What are interchange fees and why do they matter?

• Interchange fees are applied when a customer makes a card payment.
• Interchange is calculated based on multiple factors and represents a cost to the merchant.
• US merchants alone paid USD 135bn in interchange fees in 2023.
• Interchange is regulated but subject to criticism.
• FinTech provides alternative payment methods to card payment.

What are interchange fees?

Interchange fees are the costs applied to a merchant when a customer makes a card payment. The fee is collected by the payment acquirer and apportioned between the card issuer, card scheme and payment acquirer.

Example of interchange fees?

For an EUR 100 card payment the unit economics may be:

Why do interchange fees matter?

The value of interchange is massive. In 2023, the global credit card payment market was estimated at USD 558bn, and is expected to grow to USD 1.15tn by 2033. 

The global debit card payment market was valued at USD 95bn in 2023 and is projected to reach $151bn by 2032.

The Banker estimates that US merchants alone pay USD 135bn in interchange fees in 2023.

Who sets interchange fees?

Interchange fees are set by the card scheme, like Visa, Mastercard and Amex.

How is interchange calculated?

The total interchange fee comprises many elements:

Card Scheme: Each card scheme has a slightly different rate.

Card Type: Credit card payment has higher interchange fees than debit or prepaid because settlement is after 30 days thus involves credit risk.

Payment Channel: Payments occur across differerent channels such as eCommerce, POS and MOTO.

Industry: Merchants receive a merchant category code (MCC), industries like travel, gambling, and charity with high chargebacks pay more.

Customer: Corporate cards are exempt from price caps and charged higher interchange fees than consumer.

Location: Cross-border and/or currency fees apply if the card payment is made in a country different to where it was issued.

Why is interchange controversial?

Merchants

Merchants know the cost of interchange but may not understand how this rate was calculated. Small merchants typically pay more than large merchants as they lack economies of scale.

Cardholders

Buyers may not know the interchange element even if it has been passed on to them by the merchant.

Regulators

Regulators are unhappy about the lack of transparency that merchants and consumers face.

Some cards offer rewards for higher spending or cashback. These encourage consumers to take high-cost credit, with the reward being financed by higher interchange e.g. the consumer pays twice.

Regulators often cite the card scheme or card issuing bank for abuse of power as they hold large market shares.

Regulation of interchange fees

In the EU, interchange fees are capped at 0.2% for consumer debit/prepaid cards, and 0.3% for consumer credit cards by PSD2.

In the US, the Credit Card Competition Act proposed in 2022 to break the Visa-Mastercard duopoly and save merchants and consumers USD 15 bn per annum is now subject to intense lobbying by the financial services industry.

Interchange fees of 0.3-0.4% in Europe, and 2% in the US are typical.

How do card schemes justify interchange?

A card scheme is a complex global network, multi-party and real-time in nature.

It takes significant capital to build and maintain them, with significant technology, compliance and service costs.

The surge in financial crime requires card schemes to invest heavily in defences to thwart payment fraud.

Can merchants negotiate interchange?

A payments advisor like Sure can analyse a merchant’s processing history and merchant service agreement to understand if rates are appropriate.

The cost of payment processing is considered alongside other factors including the payment mix, acceptance rate, settlement terms, quality of service, customer experience, etc.

How does FinTech affect interchange?

Account to Account Payments

A2A payments involve the direct transfer of funds from one bank account to another, bypassing the card payment.

 

Open Banking

Open Banking provides real-time connectivity to banks and EMIs, enable 3rd party payment initiation (of account-to-account payments).

 

PayFac Model

Payment facilitators like Stripe play multiple roles in the payment process, including card issue, acquiring, provision of merchant accounts, checkouts and payment gateway. PayFacs utilise modern technology, driving innovation in service, embedding payments and credit into eCommerce, and API ecosystems that enable automation.

 

Banking-as-a-Service

BaaS allows non-banks to offer financial services. In recent years this has seen the emergence of payment service providers specialising in niches such as card payment.

 

Alternative Payment Methods

Fintech is expanding the payment mix available to merchants. Examples include digital wallets like Google Pay, Apple Pay, and PayPal, buy now, pay later” (BNPL) services like Klarna, cryptocurrencies and direct debit.

Interchange Summary

The payment landscape has altered significantly in the past decade as regulation, technology and customer demands impact. Card payment remains favoured for convenience and is forecast to grow, even as alternatives emerge. Card schemes remain powerful and increasingly consolidate the payments industry. Merchants have a greater choice of providers and advisors can help secure the right deal.