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How do interchange fees work?
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When it comes to payments, the topic of Interchange Fees can be complex and confusing to those outside of the industry. For merchants who want to analyse and control their card acceptance costs, it's essential to grasp how interchange fees work and what factors affect them. This knowledge serves as a valuable starting point.
Interchange fees are the main driver of card acceptance costs
Merchants accepting card payments can incur several fees:
1. Interchange Fees – represent fees defined by card schemes and are ultimately passed to the cardholder's bank (known as the Issuer Bank). These fees typically represent the most significant proportion of card acceptance costs. Fees will vary depending on the card type and merchant industry, among other considerations… more detail further in this article to help de-mystify!
2. Scheme Fees - collected by card schemes to cover the cost of maintaining the payment network
3. Acquirer Fees - applied by payment providers (more specifically, merchant acquirers who are regulated entities linking merchants to card networks) to cover the cost of providing secure and reliable payment services
4. Other – payment providers can apply a wide range of additional fees depending on their services. Examples include chargeback fees, gateway fees, monthly fees, terminal fees, and PCI compliance program fees.
The pricing models applied by payment providers to charge fees vary. For simplicity, there are two main models:
Interchange Plus Plus (IC++) - involves payment providers passing on the specific Interchange Fees (IC) and Scheme Fees (the 1st "+") directly to merchants while also adding an Acquirer Fee (the 2nd "+"). The broader fees mentioned in point 4 above will be listed individually.
- This is typically the preferred pricing model of medium to larger merchants
- The detailed transparency of fees incurred presents an opportunity for analysis and to explore fee optimisation strategies
- The downside entails an increase in overhead for managing reconciliation and complexity in data analysis.
Blended pricing - simplifies things by encompassing all fees within a percentage of each transaction amount. This percentage may fluctuate between payment types, and in some instances, a fixed amount is also added, such as €0.10 per transaction along with 2.5%. Some payment providers may also tack on extra itemised fees for particular services.
- Micro or small merchants appreciate this pricing model
- Meets the need for certainty in payment costs and facilitates lower effort back-office tasks such as reconciliation.
Tell me more about Interchange Fees
Let's go deeper into interchange fees.
Payment providers are billed interchange fees per transaction directly by card schemes. The fees are defined and published by the card schemes. The Interchange Fees applied are equal to all payment providers, unlike scheme fees that can vary between companies.
See below examples of published interchange rates for the European region:
The card schemes pay Interchange Fees to the bank that issued the card to the cardholder. These fees cover the costs associated with providing their card-issuing services. In the IC++ pricing model, the payment provider passes on these fees without any extra charges and provides detailed reports to help merchants with reconciliation.
Typically, Interchange Fees are calculated as a percentage of the transaction amount. Occasionally, there may be a minimum transaction amount; conversely, the fee could be limited to a maximum currency amount.
What determines the Interchange Fee per transaction?
Where it gets complex is the wide range of scenarios that determine how an Interchange Fee is applied to a transaction. At a high level, the fee will vary based on the following factors:
Interchange Fees are applied by all international card schemes, including Visa and Mastercard, although the application of fees per card scheme will vary due to differences in commercial pricing policies.
Card schemes offer various card types, each with its own interchange rate. Examples:
- Consumer vs Commercial
- Debit vs. Credit vs. Prepaid vs. Chargecard vs. Deferred debit
Card types providing rewards are likely to incur higher Interchange Fees in order to recover the costs of running a premium card programme.
Merchants belong to specific Merchant Category Codes (MCCs) based on their business nature, and Interchange Fees vary across MCCs. Generally, the higher the perceived fraud risk, the higher the Interchange Fee.
Interchange Fees can differ based on the transaction method, usually tied to the perceived fraud risk. Online transactions typically incur higher Interchange Fees compared to face-to-face transactions in physical stores.
Interchange Fees are typically calculated as a percentage of the total transaction amount. Consequently, larger transaction amounts result in higher fees.
Interchange Fees can vary depending on both the cardholder's issuing bank's country and the merchant's location.
In recent years, Interchange Fees have faced significant scrutiny globally, with the aim of protecting merchants and consumers from excessive fees. In Europe, since 2015, EU regulation* has imposed caps on Interchange Fees in most situations within the European Economic Area (EEA), especially for consumer cards. Similar regulations limiting Interchange Fees have been enacted in the US, Canada, Australia, and other regions, although the specific terms vary among countries.
Certain types of transactions may benefit from specific interchange programs to promote their growth.
So, the takeaways
- Interchange fees represent the largest proportion of card acceptance fees
- A broad range of factors influence Interchange Fees, including merchant location, business type and card type accepted
- Consumer and business interest groups and regulators continue to scrutinise the Interchange Fees card schemes charge closely
- It is important to be informed of how Interchange Fees are determined and keep up with changes to how they are applied over time
- Further Reading: How are interchange fees calculated article by MONEI
* Regulation (EU) 2015/751 of the European Parliament and of the European Council of 29 April 2015 on interchange fees for card-based transactions, “the IFR”