Before credit card payments took over the marketplace, paper checks were the typical method of payment to merchants.
This has changed, however, as bank-issued cards are now the standard method of payment. What caused this change? In part, it was a shift in the balancing act issuing banks played with Interchange fees. As a result, Interchange now drives market formation and growth.
What are Interchange Fees?
Interchange fees are payments made by the merchant’s bank (acquiring) to the cardholder’s bank (issuing) for handling the credit or debit card transaction and converting the card charges to cash deposits into the merchants’ accounts. They include cost factors such as credit and fraud risk along with profit and billing services.
Interchange fees are set by the card networks and have a complex pricing structure based on criteria such as card brands, regions, type of credit or debit card, type of merchant, size of merchant and type of transaction.
Why is Interchange Necessary?
Interchange was began as a way to reimburse the cardholders’ bank for any loss resulting from the debt repayment period for the cardholder, and still today Visa refers to interchange as “interchange reimbursement fees” for that reason. Visa states “the primary role of interchange is to create the right balance of incentives between a cardholders’ financial institutions – which promote and issue Visa cards to consumers – and a merchants’ financial institutions – which enroll and process Visa transactions for merchants.”
Interchange was originally established and is continually monitored and adjusted in a manner that balances the value and economics among merchants, issuing and acquiring financial institutions and the cardholders.
What does Interchange do Specifically for Merchants and Cardholders?
Interchange benefits the merchant by increasing sales through speed, reliability and efficiency while guaranteeing payment as well as making online and phone sales seamless, greater risk management and customer loyalty.
Besides ensuring benefits for merchants, cardholders also enjoy advantages such as convenience, security, fraud protection, reliability and earned rewards from airline miles to cash back.
How has Interchange Changed over the Years?
At its inception in 1971, Interchange was one set rate, however the card networks began to “incentive pricing” of Interchange fees to encourage merchant to adopt more electronic card capture. In 2005, with more merchants accepting cards new Interchange fee schedules were announced. The card networks manage Interchange rates as a delicate balancing act – if Interchange is too costly, there is no value to merchants in accepting cards – if it is too low, it is not worth the risk for banks to issue cards.
What is the Future of Interchange?
As the credit card processing landscape changes, Interchange rates are monitored and adjusted to stay abreast of the trends. Competition among new and alternative card issuing companies will drive Interchange. Along with new and developing technology, there is a large amount of competition over market share among different card companies. Banks will issue the type of card that gives them the most profit, and this largely rests on the Interchange rate.
Another trend to be cognizant of is the ever present legal and settlement costs associated with staying on top of new governance and rules which may cause increasing Interchange to rise. An important trend to watch are the compliance mandates (Payment Card Industry Data Security Standard (PCI DSS), Patriot Act and Homeland Security). These compliance and banking payment mandates serve as an infrastructure of protection but add costs for the card-issuing companies and therefore will further increase Interchange.
- Volume and transaction size.
- Standard Industrial Classification (SIC) codes.
- Registration requisites in order for merchants to receive reduced fees.
- Compliance requisites in order for merchants to receive reduced fees.
Interchange fees, as the single largest component of merchants’ discount rate pricing, play a enormous role in the marketplace.
It is fair to say that without Interchange, payment systems as we know them today would not exist. Merchants, cardholders, card-issuing banks and credit card companies would all be wise to keep their fingers on the pulse of Interchange trends.