Interchange Fees: Everything You Need to Know

interbank fees

Interchange fees operate basically as transaction fees which the merchant’s bank account is required to pay whenever one of their customers makes a purchase from their store and pays it via credit or debit card.

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Accordingly, interchange fees can add up rather quickly, so if you’re running a business, it is important to understand how they work and how to get the best out of your transactions.

As such, if you’re looking for a clever idea to keep interchange fees from chipping away at your margins, read on because we’ve got seven!

Why Do Interchange Fees Exist?

The reason for paying them is simple: the card-issuing bank is working towards covering handling costs, as well as fraud and bad debt costs. Moreover, it handles the added risk which is inherent to having to approve the payment, especially when it is a cross-border payment.

Whenever a customer buys something with a credit card, be it Visa, Mastercard, or American Express, for example, four parties get immediately involved: the customer, his bank, your business, and your business’ bank.

Both banks will need to perform mandatory steps to ensure that your client’s payment is rightly processed and securely transferred.

As that happens, your customer’s bank will send his payment to your bank (commonly referred to as the acquiring bank) a small fee must be retained: this is the interchange fee.

Once a transaction is made by means of a card scheme (think Mastercard, Visa, and so forth), the acquirer must pay an interchange fee to the cardholder’s bank. Subsequently, the business will have to pay the interchange fee back as a fraction of the card processing fee.

In fact, payment card processing is composed of three fees:

  1. The acquirer markup
  2. The card scheme fee for using the card’s network
  3. Interchange fee which is charged by the cardholder’s bank and usually represents the largest part of card processing fees

What Are Interchange Fees Used For?

Interchange fees are used as means to keep the payment systems functioning as quickly and as securely as possible.

Accordingly, interchange fees are currently helping to cover the costs of ongoing card services (rather than that cost being passed onto the end consumer) while also contributing to investment in the electronic payment industry and reducing fraud.

This investment paved the way for things like contactless payments, something which everyone around the world can benefit from today.

Interchange fees help run things like fraud prevention systems, the system’s maintenance, and even customer call centers.

How Are Interchange Fees Charged?

Payment processors, payment gateways, the merchant’s bank, card-issuing banks, and credit card payment networks will all charge each transaction with a percentage-based fee.

These charges can be bundled up or appear individually on your payment processing bill.

Interchange Fees: Static, Variable, or a Bit of Both?

For example, EU interchange fees are composed of many smaller fees, all of which are determined by highly complex variables.

As a way of simplifying costs for business owners and merchants, companies will often bundle them into a flat rate and add a percentage of the sales total after taxes.

You will find that card networks provide materials like rate tables for different types of products, cards, merchants, and even transactions. Moreover, they will periodically update their interchange rates, so it will be straightforward to keep track of those.

How Are Interchange Fees Calculated?

The standard way of the procedure here is that each transaction is met with a percentage of the sale amount, and added to that there will be a set transaction fee.

The rate which is applied is likely to vary between card networks, transaction types, card types, and so forth.

Interchange Fees Pricing Models

The pricing model that payment processors tend to use is usually one of these two:

  1. Interchange fee plus pricing: in which your business pays the associated interchange rate as well as a markup that will cover the processor’s associated services and fees.
  2. Flat-rate pricing: in which you’ll find a set rate that is based upon the type of transaction and will obviously cover the processor’s services, assessment fees, and so forth.

What Are the Problems Surrounding Interchange Fees?

Normally you’re told that competition will lead to lower prices given that companies will compete with one another by offering the lowest price they possibly can and thus beating their competitors.

However, when it comes to interchange fees or interchange fees regulation, it seems that the opposite was happening.

Issuing banks benefit from revenues from interchange fees, something which made it so that card schemes would compete by offering high interchange fees.

This would lead to an added cost for businesses which would then increase the price of their offerings and thus make the fees indirectly paid by their customers who would be fully unaware of them.

Businesses were in no position to refuse the most common cards because that would lead customers straight to their competitors, so they had to accept higher costs for those card payments while also having to slightly raise their prices.

The regulation was put in place in some places, usually capping interchange fees, as a way to change this situation and to protect both businesses and consumers from such practices.

What Factors Can Affect Interchange Fees?

The three most important factors are:

  1. The card type used in the transaction: debit cards with PINs will usually have the lowest rates (certainly lower than a credit card) given the low risks they entail. Each card company will charge its own rate. As for rewards cards, the cost of the perks they offer their holders is normally passed along to the business via interchange rates.
  2. The size of the business and its industry: different business types will be met with different rates. Normally, the larger the business the lower the rates.
  3. The transaction type: Point of sale transactions are low risk compared to, for example, a card-not-present (CNP) type of transaction given that there is less risk when you can scan a chip or enter a PIN code.

How Can Your Business Save on Interchange Fees?

Interchange fees like many other things are just a part of doing business and surely the net gain from accepting credit cards will outweigh the cost. However, you shouldn’t just accept this as something set in stone without trying to get yourself the best possible conditions.

Here Are the 7 Best Ways of Getting Low Interchange Fees:

  1. Understand that some payment types are better than others: you may find that prioritizing cash payments, card-present purchases or the usage of debit cards over credit cards will keep your interchange fees as low as possible.
  2. Compare pricing modes: if you compare the pricing models on the basis of the most common card types which are being used to make purchases, you can reduce fees by adjusting either to flat-rate (if credit cards prevail) or to interchange-plus (if debit cards represent the majority of purchases). When comparing, you’ll want to factor in everything, so remember to take additional costs into the equation.
  3. Consider adding surcharges (credit card only): albeit not the most elegant of solutions, adding a surcharge to credit card usage will cover your costs by simply passing them along (partially or entirely) to your customers. Keep in mind that some areas can either limit or prohibit surcharging entirely. If you’re in the EU, for example, you might want to check the legislation concerning interchange fees.
  4. Be on the lookout for volume discounts: depending on your sales, average transaction amount, or monthly credit card volume, a volume discount might be available to you.
  5. Make sure you’re using address verification services (AVS): an address verification service will straightforwardly reduce the risk of fraud. Consequently, if your processor becomes aware that you are actively checking your customer’s IDs, you may be entitled to lower fees.
  6. Settle transactions ASAP: the longer transactions take to settle after being authorized, the higher the interchange fee will be.
  7. Customer information should be in transactions: the number of chargebacks will instantly be reduced as the customer will be able to instantly recognize the transaction on their statements.

Wrapping Up

While interchange fees are certainly complex and have been criticized for their lack of transparency, they play a big role in maintaining the payment system while fueling innovation.

And, even though they chip away at your profit margins, there are still ways you can keep them to a minimum.

Always be on the lookout for the solution which best fits your business.