The card networks’ credit card fees charged to merchants can significantly burden some businesses—notably smaller regional establishments, whose net profit margins are often thin.
The card companies set interchange rates, typically a percentage of the transaction amount or a flat fee, depending on the type of transaction.
Costs to Consumers
Credit card interchange fees are unavoidable for businesses that accept cards, but innovative strategies can help you minimize the impact. These fees enable payment networks and card-issuing banks to cover costs like maintaining infrastructure, managing fraud risks, and providing rewards.
Interchange fees vary widely by card type, brand, and transaction type. For instance, debit transactions typically have lower rates than credit card transactions. This is because debit cards are drawn from a bank account instead of a credit line, reducing the amount of money that could be lost in case of default or non-payment.
The most common way credit card interchange fees affect consumers is by affecting the prices of goods and services sold. Merchants often pass these fees to consumers in the form of a surcharge. These fees are typically based on a percentage of the total purchase amount. While most small business owners need the option to negotiate their interchange rates, some larger retailers may be able to use their size and influence to get better deals.
Costs to Merchants
The card companies’ interchange fees are based on a complex system of variables that include the type of purchase, where it was made, and whether the card is a rewards card. There needed to be more transparency in how these rates were calculated in the past. Still, progress has been made to standardize and streamline the process.
During a card payment, the merchant’s bank (the “acquiring bank”) sends a request to the customer’s bank (the “issuing bank”) to authorize a transaction, which takes place in real-time during a sales transaction or within one to two days after an online or mail-order sale. The issuing bank does a series of checks to ensure the card isn’t being used fraudulently, that funds are available, and that the account owner has sufficient credit.
The card-issuing banks receive their interchange fees based on the size of each transaction, and there are different rate categories for consumer and business cards. Some large corporations can negotiate with card-issuing companies to lower their costs, although they still pay these fees. In a consumer-driven economy, the fees charged by the card companies are passed along to the merchants, who typically embed them in their product prices or directly charge the fee to their customers.
Transparency of Interchange Fees
For credit card transactions to occur, a complicated contracts network must be in place between banks and payment processors. These contracts set fees for different transactions and services, including the interchange fee. The fees are intended to cover the costs of the credit risk and transaction handling that financial companies take on when consumers borrow money to make a purchase. The levels of these fees have come under increasing scrutiny by regulators and competition policy agencies, particularly concerning the role of credit card networks in setting retail prices.
The interchange rate is generally a tiny percentage of the transaction amount but can also be a flat fee or a combination. The exact amount charged depends on several factors, such as the type of transaction, whether it’s online or at a brick-and-mortar store, and the specific card used. For example, a prepaid debit card typically has a lower interchange rate than a business credit card.
Several studies have analyzed the effects of limiting credit card interchange fees. These studies generally find that lowering the merchant discount rate (MDR) results in a lower card issuer fee and a smaller merchant service charge, with a slight decrease in retail prices to consumers.
Ways to Reduce Interchange Fees
Various factors impact credit card processing fees, including the type of card used, its brand, and acceptance method (swiping versus inserting or entering the number manually). Depending on these variables, the cost can vary significantly.
Aside from these factors, the card network’s interchange fee is one of the most significant costs to merchants. This fee is set by the card networks and billed to the acquiring bank for each transaction. The acquiring bank then passes this cost on to the merchant, a non-negotiable part of your processing costs.
These fees can be impacted by public policy. For instance, the Durbin Amendment to the Dodd-Frank financial regulatory reform law capped debit interchange fees. In theory, this would help align private and social benefits to card payments by ensuring that the number of transactions was optimal for all parties.
In practice, however, determining each party’s ideal transaction amount is difficult because the demand curves for card-based transactions are not observable. In addition, precise cost data for acquirers, issuers, and merchants is still being determined. This is partly because the transaction value is a function of the total purchase volume, not just each sale. You can reduce your fees by optimizing your sales and payment processes. The first step is understanding what influences interchange rates and how they are negotiated between processors and the card brands.