Definitionally
Technically, Interchange Reimbursement Fees are a revenue transfer from Acquirers (merchant banks) to Issuers and not a charge to merchants. (This does not reflect ATM interchange fees, which flows in reverse.)
Acquirers, of course, recoup the revenue transfer to Issuers from merchants. Acquirers may recoup these fees by bundling it within a general merchant discount (fees charged by Acquirers to merchants for transaction processing services) or labeling it on the merchant monthly statement as such or as a "pass-through" charge to Visa or MasterCard.
Payment cards that do not follow a network model (e.g., American Express, Discover or private label store cards) typically do not charge an explicit interchange fee to merchants. However, the associated merchant discount for those transactions funds the analogous functionality that interchange fees fund for card-network transactions.
In Theory
Credit cards can be viewed as having two functionalities: The transaction functionality and the lending functionality.
Interchange fees were intended to balance the economics of the transaction functionality of a credit card (as opposed to the lending functionality) between Issuers and Acquirers.
The Issuer bears all the costs for the lending functionality and also receives and keeps all the associated revenues (a la finance charges). As for the transaction functionality, the Issuer shares with the Acquirer the total costs and risk of processing a transaction, but the Acquirer collects all the associated revenue for the transaction (a la merchant discount).
Interchange fees were intended to share the revenue associated with the transaction functionality by reimbursing Issuers for their share of the costs and risk of processing a transaction. In theory again, if issuers were not reimbursed for their share of the costs and risk incurred for conducting a transaction, they would have little incentive to encourage or promote that functionality.
On the Other Hand
Some believe that interchange fees are a vestigial relic of the past and are no longer needed. Issuers are very profitable and handsomely compensated for their share of the costs and risk of a transaction through the finance charges they collect on revolving balances. Even more so, some believe Issuers need Acquirers and merchants to help generate credit card balances more than Acquirers and merchants need issuers to help facilitate transactions. Most egregiously, interchange, some believe, puts an added and unneeded cost onto processing transactions, suppresses economic activity, and unfairly burdens merchants.
The Murky Middle Ground
The “On the Other Hand” community, however, has a thorny issue to overcome.
Merchants and Acquirers typically do not operate their own consumer-facing transaction processing service, replete with monthly billing to the customer, customer support service, cost of funding transactions prior to being paid, collections, risk management, losses, etc. In the absence of operating their own service, merchants and Acquirers are net-effectively outsourcing that portion of the transaction processing services by accepting card payments and ought to pay for the cost of that outsourced service.
So, the question then evolves to, not if merchants and acquirers should pay, but how much they should pay to issuers for the consumer-facing portion of the transaction processing service: Pennies per transaction, dimes, dollars per transaction. What is far and reasonable? The answer to this debate is evolving.
Interchange Qualification in the US
Visa and MasterCard interchange fees have four basic qualification factors: The issuer product presented at the point of transaction, the type of merchant accepting the transaction, data requirements to qualify for various interchange fees, and other rule-based requirements.
Issuer products
Many types of credit and debit card products exist in the economy: Signature, Infinite, Traditional Rewards, Classic, Business Purchasing, Corporate, Check (debit), Prepaid cards, etc. Each of these products has a set of interchange fees assigned to it.
Merchant and transaction types
Similar to Issuer products, various merchant categories and transaction types have sets of interchange fees assigned to them: Supermarkets, utilities, retail, hotel and car rental, restaurants, card-present, card-not-present, e-commerce, transportation, etc.
Transaction amounts may also impact interchange fees: Small ticket and large ticket programs. Very large merchants may also qualify for volume interchange fee discounts in some cases.
Data requirements
Many interchange fee sets have data requirements that need to be submitted by a merchant to receive the lowest interchange fee available for that merchant, given the combination of Issuer product presented and a merchant's assigned merchant category code (MCC). For example, Business Purchasing and Corporate cards have Level II and Level III data requirements as defined by Visa and MasterCard (e.g., sales tax and invoice detail) that need to be submitted to qualify for the best available interchange fee.
Other rule-based requirements
Many rules-based requirements also exist to qualify for the best/lowest interchange fee available to a merchant. For example, a transaction must have an approved authorization and be processed within 24 hours of the time of the transaction. A host of other technical requirements need to be accommodated to qualify for that best available interchange fees: appropriate MCC and other specific responses for various data fields.
