Interchange Fees Explained

When doing business, merchants have to deal with all sorts of processing fees. In this article, we will look at the most significant part of IC++ pricing – Interchange

What are Interchange Fees?

Interchange fees are fees paid by the merchant’s bank (the acquirer) to the customer’s bank (the issuer) for each card transaction. The purpose of these fees is to cover the costs and risks of the issuers associated with their card issuing programs as well as to incentivize usage of a specific card network.

How are interchange fees determined?

Interchange rates are established by the card networks: Visa, Masterсard, Discover etc. These rates are not static – Visa and Masterсard usually update them twice a year , other networks – annually. The calculation of interchange fees is rather complex and depends on various factors, such as:

• Card brand
• Card type
• Region of the issuer, acquirer and the merchant
• Merchant’s business type
• Transaction type
• Identity of the cardholder (individual or legal entity)
• Security protocol used

The volume of transactions of a particular issuer, acquirer or a merchant is also taken into regard. Big merchants like Amazon or Walmart, for example, negotiate lower interchange fees which vary based on what is being sold, where, how and to whom. Furthermore, it should be mentioned that there are dozens of “smaller” fees that make up the overall interchange commission for each particular transaction, therefore transparency is often an issue.

Regulated and unregulated interchange

In some countries, card networks can solely determine the size of the interchange fee. In other countries, the interchange may be regulated by the Central Banks or other authorities.

In Europe, for example, The Interchange Fee Regulation caps interchange fees on EEA domestic and EEA cross-border consumer debit and credit transactions, and the Schemes set interchange fees on these transactions in compliance with the Interchange Fee Regulation. A similar approach is also applied in Australia.

Where not regulated, the Schemes set interchange rates based on their own judgment. In 2015, the EU adopted Interchange Fee Regulation (IFR). The purpose of this regulation was to place a cap on interchange fees for consumer card payments, to reduce fees merchants pay, and to ensure that their costs for accepting card payments are not higher than cash payments.

The interchange fee cap in the EU for debit card payments is 0.2% of the transaction, and for credit cards, it is 0.3%. It has been estimated that the IFR has saved merchants EUR 1.2 billion per year in fees and significantly increased card acceptance.

High interchange fees – good or bad?

Generally, it may be said that higher interchange fees lead to higher revenues for the issuing banks. Lower interchange fees, in their turn, contribute to lower prices for the merchants and, ultimately the consumers. At the same time, there are several factors that should also be considered in this regard:

• The higher the interchange fees are, the more space is created for the development of alternative payment methods, which may be cheaper
• If the issuing banks do not cover the costs of their card programs with interchange fees, the quality of their card offering may become lower

IC++ Pricing VS Blended Pricing

Interchange++ is a type of pricing, which breaks down the acquiring fees of a merchant on three components:

• The Interchange fee that goes to the issuing bank
• The scheme fee that goes to the Schemes (first +)
• The acquirer fee (second +)

Although this approach is more transparent for the merchants, its calculation and accounting is way more complicated as multiple factors should be taken into account and in many cases the merchant is unable to know the price for one or another transaction before it actually takes place. In order to resolve this problem, many acquirers use blended pricing (for example, 2.9% + fixed fee for each transaction). Generally, it may be said that blended pricing is more convenient for the startups and SMBs, while IC++ pricing works better for large businesses and corporations, which can use various mechanisms to save costs and make wider and smarter data-driven decisions when accepting payments.

Are interchange fees negotiable?

In majority of cases, interchange (as well as the Schemes’ fees) cannot be negotiated. However, you can negotiate your acquirer’s markup.

How to Calculate Interchange Fees

Interchange fees are calculated as a percentage of the transaction. The percentage is based on EU regulations, the type of card used, and the fee set by the card issuing company. The max interchange fee for a credit card transaction in the EU is 0.3%. So on a $100 credit transaction, the merchant would pay a maximum of $0.3 ($100 x 0.003).

