How do interchange rates affect credit and debit card transactions?

If you’re a business that accepts credit or debit card payments from customers, you pay interchange fees. These are taken from merchants by their acquirer after the merchant accepts a card payment. They cover the costs incurred by all the financial institutions that are involved in completing the transaction. 

Even if you have been paying interchange fees for some time, you may not be aware of how exactly they break down and how they can be reduced. In this article, we’ll look at what interchange fees are, the factors impacting interchange rates, and how your business can save money by lowering the cost of these fees. 

What are interchange fees?

Interchange fees apply whether a customer is swiping a card in a store or typing a credit card number into a check-out page online. That’s because a complex process is happening behind the scenes. Data is being authenticated and transmitted, financial institutions are communicating and transferring funds between accounts, and work is being done to ensure information is kept private and secure. 

Although merchants typically receive interchange fees as a single per-transaction amount, they are actually made up of several components. These correspond to the different financial institutions that play a role in each transaction:

• Card issuer: the customer’s bank or a credit card company

• Card network: e.g. Visa, Mastercard, Discover, American Express

• The acquirer: the merchant’s bank or payment facilitator, like Airwallex

How does interchange work?

Imagine that a customer is buying a sandwich in a store, and pays using their debit card. This is the process that happens in order to complete the transaction:

1. The merchant’s acquirer sends transaction data to the customer’s card network.

2. The card sends this on to the card issuer (i.e. the bank or card company.)

3. The card issuer performs checks, including verifying if there is sufficient funds (or overdraft allowance) to cover the payment. It then lets the card network know whether the transaction is approved or declined. 

4. The card network sends this information back to the acquirer. 

5. The acquirer processes the transaction. 

6. Funds are settled from the card issuing bank into the acquiring account.

The acquirer pays the card issuer and card network a fee every time a transaction happens. This is to cover several costs; for example, the card issuer is taking on the risk of card fraud. The card network and card issuer also have the costs of maintaining the infrastructure needed for these payments to happen.

The acquirer then passes along these fees to the merchant who is accepting the payment. The acquirer will also add its own fee to this total, to cover the risks it takes on and the services it provides. This total interchange rate is usually charged to the merchant as a fixed per-transaction fee, plus a percentage of the transaction value. 

Factors that influence interchange rates

Debit versus credit card payments

When debit cards are used for transactions, there is less risk for the financial institutions involved than if the consumer was using a credit card. That’s because the buyer is typically spending money in their account when using a debit card, rather than borrowing as they would with a credit card. For this reason, interchange fees are generally lower for transactions made with a debit card.

In-store versus online transactions

Again, this issue is about the degree of risk financial institutions assume. Online purchases (aka card-not-present transactions) are more likely to be fraudulent than transactions made in store. The card issuers compensate for this risk by charging higher fees for transactions in which the card is not present.

Visa versus Mastercard (and other card networks)

Every card network charges their own rates, and these can vary. Visa and Mastercard are two popular card networks that back cards issued by banks, which have specific interchange fees. The same is true for JCB and UnionPay, two other major credit card networks, which are based in Japan and China, respectively. Other card networks like American Express and Discover that act as both network and card issuer; again they have their own fee structures.

Merchant Category Code (MCC)

The type of business you are conducting can affect your interchange fees. High-risk businesses like online gaming sites are charged higher fees than others, like charities. Every merchant is assigned a four-digit merchant category code (MCC) according to their industry, and it’s this code that affects the interchange fees charged.

International transactions

Interchange rates may vary depending on whether the transaction being completed is domestic or international. That’s because of the additional complexities and risks associated with cross-border payments.

Geographic location

The location of the transaction can also make a big difference. In the Europe Economic Area (EEA), for instance, domestic interchange fees are relatively low for both credit and debit cards due to financial legislation. In the US, fees are higher, especially for credit cards, because there is no cap on the interchange rate for credit cards. 

Security technology

Merchants who use advanced payment technologies may qualify for lower interchange fees because they are reducing the rate of fraudulent transactions. Examples of these technologies include tokenisation, 3D Secure (3DS) Protocol and biometric authentication.

Interchange++ versus Blended pricing

These are the two main pricing models for interchange fees:

Interchange++ is more transparent and variable. For each transaction, you’ll be able to see a full breakdown of the fees you have been charged from the card issuer, card network and acquirer for each transaction.

Blended offers something closer to a flat-rate fee for each transaction. There are some variables, like whether the transaction is domestic or international, but there will be less variability than with Interchange++. This means there is less risk of unexpected spikes in cost. 

Strategies to reduce your interchange costs

• Crunch the numbers and check whether a Blended or Interchange++ pricing model would work best for your business.

• Larger businesses may be able to negotiate custom fees.

• Use fraud prevention technology.

• Switch a more cost-effective payment processor. We’ll explain how to do this below.

How to choose a cost-effective payment processor

One of the most significant ways you can use to reduce your fees is by choosing the right payment processor or acquirer. As well as interchange fees, there may be other costs, such as currency conversion markups, which may be hidden. Consider choosing a payment processor with transparent pricing. It can also be a worthwhile investment to choose a service that offers advanced fraud prevention techniques to further lower your interchange costs.

Airwallex is an ideal payment processor and acquirer for businesses that sell globally and domestically. Airwallex enables businesses to avoid unnecessary currency conversions when collecting overseas payments, by allowing them to collect customer payments multiple currencies and settle ‘like-for-like’ into a multi-currency Wallet. Businesses can then pay out funds to global suppliers, employees and contractors using Airwallex cards and transfers, all whilst avoiding currency exchange fees.  By cutting out currency exchange fees, you can significantly lower the cost of selling overseas. Airwallex offers competitive payment processing rates and best-in-class security technology, including network tokenization and 3DS2. For more personalised advice on managing your business’s interchange costs, contact our sales team.