Understanding the cost of a transaction is a key metric for any merchant. Different payment methods attract different costs. For card payments, one of the most significant is known as the ‘interchange fee.’ Yet, many merchants don’t have a clear view of what it is or how much it costs them. That makes it harder for them to manage the cost more effectively, which in turn hurts their profit margins.
In this article, we’ll be going back to basics, explaining what the interchange fee is, how merchants can get more visibility over what it’s costing them, and how they may be able to pay less.
What is the interchange fee?
Let’s remind ourselves of what happens when a card payment takes place. The merchant’s bank (the acquirer) sends a payment request to the customer’s bank (the issuer) via the card network. The issuing bank then performs a number of checks to determine whether to accept or reject the request, mainly to ensure that the card isn’t being used fraudulently and that the customer has the necessary funds or credit in their account.
The issuing bank then deposits the money with the acquiring bank — or sends a rejection notice. Though all this happens in the blink of an eye, it’s a complex process for which the issuing bank gets paid. This is known as the interchange fee.
In theory, the interchange fee is charged by the card scheme to the acquiring bank. However, the card operator passes this fee to issuing banks as an incentive for the banks to offer and promote their card over others. That’s why most people understand the interchange fee as taking place between the issuing bank and acquiring bank.
In practice, the issuing bank withholds the value of the interchange fee, and the acquiring bank simply passes this balance through when they deposit the funds in the merchant’s account. So, in the end, it’s the merchant that foots the bill.
How much is the interchange fee?
Though the interchange fee is ‘paid’ to the issuing bank, the rate is set by the card networks. The interchange fee is made up of a percentage of the transaction value plus a fixed fee. There is no standard rate.
Instead, individual card networks take into account a range of criteria to determine the interchange fee, including:
- The type of card
- How the payment was made (i.e. online vs. in-person)
- The security protocols used (i.e. chip and pin, 3DSecure)
- What sector the merchant is operating in
- The country where the transaction has taken place
- Where the card was issued. For example, if the acquiring bank and the issuing bank are in different countries or jurisdictions, a higher interchange fee will reflect the additional complexity of the payment process.
The volume of transactions is also considered, with big merchants expecting to negotiate lower interchange fees. In other words, there are different interchange fees depending on what is being sold, where, how, by who, and to whom. There are actually hundreds of ‘mini’ fees that make up the overall interchange fee for each transaction. So transparency is an issue.
Demystifying interchange fees
With interchange fees becoming better understood (and their cost and complexity questioned by merchants and regulators alike), new initiatives have been introduced to improve transparency and fairness.
For example, in the European Union, interchange fees are now capped at 0.2% of the transaction value for consumer debit cards and 0.3% for consumer credit cards. Australia has since adopted similar controls.
In the United States, there is no cap on interchange fees for credit card payments, but the Durbin Amendment caps interchange fees on debit card payments at $0.22 per transaction and five basis points multiplied by the value of the transaction — only where the card is issued by banks with over $10 billion in assets.
Other changes have been about providing merchants with better insight into what they’re paying in interchange fees. One of the most significant has been the introduction of Interchange++ pricing, also known as unblended or unbundled pricing.
Traditionally most merchants have paid a standard ‘bundled’ interchange fee for all their transactions — especially when working with legacy payments providers or those primarily serving the SMEs. That's why that 48% of merchants do not receive a detailed breakdown of their payment costs from their payment service providers. Switching to a provider that offers Interchange++ pricing can help merchants solve this issue by giving them more transparency into the fees they pay.
Interchange fees may be inescapable, but how much merchants pay is not. Seemingly small percentage fees can quickly amount to become a drag on growth, especially for smaller merchants with tighter margins. For larger companies, ignorance of interchange fees can mean millions in avoidable costs. But as we’ve seen with other aspects of payments, the innovative merchants will view interchange fees as not just a chance to save costs. The enhanced transparency and insights from interchange++ are also an opportunity to make wider and smarter data-driven decisions.