While credit card companies generate large amounts of revenue through interest and fees from cardholders, they also draw income from interchange fees paid by merchants who accept their cards.
Interchange fees are essentially fees charged to merchants for the processing of credit card payments. The fees can run as high as 5 percent of every purchase, depending on the card company and the merchant. This is the reason why many merchants don’t accept some credit cards, or would prefer to be paid in cash or by check.
Interchange fees are big revenue generator for credit card companies. According to industry experts, the average American household pays about $337 in interchange fees as a result of their credit card purchases each year. This amounts to about $48 billion in revenue for credit card companies per year. In 2005, Visa and Mastercard, the two leading companies which control about 90 percent of the payment processing market for credit cards collected about $30 billion in interchange fees.
How it works
There are two key players in credit card issuance, the banks issuing the cards and the company handling payment. Banks provide the capital that’s lent through the credit cards, and the payment processing companies handle the transactions. That’s why your Acme Bank, Generic Bank or Omni Bank cards may also be Visa or Mastercard cards.
Merchants have agreements with Visa, Mastercard or other payment processors to accept their cards. For their work in processing transactions made with credit cards, the merchants must pay a portion of the transaction to the credit card company. The banks issuing the credit cards get a cut of this interchange fee, as do the payment processors (i.e. Visa, Mastercard, etc.).
According to industry experts, interchange fees have a very complicated price structure, which is determined by the type and brand of credit card being used, the size and business of the merchant, and the nature of the transaction being processed. The average interchange fee in the U.S. is about 2 percent of the value of the transaction, but some fees may be higher than this average. Online sales and telephone sales tend to carry higher interchange fees than other credit card transactions.
Controversy
Interchange fees have become a sore issue in the market, as they cut into merchants profits and contribute to inflation. In the U.S., the fees have come under investigation for alleged violations of antitrust and fair trade law.
Some economists argue that interchange fees lead to higher prices because merchants must increase prices to offset the cost of interchange fees. Refusing to accept credit cards isn’t practical for most businesses, as fewer and fewer customers are choosing to carry cash to pay for transactions. While large chains like Wal-Mart may be able to use their size to leverage reduced interchange fees, smaller businesses don’t have the muscle to pressure credit card companies into accepting such an agreement.
Merchants are also arguing that the costs to credit card processors that interchange fees are supposed to help defray have decreased as information technology has made payment processing easier. Despite the improvements in technology, the interchange fees have doubled in the past decade. Credit card companies claim that the interchange fees help offset the cost of rewards offers to clients, and that doing away with them would result in increased fees and higher interest to cardholders.
Several lawsuits have been filed claiming that the credit card companies interchange fee policies violate federal antitrust and price fixing law. Credit card companies have been extremely closed-mouthed about their interchange fees structure and policy, and only released this information to Congress after considerable pressure was exerted by lawmakers.
How other countries deal with interchange fees
Several foreign countries have some strict regulations dealing with interchange fees. For example, Australia forbids interchange fees of higher than .05 percent of transactions and also allows merchants to tack a surcharge directly on the purchases of customers paying by credit card. The result has been a reduction in the use of credit cards for payment. The European Union has fined banks regarding interchange fees and is considering legislation to more tightly regulate interchange fees on the premise that these fees constitute price fixing by credit card companies and banks.
In the U.S., Congress has made hints that it may decide to examine possible legislation concerning interchange fees in the near future. The U.S. government has taken steps to regulate other perceived excesses of the credit card industry in recent months that target cardholders.