Factors affecting interchange rates

The interchange rates can vary significantly from transaction to transaction. Here are the key factors that influence interchange fees:

1. Card Issuing Company – Card issuing companies are free to set their own interchange rate as long as it is not over the EU cap. Visa and Mastercard typically charge the lowest fees while American Express charges the highest.
2. Credit Card vs. Debit Card – Debit cards have much lower interchange fees compared to credit cards (as much as 5x lower), because there is far less risk involved in processing debit card payments.
3. Type of Transaction – Only consumer transactions are subject to the EU interchange fee cap, corporate transactions tend to have much higher fees as card issuing companies can set their own fee.

Interchange Fee Rates Examples

To see just how much interchange fee rates can differ based on different types of cards and purchases, check out this interchange fee example:

A woman comes into your store and decides to go on a shopping fee and buys $1000 worth of clothes. You have a massive smile on her face until she pulls out her American Express card. Based on American Express’ interchange fees, you could end up coughing up as much as $35! But if the woman had used a Visa, the fee could be as low as $14.

The average Visa and Mastercard interchange fee rate ranges from 1.4% (Visa) or 1.5% (Mastercard) to 2.5% (Visa) or 2.6% (Mastercard). However American Express has much higher interchange fees, ranging from 2.3% to 3.5% which is why American Express’ acceptance rate is much lower than Visa or Mastercard.

Whether a customer uses a credit or debit card also greatly impacts the interchange fee and the location of the card issuer. The average interchange for credit cards is around 2%, but it is only 0.3% for debit cards.

For example, let’s say a person with an EU-issued credit card goes online and purchases 2 airline tickets for $500. The merchant would only have to pay a 0.3% interchange fee due to the EU IFR regulation. However, if that same person uses a non-EU-issued credit card, the interchange fee could surpass 2%!

How to Keep Away From Interchange Fees

Are interchange fees eating into your bottom line? Fortunately, you can shave interchange rates by:

1. Promoting debit card usage
2. Negotiating with the credit card company
3. Prioritizing certain types of transactions
4. Using Address Verification Service (AVS)
5. Exploring alternative payment types

Promote debit card usage

Debit cards have an interchange fee of 0.2% in the EU, while credit cards have a 0.3% interchange fee. If your business is generating a significant amount of sales, for example, $10 million per year, if you could convince 100% of your customers to use debit cards instead of credit cards your business would have an extra $10,000 in annual revenue.

Try to cut your charges by haggling with the credit card company

If you are a large company, you definitely have some negotiating power! Often a card issuer will offer a small discount if you generate a significant amount of revenue and are able to thrive without their card network. Even if you are a small company, it doesn’t hurt to ask for a discount.

Check the transaction types you use

Card present and card not present transactions have completely different interchange fees when the card is issued outside the EEA. For example, a non-EU-issued Visa consumer credit card used in a card not present transaction has a 1.5% interchange fee, while an EU-issued Visa credit card has just a 0.3% interchange fee. Also, business transactions are not subject to the EU price cap. For a Visa business credit card transaction, the interchange fee is 2.05% but for a Visa consumer credit card transaction, the interchange fee is just 0.3%.

Use the address verification service (AVS)

If a transaction you process gets hit with a chargeback, you lose the interchange fee applied to the transaction. Also, if your business is subject to a number of chargebacks, your company may be deemed high risk, and the card issuing company could increase your interchange fee. To avoid this situation, you should use an Address Verification Service (AVS). AVS reduces the chances of fraudulent transactions by automatically verifying the cardholder’s billing address with the card issuer.

To use AVS, you need to collect the buyer’s billing address and submit it while making an authorization request. You then need to develop a system based on the results of the AVS. For example, if neither the postal code or address match the card, you may opt to automatically decline the payment. While if the address matches but not the postal code, you may set a purchasing limit.

Consider alternative payment types

Alternative payment methods often lower transaction costs especially compared to credit cards. Here are some common popular cheap alternative payment types worth exploring:

• Online bank transfer – Give your customers the ability to send money directly from their bank account to yours and cut out the middlemen!
• E-wallets – E-wallets allow consumers to make secure electronic cashless transactions from an app. Popular e-wallets include Apple Pay, Cash App, PayPal, Google Pay, and Venmo.
• Prepaid cards – Prepaid cards are similar to debit cards but are not connected to a bank account and instead have money loaded on them. Visa, Mastercard, and Paysafe are common providers.

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