Interchange fee

Interchange fee is a term used in the payment card industry to describe a fee that a merchant’s bank (the “acquiring bank”) pays a customer’s bank (the “issuing bank”) when merchants accept cards using card networks such as Visa and MasterCard for purchases. In a credit card transaction, the card-issuing bank in a payment transaction deducts the interchange fee from the amount it pays the acquiring bank that handles a credit or debit card transaction for a merchant. The acquiring bank then pays the merchant the amount of the transaction minus both the interchange fee and an additional, smaller fee for the acquiring bank.

These fees are set by the credit card associations, [http://www.sec.gov/Archives/edgar/data/1403161/000119312507242653/ds1.htm United States Securities and Exchange Commission FORM S-1] , November 9, 2007.] and are by far the largest component of the various fees that banks deduct from merchants' credit card sales, representing 70% to 90% of these fees. Interchange fees have a complex pricing structure, which is based on the card brand, the type of credit or debit card, the type and size of the accepting merchant, and the type of transaction (e.g. online, in-store, phone order). Further complicating the rates schedules, interchange fees are typically a flat fee plus a percentage of the total purchase price (including taxes). In the United States, the fee averages approximately 2% of transaction value.

In recent years, interchange fees have become a controversial issue, the subject of regulatory and antitrust investigations. Only very large merchants such as Wal-Mart might have the leverage to negotiate fee prices, [http://www.minneapolisfed.org/pubs/region/06-06/interchange.cfm The Interchange Debate: Issues and Economics] James Lyon, Jan. 19, 2006.] and while many merchants prefer cash or PIN-based debit cards, most cannot realistically refuse to accept the major bankcard association-branded cards. This holds true even when their interchange-driven fees exceed their profit margins. [http://www.rnejournal.com/articles/hayashi_march06.pdf A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?] Fumiko Hayashi, March 2006.] Some countries have established significantly lower interchange fees. The fees are also the subject of several ongoing lawsuits in the United States.

Overview

[
GAO report explaining how the interchange fee works.] Interchange fees are set collectively by the financial institutions which are stakeholders in Visa and MasterCard (both public companies). Many of these banks issue both credit and debit cards. JPMorgan Chase is the largest issuer of both.

While the credit card market in the United States continues to grow, exceeding $1.3 trillion annually, the number of card-issuing banks has shrunk. The top five credit card issuing banks (JPMorgan Chase, Citigroup, Bank of America, Capital One and HSBC) now control about 90% of all credit card accounts. Card issuers now make over $30 billion annually from interchange fees, an increase of 85% since 2001.

Originally, banks operating under the Visa or MasterCard umbrellas, set interchange fees to maintain balance in the incentive structure between issuing and acquiring banks. Typically, the bulk of the fee goes to the issuing banks. Issuing banks’ interchange fees are extracted from the amount collected by the merchants when they submit credit or debit transactions for payment through their acquiring banks. Interchange fees collected by Visa [ [http://usa.visa.com/merchants/operations/interchange_rates.html Visa Interchange Rates] ] and MasterCard [ [http://www.mastercard.com/us/merchant/how_works/interchange_rates.html MasterCard Interchange Rates] ] totaled $26 billion in 2004. In 2005 the number was $30.7 billion, up 85 percent compared with 2001. Banks who provide credit cards for the very rich usually do not expect to make a significant amount of money from late fees and interest charges, and expect to make their profits on the interchange fee charged to merchants. [ [http://www.forbes.com/home/wallstreet/2007/07/03/banking-credit-wealth-biz-wall-cx_lm_0703credit.html The World's Most Exclusive Credit Cards] "Forbes", July 3, 2007.]

Interchange rates are established at differing levels for a variety of reasons. For example, a premium credit card that offers rewards generally will have a higher interchange rate than do standard cards. Transactions made with credit cards generally have higher rates than those with signature debit cards, whose rates are in turn typically higher than PIN debit card transactions. Sales that are not conducted in person, such as by phone or on the Internet, generally are subject to higher interchange rates, than are transactions on cards presented in person.

