I often encounter three misconceptions about interchange fees. They may seem trivial, but they are truly fundamental to understanding the payment market, which will help you discuss fees more meaningfully with your partners and influence your company’s revenue.
First of all: where did the commissions come from and where are they flying to?
One of the reasons for the interchange fee to appear initially was the intention that the acquirer should pay the issuer for the fact that the cardholder is buying goods and services using a credit card and thus is increasing the merchant’s turnover. And
the interchange fee change for most of its history was skewed towards growth.
For example, Interchange fees have historically increased, with rates generally rising from 0.8-1.8% in the early 2000s to 1.5-2.3% in recent times*. This growth can be attributed to various factors, but the main one has been to stimulate cardholders to
pay with their cards.
But when the share of cashless transactions within merchants’ turnover accelerated its growth, they realized that absolute costs are growing at a much faster pace: 1.5% fees out of 10% of turnover is completely different from 1.5% fees out of 80% of turnover.
So once the share of cashless transactions in merchant turnover started reaching 50-70% and more they started pressuring card networks to reduce transaction costs, which are heavily influenced by interchange rates. This led to the introduction of special
interchange rates for specific merchant categories, discounted multipliers and other strategies to address these concerns.
As a result, interchange rates have grown more complicated, featuring various matrices, combinations, and exceptions, which complicates their analysis and forecasting.
Myth #1 (FALSE): Interchange fees are collected by card networks
Interchange fees are not just another charge from card networks; rather, they are fees utilized by networks like Visa, Mastercard, JCB, and UPI to manage the distribution of transactional revenue among their participants: card issuers and merchant acquirers.
These fees do not generate income for card networks, as the entire interchange fee is transferred directly from one member to another through the card network infrastructure.
This is fundamentally different from network fees, also known as scheme fees, which are paid by both issuers and acquirers to card networks based on their pricing guidelines for processing card transactions and other services.
Myth #2 (FALSE): The issuer gains income from the interchange fee, while it costs the acquirer
That’s not true. Depending on transaction type Interchange fees might be either paid by acquirer to issuer or vice versa.
Interchange rates are defined by the card networks (and in some regions are also regulated by financial authorities) and are used to control and stimulate the development various parts of the payments markets, e.g.:
- regionally and worldwide;
- specific transaction types;
- specific merchant categories;
- etc.
On a high level interchange rate depends on:
- card type / product;
- transaction jurisdiction (domestic, intraregional, interregional);
- merchant parameters;
- transaction type.
Myth #3 (FALSE): Issuer may rely on basic interchange rates
In the markets where interchange rates are not regulated, interchange fee associated with each card type is fully determined by the payment network. For standard mass-market cards, this fee typically falls within the range of 1.2% to 1.5% for “purchase”
transactions. On the other hand, premium card offerings generally feature interchange fees between 1.8% and 2.3%, while fees for business cards can exceed 2.0%.
Historically, issuers could confidently estimate their expected interchange revenue for “purchase” transactions based on these standard rates, which simplified financial planning. However, recent changes have introduced additional complexities: increases
in interchange fees are often counterbalanced by special rates for specific merchants, regulatory measures in various regions, and tailored programs aimed at large retailers.
Consequently, the average interchange for “purchase” transactions during processing periods frequently falls below the rates promoted by payment networks. The spending behavior of cardholders now significantly impacts the profitability of issuers, especially
when transactions occur at merchants with special agreements and lower interchange rates, resulting in decreased income.
Our review of commission structures for issuer clients shows that the average interchange for “purchase” transactions can be 20-25% lower than the initially set standards, and in some cases, even more. Therefore, ongoing and careful monitoring of interchange
rates is crucial for issuers looking to sustain their profitability.
*Note: these figures do not account for local regulations such as the EU Interchange Fee Regulation.
