We all find credit and debit cards useful, for lots of reasons. We don’t have to carry so many notes and coins around. Cards are more secure. They give us more flexibility in budgeting our spending.
But of course, it costs money to develop and run the systems which support card transactions.
The banks recover this money through interchange fees.
In this article, we will look at what these interchange fees are and how they are applied. We will also look at how the fee structures have changed recently.
When you buy a cappuccino from a coffee bar with cash, there are just two parties to the transaction: you and the retailer.
But when you pay with a card, there are two further parties involved. There’s the bank who issued your card, and there’s the retailer’s bank (also known as the acquirer).
These two banks are also part of the very same transaction. And they are involved in real time; not later, but at the moment when you put your card into the card reader.
Several things happen in quick succession. The card reader triggers a request from the retailer’s bank to your bank. You authorise your bank to charge your card. Your bank releases payment to the retailer’s bank. The retailer’s bank confirms receipt to the retailer. And finally, the retailer hands over your cappuccino.
Something else happens too. A credit card provider normally guarantees your purchase. That may not matter so much when you’re buying a coffee, but it’s very valuable if you’re buying a computer or a cruise.
Over time, the industry is trying to make cards more convenient still. For example, many cards are now contact-less, and it’s increasingly common to use a mobile phone as though it were your card.
All these things cost money, of course. The IT systems which the banks use to process the transactions. The security measures which reduce fraud. The guarantees in cases where one party to the transaction defaults.
These costs are costs of the whole system, and they need to be balanced out between the various participants. Which is why interchange fees exist.
Imagine buying a computer for £1000 using your credit card. The bank that issued your credit card doesn’t hand over the full £1000 to the retailer’s bank. It deducts the interchange fee first.
Since 2015, the EU has capped interchange fees for domestic credit card transactions at 0.3% of the value of the transaction. You pay for your £1000 computer with a credit card, and the interchange fee is capped at £3. So your bank pays the retailer’s bank only £997.
The retailer’s bank will reduce the payment to the retailer further still, to reflect processing costs and costs of the card reading systems. In this example, the retailer might receive £995. The total cost of £5 borne by the retailer – including the £3 interchange fee – is called the Merchant Service Charge or MSC. This is negotiable, and large retailers tend to get much better deals than small merchants.
So the interchange fee is paid by the retailer’s bank but is passed on as part of the MSC to the retailer. Visa and Mastercard try to prevent the retailer passing on these charges in the form of higher prices which discriminate against card users.
For debit cards used in domestic transactions, the cap is slightly lower, at 0.2%.
Note that the caps apply only to personal cards with an intermediary, not to Amex cards or cards issued to businesses. Cards issued to businesses often include the words ‘business’ or ‘purchasing’ or ‘corporate’ on the face of the card. The multilateral interchange fees for these cards can be much higher - at between 1.3% and 1.5% in the EU, for example.
SOURCE: Visa Europe.
For retailers who (ultimately) have to pay the fee, it’s obviously better to have a cap rather than not having one. But in practice, in the transition to the new rates, some transactions will cost less and some will cost more.
That’s because fee structures are moving from fixed or tiered to variable – a percentage of the value. So high value transactions will cost more than they used to.
Take Visa’s interchange fees for consumer debit cards, for example. Before March 2015, they used to charge 8p fixed rate for a Chip and Pin transaction. They then changed to a 0.2% (+1p) flat rate fee.
- For a low value transaction, e.g. £20, the interchange fee fell from 8p to 5p.
- But for a higher value transaction of £100, the fee rose from 8p to 21p.
Visa offered some transitional relief – which meant that all Chip and Pin debit transactions above £245 were capped at 50p.
However, those transitional arrangements ended on 1st September 2016, so very high value transactions have become much more expensive in terms of interchange fees. A £5000 debit transaction used to cost 8p, then 50p under the transitional arrangements, and will now cost £10.
Where the value of the transaction is low, the interchange fee might fall. But it is not certain that the seller’s bank will reduce the overall Merchant Service Charge to the seller. The MSCs are often fiercely negotiated and banks have a track record of not always passing on savings.