For one example of how interchange functions, imagine a consumer making a $100 purchase with a credit card. For that $100 item, the retailer would get approximately $98. The remaining $2, known as the merchant discount [http://en.wikipedia.org/wiki/Merchant_account] ] and fees, gets divided up. About $1.75 would go to the card issuing bank (defined as interchange), $0.18 would go to Visa or MasterCard association (defined as assessments), and the remaining $0.07 would go to the retailer's merchant account provider. If a credit card displays a Visa logo, Visa will get the $0.18, likewise with MasterCard. Visa's assessment is fixed at 0.0925% of the transaction value and MasterCard's assessment is fixed at 0.0950% of the transaction value. On average the interchange rates in the US are 179 bps (1.79%) and vary widely across countries; in April 2007 Visa announced it would raise its rate .6% to1.77%. [http://www.digitaltransactions.net/newsstory.cfm?newsid=1311 Visa Hikes Overall Interchange 0.6%, Effective April 14] "Digital Transactions", April 12, 2007. Retrieved May 22, 2007.]

According to Diamond, a management and technology consulting firm, only 13% of interchange costs go to processing, which is the fee’s original purpose, while about 44% goes to paying for reward programs and 35% covers cost of funds and profit margins. According to Diamond, interchange costs are “paid for by merchants without directly benefiting them or their customer relationships. In fact, these rewards programs drive consumers to payment choices that are the most expensive for merchants." [ [http://web.archive.org/web/20070122122659/http://www.diamondconsultants.com/PublicSite/ideas/perspectives/downloads/INSIGHT+-+New+Card+Business+Model.pdf A New Business Model for Card Payments] ]

According to a January 2007 poll by Harris Interactive, 32% of the public had heard of the interchange fee; once explained to them, 91% said Congress "should compel credit card companies to better inform consumers" about the fee. [http://www.latimes.com/business/la-fi-credit2apr02,1,2223589.story Card issuers, retailers at odds] "Los Angeles Times", April 2, 2007. Retrieved May 22, 2007.]

Controversy

Regulators in several countries have questioned the collective determination of interchange rates and fees as potential examples of price-fixing. Merchant groups in particular, including the U.S.-based Merchants Payments Coalition and Merchant Bill of Rights, also claim that interchange fees are much higher than necessary, [http://www.indystar.com/apps/pbcs.dll/article?AID=/20070521/BUSINESS/705210336 Merchants, pay attention to rising credit-card fees] "Indianapolis Star", May 22, 2007. Retrieved May 22, 2007.] pointing to the fact that even though US technology and efficiency has improved, interchange fees have more than doubled in the last 10 years. Issuing banks argue that reduced interchange fees would result in increased costs for cardholders, and reduce their ability to satisfy rewards on cards already issued.

Merchant lawsuits claim that interchange fees in the U.S. are out of line with falling technology costs and similar fees charged outside the United States, resulting in higher prices, lower profits and harm to the consumer. The lawsuits allege that these high fees represent collusion and price fixing among the bank card networks and their card issuing banks, in violation of antitrust laws. Bank card networks disagree, claiming interchange fees represent an effort to balance incentives to issuing banks to issue more cards with better rewards against the need to bring an optimum number of card-accepting merchants into their credit card systems. They also claim that the interchange fees bring consumer benefits such as more rewards, reduced fraud, lower interest rates and system innovations.

Senate hearings in the United States have focused on the secrecy surrounding interchange fee schedules and card operating rules. In 2006 Visa and MasterCard both released some fee schedules and summary reports of their card rules, though pressure continues for them to release the full documents. In January 2007, Senate Banking committee chairman Chris Dodd cited interchange fees at a hearing on credit card industry practices and again in March the fees were criticized by Sen. Norm Coleman. [http://hsgac.senate.gov/_files/OPENINGColemanFinal00.pdf Sen. Coleman statement] , Senate.gov, March 7, 2007. Retrieved May 22, 2007.] In January 2007, Microsoft chairman Bill Gates cited high interchange fees as a significant reason Microsoft believes it can be competitive in online micropayments.

In March 2007, MasterCard announced it was changing its rate structure, splitting the lower, "basic" tier for credit cards into two new tiers. The "Wall Street Journal" reported [http://online.wsj.com/article/SB117271151543322784.html?mod=googlenews_wsj MasterCard Alters Fee Structure] , "Wall Street Journal", March 1, 2007. Retrieved May 22, 2007.] that the document outlining the shift "makes it difficult to determine if the new rates, on average, are rising." MasterCard spokesman Joshua Peirez said the new structure "allows us to have a more sophisticated way to break up our credit card portfolio," while National Retail Federation general counsel Mallory Duncan said, "They are pricing each tier at the absolute most they can so they can maximize their income."

