Interchange Fees

A lot of attention is being paid to interchange fees as of late. Various retail groups are pushing Congress to reduce them, while Visa and MasterCard, and their member banks, are lobbying heavily in the opposite direction. It is likely that a new legislation will be passed sometime this year, although it is everyone’s guess exactly how it will regulate the interchange fees. A previous post on this blog shows how the interchange plus pricing compares to the tiered pricing model but perhaps a closer look at the interchange fees is needed.

The interchange makes up by far the largest share of the total processing costs that merchants pay for accepting card payments. Various sources put its share at anywhere between 70% – 90%, but it is estimated that interchange fees made up about 75% of the total processing fees U.S. merchants paid in 2008. Both Visa and MasterCard publish their interchange rates annually and they are available for everyone to see. Discover and American Express do not use interchange, as they act as both an issuer and acquirer for transactions involving their cards.

Interchange is the fee that a processing bank (also known as an acquiring bank, an acquirer, or a processor) pays to a card issuing bank (the issuer) when a payment card (issued by the issuer) is used by a consumer to pay for a product or a service, provided by a merchant who has established a card payment processing relationship (merchant account) with the processing bank. The issuer pays the processing bank the transaction amount minus the interchange fee. The processor then pays the merchant the transaction amount, after subtracting both the interchange fee and its own card processing cost, thus bringing the transaction cycle to an end. It is important to understand that the interchange fee is established by the Card Associations (Visa and MasterCard) and collected solely by the issuer. The fees charged by the processing bank are established and collected by the processing bank, not by Visa and MasterCard. Even if interchange fees are regulated in one way or another, this will have no effect on what the processor charges.

Both Visa and MasterCard publish dozens of different interchange fees, varying by card type (regular consumer, rewards, commercial, purchasing, etc.) and transaction environment (card-present or card-not-present). All interchange fees, however, are comprised of a percentage of the transaction amount (for example 1.90%) plus a fixed fee (for example $0.10). Neither Visa nor MasterCard disclose the exact mechanisms of establishing these rates and we do not know many details. Typically, payments that are taken in a card-not-present environment (e-commerce and MO / TO) are processed at a higher interchange than payments taken in a card-present environment. That is the reason why internet and direct marketing merchants pay higher payment processing fees than brick-and-mortar merchants like grocery stores or donut shops.

Whether interchange fees are regulated or not, merchants are not likely to gain any leverage over them. Still, it is in your best interest to know which interchange fees are applicable to your payment processing environment, so that, when reviewing a pricing proposal from a prospective processor, you will be in a much better position to make an informed decision. There are several card processing pricing structures and you can review how they compare in our Interchange Plus Pricing vs. Tiered Pricing post.

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