Interchange Fees Forum

PayPal Inc., the fastest-growing unit at online marketplace EBay Inc., said the Federal Reserve shouldn’t subject the company to a cap on debit-card transaction fees, a move that could threaten most of its U.S. revenue.

The Fed is seeking public comment about whether limits passed by Congress should apply to “non-traditional” payment systems such as PayPal that are vying for part of the $4 trillion U.S. market dominated by Visa Inc. and MasterCard Inc. PayPal’s business would be damaged if it’s regulated like payment-card networks, according to Patricia Hewitt, a director at consulting firm Mercator Advisory Group.

The central bank has suggested capping interchange, or “swipe” fees, at 7 cents to 12 cents for each debit-card transaction, replacing a formula that costs merchants about 1 percent of the purchase. The Fed raised the question of whether those curbs apply to PayPal last month in a proposed rule to enforce the financial industry overhaul passed by Congress.

“We will be making the case that PayPal is not a payment- card network,” said Sara Gorman, an Atlanta-based spokeswoman for PayPal, in a telephone interview. “We don’t charge interchange fees. We’re confident that we won’t be regulated.”

PayPal’s U.S. business comprised 16 percent of EBay’s revenue and 11 percent of operating income in 2010, according to estimates by Goldman Sachs Group Inc. Worldwide, payments generated 37 percent of EBay’s revenue in the third quarter, or about $838 million, Bloomberg data show. EBay is scheduled to report financial results today.

PayPal’s Model

PayPal makes money by charging merchants a percentage of the purchase price, typically 1.9 percent to 2.9 percent plus a fixed 30 cents. The arrangement could be interpreted as an interchange fee, said Hewitt at Maynard, Massachusetts-based Mercator, which specializes in the payments industry.

“If the Fed says in general that your PayPal account is a regulated account and anything that moves through it can only be charged an interchange fee of 7 to 12 cents, then that certainly has a serious impact on their business model,” said Hewitt, whose 30-year career in payments included working for SunTrust Banks Inc. and a predecessor of First Data Corp. “It’s a tremendous blow.”

Instead of classifying PayPal as a payments network, the Fed could opt to view the firm as a “merchant acquirer,” a company that sets up retailers to accept electronic payments. The so-called Durbin amendment that mandates debit interchange caps doesn’t regulate acquirers’ fees.

‘Best Reading’

“The best reading of the statute on its face is it doesn’t apply to people like PayPal,” said Ronald Mann, a law professor at Columbia University in New York, whose specialties include payment systems and electronic commerce. “Could the Federal Reserve interpret that to mean something different? Yeah, they could.”

MasterCard and Visa set interchange fees and pass the money to card-issuing banks such as JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. Debit interchange totaled $16.2 billion in 2009, according to the document outlining the Fed’s proposals.

In one scenario, PayPal may benefit from the cap. That’s because PayPal pays conventional interchange fees set by Visa and MasterCard when individual customers load their accounts using debit cards. PayPal could come out ahead if it’s allowed to continue charging merchants its current fee while its own costs tied to accepting Visa and MasterCard debit cards drop.

“The card networks treat us as a merchant,” said Gorman, the PayPal spokeswoman.

Fed’s Intent

Spencer Wang, an analyst with Credit Suisse Group AG in New York, said the Fed probably won’t regulate PayPal as a payment card network.

“While the regulatory uncertainty bears monitoring, we view the implications for PayPal from the Durbin amendment as essentially neutral and potential risks as manageable,” Wang said in a Jan. 11 note to clients.

Hewitt said it’s difficult to divine the Fed’s intent.

“They’re looking very seriously at it,” she said. “They’re clearly looking for guidance.”

Susan Stawick, a Fed spokeswoman, declined to comment, as did James Issokson of MasterCard, based in Purchase, New York, and Denise Dunckel of San Francisco-based Visa.

The central bank’s rules, which must be completed in April and in effect by July 21, could affect other payments startups, such as PayPal partner Bling Nation, which had marketed itself as a cheaper alternative to Visa, MasterCard and New York-based American Express Co.

Meyer Malka, the co-chief executive officer at Palo Alto, California-based Bling, said the impact of a fee cap would be minimal because the company now is focusing more on charging for other services, such as helping retailers network with customers on Facebook and Twitter.

Credit-card interchange fees, which average about 2 percent, weren’t covered in legislation pushed by U.S. Senator Richard Durbin, an Illinois Democrat, as part of the Dodd-Frank Act that revised laws governing the U.S. financial industry.