What to Know about Interchange Fees — Revenue Generators That Power Fintechs
Cards are central to any company that is offering financial products to its customers. That’s because interchange is one of the primary sources of revenue for fintechs, as well as a major value proposition fintechs can offer potential bank partners. Let’s start with the basics: what is an interchange fee for cards? It’s the fee merchants pay card issuers to process transactions, every time a card is used to make a purchase, and it’s a growing payment rail: digital debit card transaction value is expected to reach $443 billion by 2023.
Just how much revenue fintechs and banks can earn from interchange fees depends on payment solution specifics. For example, interchange fees vary depending on whether the transaction is processed online or in person; whether the card is debit or credit; and whether the use case is commercial or consumer.
Here’s a quick guide to understanding interchange dynamics, so that your company can make informed decisions about how to issue cards. A banking as a service (BaaS) provider like Treasury Prime can work with you to launch card products and collect interchange fees.
How does interchange work?
Interchange involves a lot of different parties who play different roles in the process. Before explaining what interchange means, let’s explain who is involved in the card network process.
Who is involved in the interchange process?
- Cardholder: Cardholders get cards from their issuing bank and use them to make a purchase.
- Issuing bank: The bank that issued the card to the cardholder, where your customer’s money is stored.
- Issuer processor: At the point of sale, issuer processors connect the issuing bank to the card network.
- Card network: Card networks like Visa and Mastercard process transactions by bridging the gap between the issuing & acquiring sides of the network. The network defines the network fee and interchange fee.
- Merchant: The merchant is whoever sells the item or service to the cardholder.
- Acquiring processor: The acquiring processor (also sometimes called “card acquirer” or “credit card acquirer”) is the processor on the merchant’s side. They connect the bank that holds the merchant’s account to the card network.
- Acquiring bank: The acquiring bank holds the merchant’s account and accepts the merchant payment (full transaction amount minus any fees).
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The total transaction/clearing amount
- Merchant Payment: The total amount received by the merchant for the services or goods.
- Interchange Fee: Fee determined by the card network and paid to the issuing bank for enabling the cardholder to initiate a card transaction. Portions of this fee are distributed between banks, card processors, card networks, BaaS providers, and fintechs.
The process of charging interchange
Here’s a basic summary of how interchange works: The cardholder buys something from the merchant, using a card. The issuing bank charges the merchant a fee — determined by the card network — to enable the card transaction. The issuing bank then splits the fee up among different parties that helped make the transaction possible. The dynamic is basically the same for all cards, but exact fees and rates differ.
Below is a map of the funds flow with a sample transaction, with some sample interchange fees that may result from a transaction:
Here’s a general example: Let's say a cardholder goes to a furniture store and buys a $100 couch using a card. The interchange fee varies depending on individual details, but let’s say in this case, it is 2 percent. That means the merchant must pay a $2 fee to the issuing bank to enable the $100 transaction. So while the consumer paid $100, the furniture store that sold the couch earned $98 after fees.
The $2 interchange fee is then distributed among the different parties that helped make the transaction possible. The card network takes a portion of the money. Another portion of the interchange fee is retained by the issuing processor. The issuing bank takes the remainder of the fee.
The issuing bank may share its portion with BaaS providers and fintech programs. The fintech may pass a portion of what they earn along to customers in the form of cash back or other rewards. For example, if you, as a consumer, have a frequent-flyer card or receive cash back on card purchases, that money is probably coming from interchange fees.
How interchange pass-through pricing varies
How many interchange rates are there? A lot. Commercial and retail rates differ, the size of the issuing bank comes into play, the type of card matters — there are a lot of factors that go into determining how much a merchant is required or is willing to pay to process a card transaction. Merchants are generally willing to pay higher interchange fees for cards associated with greater spending.
Higher interchange fees translate into greater revenue per transaction for fintechs and banks. But at the same time, options that draw higher fees may also be more expensive and time-intensive to manage, diluting the higher revenue per transaction. Additionally, higher interchange fees translate into greater costs for merchants accepting payments, so it’s best to think about interchange as the market-clearing rate for card payments. In other words, what price are merchants actually willing to pay?
Commercial versus consumer card
Who is using the card, and how? For consumers buying consumer products and services, interchange rates are lower, because individual consumers, relative to businesses, have lower buying power. Cards that cater to businesses — such as corporate credit or debit cards and other cards attached to business accounts — typically have higher interchange fees. This is because businesses tend to have greater buying power than individuals, and also tend to make bigger purchases (think: a bulk order of computers for the office). As a result, merchants are willing to pay more to process these cards, because they want access to these bigger sales.
Type of card
Debit or credit? Your answer factors into how much interchange revenue you can make from your card.
Merchants are often willing to pay higher interchange on credit transactions because, by definition, card users can spend more with a credit card than with a debit card. That’s because they aren’t restricted to the money currently in their bank account, and can pay credit transactions off over time. At the same time, credit cards are higher risk, because they carry the risk of the cardholder defaulting. For that reason, credit interchange rates are higher to account for that risk.
Size of bank
Depending on the size of the bank, interchange rates vary. Specifically, for smaller banks, networks can charge higher debit interchange fees by the network. This is because the Durbin Amendment, passed in 2010 as part of the Dodd-Frank law, capped debit card interchange that could be assessed by the network at large banks. The amendment lowered the debit card interchange fees larger banks could charge retailers. Smaller financial institutions — meaning those with less than $10 billion in assets — are exempted.
Many partner banks that work with Treasury Prime are Durbin exempt, opening up the potential for our fintech partners to earn greater interchange revenue.
Card networks calculate interchange rates for different industries separately. That means the rate on a card purchase of an airline ticket may differ from the rate on a meal purchased at a restaurant.
Rates may also vary within industries depending on different factors — for example, different grocery store chains or locations may qualify for different tiers which have their own rates. As you can see from this table of rates by industry for Mastercard, it can get pretty complicated. `
Online or in-store
In-store purchases often have lower interchange rates than online purchases. This is because, when someone physically enters a store, the risk of fraud is lower. The merchant can check the customer’s driver’s license against their card to make sure the name is the same. In-store fraud would also typically require a physical card or digital wallet on a physical phone. Fraudulent purchases online, however, generally require the fraudster to type card information into a website, which is easier.
These factors that we’ve mentioned — where the purchase takes place, merchant industry, credit versus debit, the size of the card-issuing bank, commercial versus consumer — aren’t the only factors that can influence interchange rates. Premium card reward programs (versus standard issue debit cards), as well as whether a card is swipe-only (versus a chip) are also associated with higher interchange rates.
Ultimately, interchange is complicated, and that’s why fintechs need experienced BaaS and bank partners with a solid track record of handling card transactions that are willing to walk them through the process of getting a card to market. With the right partners, you can tweak your card approach to get the highest value program available to you and your customers. That said, just as it’s not possible to predict one’s overall revenue to the penny, you won’t know what your interchange revenue will be until you build and deploy a program and monitor the data that comes through.
Want to learn more about issuing debit and credit cards as a fintech? Watch our webinar with partner card issuing platform Marqeta. Developers can also experiment with Treasury Prime’s API in our Sandbox, and our sales team is always available to answer your questions.