Transactions that fail a requested interchange fee qualification may get downgraded to a Standard fee rate, the highest interchange fee available.
Durbin Amendment
The Durbin Amendment within the Dodd–Frank Wall Street Reform and Consumer Protection Act caps debit card interchange fees that can be charged to merchants (irrespective of all other qualification requirements). The amendment applies to all debit card transactions acquired in the US (PIN and non-PIN debit card transactions, and Prepaid cards transactions).
The amendment exempts small Financial Intuitions from the cap. Small institutions are defined as those with less than $10 Billion in assets. Exempt Financial Institutions continue to use a higher and more complex set of interchange fees rates.
Visa published their Interchange Fee. https://usa.visa.com/dam/VCOM/download/merchants/visa-usa-interchange-reimbursement-fees.pdf
Geographic Regions
Interchange fee schedules differ by geographic region: US vs. Europe, Latin America, Asia Pacific, and Middle East. The region in which a transaction is acquired (the region in which a merchant conducts a transaction) dictates which interchange fee schedule applies.
Currently, the US region has the highest interchange fees of all the regions and consequently facilitates an exception to cross-border interchange fees. If a cardholder conducts a transaction with a US-issued card in a different region, the associated issuer receives interchange revenue as specified by the fee schedule of that other region. However, if a cardholder conducts a transaction with a card issued from a non-US region with a US-acquired merchant, the associated issuer in the other region receives only the interchange revenue associated with the interchange fee schedule for that other region. The difference in interchange fee between the two regions is kept as a revenue to Visa.
Revenue Importance
Interchange fees typically equate to 10% to 15% of all revenues for a credit card portfolio.
For debit and purchasing cards (products without a revolving line of credit – balances due in full each month), interchange fees constitute most or all of the direct revenues for those products.
In Reality Today
Despite all the definitions and theory stated, interchange fees in reality are just another price point with which Visa and MasterCard use to manage Issuer and Acquirer behavior, compete with each other and other payment options, and maximize profitability for shareholders.
© 2023 Robert Holden
Technically, Interchange Reimbursement Fees are a revenue transfer from Acquirers (merchant banks) to Issuers and not a charge to merchants. (This does not reflect ATM interchange fees, which flows in reverse.)
Acquirers, of course, recoup the revenue transfer to Issuers from merchants. Acquirers may recoup these fees by bundling it within a general merchant discount (fees charged by Acquirers to merchants for transaction processing services) or labeling it on the merchant monthly statement as such or as a "pass-through" charge to Visa or MasterCard.
Payment cards that do not follow a network model (e.g., American Express, Discover or private label store cards) typically do not charge an explicit interchange fee to merchants. However, the associated merchant discount for those transactions funds the analogous functionality that interchange fees fund for card-network transactions.
In Theory
Credit cards can be viewed as having two functionalities: The transaction functionality and the lending functionality.
Interchange fees were intended to balance the economics of the transaction functionality of a credit card (as opposed to the lending functionality) between Issuers and Acquirers.
The Issuer bears all the costs for the lending functionality and also receives and keeps all the associated revenues (a la finance charges). As for the transaction functionality, the Issuer shares with the Acquirer the total costs and risk of processing a transaction, but the Acquirer collects all the associated revenue for the transaction (a la merchant discount).
Interchange fees were intended to share the revenue associated with the transaction functionality by reimbursing Issuers for their share of the costs and risk of processing a transaction. In theory again, if issuers were not reimbursed for their share of the costs and risk incurred for conducting a transaction, they would have little incentive to encourage or promote that functionality.
On the Other Hand
Some believe that interchange fees are a vestigial relic of the past and are no longer needed. Issuers are very profitable and handsomely compensated for their share of the costs and risk of a transaction through the finance charges they collect on revolving balances. Even more so, some believe Issuers need Acquirers and merchants to help generate credit card balances more than Acquirers and merchants need issuers to help facilitate transactions. Most egregiously, interchange, some believe, puts an added and unneeded cost onto processing transactions, suppresses economic activity, and unfairly burdens merchants.
The Murky Middle Ground
The “On the Other Hand” community, however, has a thorny issue to overcome.
