Interchange Fee

“Interchange Fee” is a word referred to in the credit card and banking industries to describe the amount that the bank of a merchant pays a the bank of a customer when a merchant allows cards that use major credit card networks like MasterCard, Visa or Discover for sales transactions. In the course of sales transaction using a credit card, the customer’s bank takes away an interchange fee from the quantity that it pays to an acquiring bank for handling a debit card or credit card transaction of a merchant. At that time, the acquiring bank moves ahead and pays the merchant the quantity of the sales transaction, less the interchange fee and a smaller additional one that goes to the acquiring bank.

The credit card associations determined all of the above fees. These are the most substantial component of the many fees that banks ultimately deduct from merchant credit card sales transactions. The interchange rate can reach a total of seventy to ninety percent of these costs. The actual credit card brand, the type of credit or debit card, the type and size of the merchant that accepts payment cards and the transaction type (online store, retail location, telephone or mail order, etc.) are all factored into the complex pricing structures of interchange fees. Interchange fees usually are a flat fee in addition to a percentage of the purchase cost plus taxes. The interchange fee is typically close to two percent of the sales transaction total.

Controversies and Solutions

Interchange fees have been a contentious issue in the last decade and have been the target of antitrust and regulatory examinations. Although a lot of merchants prefer cash or ATM debit cards, most businesses can’t really refuse to accept the major bank credit payment cards or they would lose business, so they have to pay the interchange fees. Large companies that do high volumes of sales, of course, have the leverage to negotiate fee prices. Internationally, other countries offer much lesser interchange fees than those of the U.S.

The financial institutions that are stockholders in major credit card companies collectively determine the interchange fees. Of course, a fair number of banks, as such, issue debit and credit cards. Interestingly, the market of credit cards is still growing domestically, even as the credit card-issuing bank number has been reduced in recent years. The top five credit card issuing banks control nearly ninety percent of all of the credit card accounts in the U.S. today. Credit card issuers currently make over thirty billion dollars every year in interchange fees alone, up eighty-five percent since 2000.

Past, Present and Future

In the early days of the credit card industry, banks working with the major credit card companies set interchange fees in order to maintain balance in the incentive structure between acquiring and issuing banks. On the whole, the fee mostly is taken by issuing banks. The interchange fees of the issuing banks are subtracted from the total amount that merchants collect at the time that they submit debit or credit transactions at the end of the day through their acquiring banks for payment. Ultimately, banks that issue credit cards to the wealthy and/or high-credit-score customers do not typically intend to earn a lot from interest charges and late fees, but will instead make profits directly from merchants on interchange fees.

There are many different reasons why interchange rates were established, and why they continue to be a part of the industry’s financial formula. To provide an example, a high-end credit card which provides rewards will almost always have a more significant interchange rate than regular cards. Credit card sales transactions normally have greater rates than ones made by a signature debit card, the rates of which are usually higher than ATM-type debit card sales transactions. Transactions for credit card sales which are made remotely by telephone or online generally entail higher interchange rates than are those made with credit cards done face-to-face, since there is a significantly higher fraud risk when there is no cardholder presenting corroborating identification.

Bottom Line Example

To see how interchange rate is broken down, let’s look at an example. If a customer purchased a thousand dollars’ worth of lawn furniture, the merchant would receive about $980. The remaining twenty dollars, which is the merchant discount and other fees, is then divided. The interchange fee paid to the issuing bank of the credit card is close to $17.50. About $1.80 is paid to the major credit card companies as assessments. The remaining 70¢ goes to the merchant account provider of the business where the transaction took place.

If a merchant displays a major credit card company’s logo inside and/or on his door or window, that is the credit card company that is getting the $1.80. The interchange rates averages domestically about 1.8% though these rates vary widely around the world. About thirteen percent of interchange costs are for actual credit card processing, about forty-four percent is for paying for credit card reward programs and the remainder covers “cost of funds” and profits for the issuing bank.