The Role of Interchange Fees and the Organization of payment networks
Interchange fees keep the payment system in balance and is designed to maximize both merchant acceptance and card issuance. It’s important to understand that there are two consumers of payment systems – the cardholder and the merchant.
Two types of payment systems
- A four party payment system like MasterCard and Visa which is characterized as an open loop system with explicit Interchange fees. The four parties are: 1) Issuer 2) Cardholder 3) Merchant 4) Acquirer.
The four party payment system:
- The cardholder’s issuing bank markets and issues payment cards to consumers, and extends credit to cardholders from the time a purchase is made until payment is due.
- The cardholder uses a payment card to purchase goods and services at millions acceptance locations around the world.
- The merchant accepts payment cards in exchange for goods and services, and receives increased sales.
- The acquiring bank enrolls merchants into programs that accept payment cards.
- A three party payment systems like American Express which is characterized as a closed loop system with implicit Interchange fees. In proprietary three party systems, managers chose customer and merchant fees to maximize its profit.
Organization of Payment Networks
In the US, payment card networks coordinate the activities of thousands of financial institutions that issue cards, millions of retail locations that accept them, and several hundred million consumers that use them. This coordination may include the collective setting of certain prices and other network rules.
- Card issuers are banks that offer cards to consumers and determine the level of any fees or finance charges their customers see on their regular statements
- Merchants also have banks, called acquirers that process card payments on their behalf. Merchants pay their acquirer for these services by accepting a merchant discount
- Bankcard Associations coordinate through Networks, Rules & Pricing. In a 4 party system, with so many participants, coordination is essential