Interchange fee

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Interchange fee is a term used in the payment card industry to describe a fee that a merchant's bank (the "acquiring bank") pays a customer's bank (the "issuing bank") when merchants accept cards using card networks such as Visa and MasterCard for purchases.

In a credit card transaction, the card-issuing bank in a payment transaction deducts the interchange fee from the amount it pays the acquiring bank that handles a credit or debit card transaction for a merchant. The acquiring bank then pays the merchant the amount of the transaction minus both the interchange fee and an additional, usually smaller fee for the acquiring bank or ISO, which is often referred to as a discount rate, an add-on rate, or passthru.

For cash withdrawal transactions at ATMs, however, the fees are paid by the card-issuing bank to the acquiring bank (for the maintenance of the machine).

These fees are set by the credit card networks,[1] and are the largest component of the various fees that most merchants' pay for the privilege of accepting credit cards, representing 70% to 90% of these fees by some estimates, although larger merchants typically pay less as a percentage. Interchange fees have a complex pricing structure, which is based on the card brand, regions or jurisdictions, the type of credit or debit card, the type and size of the accepting merchant, and the type of transaction (e.g. online, phone order, in-store, whether the card is present for the transaction, etc.). Further complicating the rate schedules, interchange fees are typically a flat fee plus a percentage of the total purchase price (including taxes). In the United States, the fee averages approximately 2% of transaction value.[2]

In recent years, interchange fees have become a controversial issue, the subject of regulatory and antitrust investigations. Many large merchants such as Wal-Mart have the ability to negotiate fee prices,[3] and while some merchants prefer cash or PIN-based debit cards, most believe they cannot realistically refuse to accept the major card network-branded cards. This holds true even when their interchange-driven fees exceed their profit margins.[4] Some countries, such as Australia, have established significantly lower interchange fees, although according to a U.S. Government Accountability study, the savings enjoyed by merchants were not passed along to consumers[5]. The fees are also the subject of several ongoing lawsuits in the United States.

Contents

[edit] Overview

Image from a GAO report explaining how the interchange fee works.

Interchange fees are set collectively by the financial institutions that are stakeholders in Visa and MasterCard (both public companies). Many of these banks issue both credit and debit cards. JPMorgan Chase is the largest issuer of both.

While the credit card market in the United States continues to grow, exceeding $1.3 trillion annually, the number of card-issuing banks has shrunk. The top five credit card issuing banks (JPMorgan Chase, Citigroup, Bank of America, Capital One and HSBC) now control about 90% of all credit card accounts. Card issuers now make over $30 billion annually from interchange fees. Interchange fees collected by Visa[6] and MasterCard[7] totaled $26 billion in 2004. In 2005 the number was $30.7 billion, and the increase totals 85 percent compared to 2001.

The origins of the interchange fee are a matter of some controversy. Often they are assumed to have been developed to maintain and attract a proper mix of issuers and acquirers to bank networks. Research by Professor Adam Levitin of Georgetown University Law Center, however, indicates that interchange fees were originally designed as a method for banks to avoid usury and Truth-in-Lending laws.[8] Typically, the bulk of the fee goes to the issuing bank. Issuing banks’ interchange fees are extracted from the amount collected by the merchants when they submit credit or debit transactions for payment through their acquiring banks. Banks do not expect to make a significant amount of money from late fees and interest charges from creditworthy customers (who pay in full every month), and instead make their profits on the interchange fee charged to merchants.[9]

Interchange rates are established at differing levels for a variety of reasons. For example, a premium credit card that offers rewards generally will have a higher interchange rate than do standard cards. Transactions made with credit cards generally have higher rates than those with signature debit cards, whose rates are in turn typically higher than PIN debit card transactions. Sales that are not conducted in person, such as by phone or on the Internet, generally are subject to higher interchange rates, than are transactions on cards presented in person.

