What is Interchange?

Interchange fees are the single largest component of your discount rate pricing

Simply put, Interchange fees are paid by merchant-acquiring banks to cardholder-issuing banks to cover the cost to convert a charge on a cardholder's card to a cash deposit in a merchant's business checking account.   The Interchange rate is paid to the card issuing bank as a financial incentives for banks to market, issue, and accept credit risk of cardholders.  Since card issuing banks can't count on cardholders running up balances and paying finance charges, Interchange fees are particularly fundamental. 

MasterCard and Visa are competing card companies and have different market share and their customers are the banks that issue cards and acquire merchants. For example, banks can choose to issue a MasterCard card product or a Visa card product. This choice is in part made based on the Interchange levels and income to be made. Since issuing banks make the Interchange fee each time one of their cardholders uses their card at a merchant location, higher Interchange results in higher fee income for the bank.

The Network Effects of Interchange

Interchange is important to a payment system because it facilitates growth. It helps to overcome the which comes first question, "the chicken or the egg". Without cardholders, merchants would have no incentive to accept credit cards and without merchants, cardholders would not carry cards.   The network effects of adding cardholders and merchants into the payment system increase the value of the system.  The more places that accept credit cards, the more valuable it becomes to carry a card.

In the beginning, each individual merchant was extending credit to its customers.  This was expensive to manage and usually only the smallest of corner stores or the largest of big box retailers where able to effectively manage this service in-house.  To sign up merchants, the card companies had to show enough value in bringing in new customers with credit to make immediate purchases so the retailer no longer has to extend store credit or take credit risk or payment terms over time.  By paying merchants immediately and eliminating the cost of billing and collections, merchants were willing to pay the Interchange fee charged by the issuing bank.

Once established the card companies began to expand into new markets and grow the payments network.   For example, it was not too many years ago that personal paper checks dominated at the grocery industry checkout.  Today, through the use of special Interchange levels set at a reduced rate specifically for grocers, electronic card payments rule.  Or take the example of business, corporate, and government purchasing cards.  In the beginning, Interchange rates were set high to provide an incentive to card issuers to outfit business owners and their employees with credit cards to manage spending.  Now with a market of business card cardholders, more businesses are accepting cards from other businesses for payment. 

What's the future of Interchange?

Interchange is growing more complex each year. Technology advances have made it easier to implement and manage a wide array of specialized Interchange rates and fees by card type and merchant type. New indicators built into the system will allow not just by industry segmentation, but merchant segmentation within an industry. Interchange based on ticket size and volume is more promenient today.  And with the end of the mag stripe giving way to chip cards and smart phones, bar codes and the like, plus continual government regulation and court litigation, the complexity of Interchange is likely to continue. 

With the constant changes to Interchange, it is important for merchants to understand why they need a direct Interchange pass through billing structure and what they need to effective manage Interchange qualications.  Vantage is here to provide a clear view of Interchange and help you structure your billing in the most beneficial and cost effective way.

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