could drive cost migration to consumers, via fees on accounts or curtailment of low-cost/free banking products. Conversely, merchants and retailers stand to benefit from lower transaction costs—but only if savings are transmitted to them. Regulatory risk remains high, as courts or future Fed rulemaking may reshape not only caps but allowable cost categories and acceptable methodology.