On July 19, 2007 the House Judiciary Committee antitrust task force held the first hearing to study the specific issue of interchange fees. NRF's Duncan testified, as did representatives from the credit card industry. Subcommittee chairman John Conyers, leading the panel, said, "While I come into the hearing with an open mind, I do believe the burden of the proof lies with the credit card companies to reassure Congress that increasing interchange fees are not harming merchants and ultimately consumers." [http://asia.news.yahoo.com/070719/3/35278.html U.S. lawmaker wants proof credit card fees don't harm] Reuters, July 19, 2007. Retrieved July 20, 2007.]

Reps. John Conyers (D-MI) and Chris Cannon (R-UT) introduced the "Credit Card Fair Fee Act" on March 6, 2008. which would create a panel of judges, appointed by the Department of Justice Antitrust Division and Federal Trade Commission to oversee interchange fees. [http://www.sltrib.com/ci_8523860 Cannon taking on credit card companies] , "Salt Lake Tribune", March 7, 2008.]

Outside the United States

In 2003, the Reserve Bank of Australia required that interchange fees be dramatically reduced, from about 0.95% of the transaction to approximately 0.5%. One notable result has been the reduced use of reward cards and increased use of debit cards. Australia also removed the "no surcharge" rule, a policy established by credit card networks like Visa and MasterCard to prevent merchants from charging a credit card usage fee to the cardholder. A surcharge would mitigate or even exceed the merchant discount paid by a merchant, but would also make the cardholder more reluctant to use the card as the method of payment. Australia has also made changes to the interchange rates on debit cards, and has considered abolishing interchange fees altogether.

As of November 2006, New Zealand is considering similar actions, following a Commerce Commission lawsuit alleging price-fixing by Visa and MasterCard. In New Zealand, merchants pay a 1.8% fee on every credit card transaction.

In 2002 the European Commission exempted Visa’s multilateral interchange fees from Article 81 of the EC Treaty that prohibits anti-competitive arrangements. [ [http://europa.eu/rapid/pressReleasesAction.do?reference=IP/02/1138&format=HTML&aged=1&language=EN&guiLanguage=en EUROPA - Rapid - Press Releases ] ] However, this exemption has expired on December 31, 2007. In the United Kingdom, MasterCard has reduced its interchange fees while it is under investigation by the Office of Fair Trading.

In January 2007, the European Commission issued the results of a two-year inquiry into the retail banking sector. The report focuses on payment cards and interchange fees. Upon publishing the report, Commissioner Neelie Kroes said the "present level of interchange fees in many of the schemes we have examined does not seem justified." The report called for further study of the issue. [ [http://europa.eu/rapid/pressReleasesAction.do?reference=IP/07/114&format=HTML&aged=1&language=EN&guiLanguage=en EUROPA - Rapid - Press Releases ] ]

On December 19, 2007, the European Commission issued a decision prohibiting MasterCard's multilateral interchange fee for cross-border payment card transactions with MasterCard and Maestro branded debit and consumer credit cards. The Commission concluded that this fee violated Article 81 of the EC Treaty that prohibits anti-competitive agreements. [ [http://europa.eu/rapid/pressReleasesAction.do?reference=IP/07/1959 EUROPA - Rapid - Press Releases ] ] MasterCard has appealed the Commission's decision before the EU Court of First Instance; while the appeal is pending MasterCard has temporarily repealed its multilateral interchange fees.

On March 26, 2008, the European Commission opened an investigation into Visa's multilateral interchange fees for cross-border transactions within the EEA as well as into the "Honor All Cards" rule (under which merchants are required to accept all valid Visa-branded cards). [ [http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/170&format=HTML&aged=0&language=EN&guiLanguage=en EUROPA - Rapid - Press Releases ] ]

The antitrust authorities of EU Member States other than the United Kingdom are also investigating MasterCard's and Visa's interchange fees. For example, on January 4, 2007, the Polish Office of Competition and Consumer Protection fined twenty banks a total of PLN 164 million for jointly setting MasterCard's and Visa's interchange fees. [http://www.uokik.gov.pl/en/press_office/press_releases/art72.html. See also the press release concerning the Hungarian investigation at http://www.gvh.hu/gvh/alpha?do=2&st=2&pg=154&m129_doc=4413]

Notes

VISA Interchange Rates are at http://usa.visa.com/download/merchants/Interchange_Rate_Sheets.pdf