Merchants and Acquirers typically do not operate their own consumer-facing transaction processing service, replete with monthly billing to the customer, customer support service, cost of funding transactions prior to being paid, collections, risk management, losses, etc. In the absence of operating their own service, merchants and Acquirers are net-effectively outsourcing that portion of the transaction processing services by accepting card payments and ought to pay for the cost of that outsourced service.
So, the question then evolves to, not if merchants and acquirers should pay, but how much they should pay to issuers for the consumer-facing portion of the transaction processing service: Pennies per transaction, dimes, dollars per transaction. What is far and reasonable? The answer to this debate is evolving.
Interchange Qualification in the US
Visa and MasterCard interchange fees have four basic qualification factors: The issuer product presented at the point of transaction, the type of merchant accepting the transaction, data requirements to qualify for various interchange fees, and other rule-based requirements.
Issuer products
Many types of credit and debit card products exist in the economy: Signature, Infinite, Traditional Rewards, Classic, Business Purchasing, Corporate, Check (debit), Prepaid cards, etc. Each of these products has a set of interchange fees assigned to it.
Merchant and transaction types
Similar to Issuer products, various merchant categories and transaction types have sets of interchange fees assigned to them: Supermarkets, utilities, retail, hotel and car rental, restaurants, card-present, card-not-present, e-commerce, transportation, etc.
Transaction amounts may also impact interchange fees: Small ticket and large ticket programs. Very large merchants may also qualify for volume interchange fee discounts in some cases.
Data requirements
Many interchange fee sets have data requirements that need to be submitted by a merchant to receive the lowest interchange fee available for that merchant, given the combination of Issuer product presented and a merchant's assigned merchant category code (MCC). For example, Business Purchasing and Corporate cards have Level II and Level III data requirements as defined by Visa and MasterCard (e.g., sales tax and invoice detail) that need to be submitted to qualify for the best available interchange fee.
Other rule-based requirements
Many rules-based requirements also exist to qualify for the best/lowest interchange fee available to a merchant. For example, a transaction must have an approved authorization and be processed within 24 hours of the time of the transaction. A host of other technical requirements need to be accommodated to qualify for that best available interchange fees: appropriate MCC and other specific responses for various data fields.
Transactions that fail a requested interchange fee qualification may get downgraded to a Standard fee rate, the highest interchange fee available.
Durbin Amendment
The Durbin Amendment within the Dodd–Frank Wall Street Reform and Consumer Protection Act caps debit card interchange fees that can be charged to merchants (irrespective of all other qualification requirements). The amendment applies to all debit card transactions acquired in the US (PIN and non-PIN debit card transactions, and Prepaid cards transactions).
The amendment exempts small Financial Intuitions from the cap. Small institutions are defined as those with less than $10 Billion in assets. Exempt Financial Institutions continue to use a higher and more complex set of interchange fees rates.
Visa published their Interchange Fee. https://usa.visa.com/dam/VCOM/download/merchants/visa-usa-interchange-reimbursement-fees.pdf
Geographic Regions
Interchange fee schedules differ by geographic region: US vs. Europe, Latin America, Asia Pacific, and Middle East. The region in which a transaction is acquired (the region in which a merchant conducts a transaction) dictates which interchange fee schedule applies.
Currently, the US region has the highest interchange fees of all the regions and consequently facilitates an exception to cross-border interchange fees. If a cardholder conducts a transaction with a US-issued card in a different region, the associated issuer receives interchange revenue as specified by the fee schedule of that other region. However, if a cardholder conducts a transaction with a card issued from a non-US region with a US-acquired merchant, the associated issuer in the other region receives only the interchange revenue associated with the interchange fee schedule for that other region. The difference in interchange fee between the two regions is kept as a revenue to Visa.
Revenue Importance
Interchange fees typically equate to 10% to 15% of all revenues for a credit card portfolio.
For debit and purchasing cards (products without a revolving line of credit – balances due in full each month), interchange fees constitute most or all of the direct revenues for those products.
In Reality Today
Despite all the definitions and theory stated, interchange fees in reality are just another price point with which Visa and MasterCard use to manage Issuer and Acquirer behavior, compete with each other and other payment options, and maximize profitability for shareholders.
© 2023 Robert Holden