For one example of how interchange functions, imagine a consumer making a $100 purchase with a credit card. For that $100 item, the retailer would get approximately $98. The remaining $2, known as the merchant discount [10] and fees, gets divided up. About $1.75 would go to the card issuing bank (defined as interchange), $0.18 would go to Visa or MasterCard association (defined as assessments), and the remaining $0.07 would go to the retailer's merchant account provider. If a credit card displays a Visa logo, Visa will get the $0.18, likewise with MasterCard. Visa's assessment is fixed at 0.1100% of the transaction value and MasterCard's assessment is fixed at 0.0950% of the transaction value. On average the interchange rates in the US are 179 basis points (1.79%) and vary widely across countries; in April 2007 Visa announced it would raise its rate .6% to 1.77%.[11]

According to a January 2007 poll by Harris Interactive, 32% of the public had heard of the interchange fee; once explained to them, 91% said Congress "should compel credit card companies to better inform consumers" about the fee.[12]

[edit] Controversy

Regulators in several countries have questioned the collective determination of interchange rates and fees as potential examples of price-fixing. Merchant groups in particular, including the U.S.-based Merchants Payments Coalition and Merchant Bill of Rights, also claim that interchange fees are much higher than necessary,[13] pointing to the fact that even though technology and efficiency has improved, interchange fees have more than doubled in the last 10 years. Issuing banks argue that reduced interchange fees would result in increased costs for cardholders, and reduce their ability to satisfy rewards on cards already issued. The Merchants Payments Coalition argues that consumers pay more than they should because of "hidden" interchange fees and that reducing these fees would result in lower retail prices.

However, in 2009, the U.S. Government Accountability Office (GAO) examined the issue of interchange fees in the U.S. and concluded that any remedies for reducing these fees have risks that and may end up costing consumers more money than they pay today[14]. Notably, the GAO report examined the experience after the Reserve Bank of Australia regulated interchange fees in that market, and concluded that retailers did not reduce prices to reflect their reduced interchange fees, something the Merchants Payments Coalition has suggested would occur if interchange fees were regulated in the United States.

[edit] By region

[edit] United States

Merchant lawsuits claim that interchange fees in the U.S. are out of line with falling technology costs and similar fees charged outside the United States, resulting in higher prices, lower profits and harm to the consumer. The lawsuits allege that these high fees represent collusion and price fixing among the bank card networks and their card issuing banks, in violation of antitrust laws. Bank card networks disagree, claiming interchange fees represent an effort to balance incentives to issuing banks to issue more cards with better rewards against the need to bring an optimum number of card-accepting merchants into their credit card systems. They also claim that the interchange fees bring consumer benefits such as more rewards, reduced fraud, lower interest rates and system innovations.

Senate hearings in the United States have focused on the secrecy surrounding interchange fee schedules and card operating rules. In 2006 Visa and MasterCard both released some fee schedules and summary reports of their card rules, though pressure continues for them to release the full documents. In January 2007, Senate Banking committee chairman Chris Dodd cited interchange fees at a hearing on credit card industry practices and again in March the fees were criticized by Sen. Norm Coleman.[15] In January 2007, Microsoft chairman Bill Gates cited high interchange fees as a significant reason Microsoft believes it can be competitive in online micropayments.

In March 2007, MasterCard announced it was changing its rate structure, splitting the lower, "basic" tier for credit cards into two new tiers. The Wall Street Journal reported[16] that the document outlining the shift "makes it difficult to determine if the new rates, on average, are rising." MasterCard spokesman Joshua Peirez said the new structure "allows us to have a more sophisticated way to break up our credit card portfolio," while National Retail Federation general counsel Mallory Duncan said, "They are pricing each tier at the absolute most they can so they can maximize their income."

On July 19, 2007 the House Judiciary Committee antitrust task force held the first hearing to study the specific issue of interchange fees. NRF's Duncan testified, as did representatives from the credit card industry. Subcommittee chairman John Conyers, leading the panel, said, "While I come into the hearing with an open mind, I do believe the burden of the proof lies with the credit card companies to reassure Congress that increasing interchange fees are not harming merchants and ultimately consumers."[17]

Reps. John Conyers (D-MI) and Chris Cannon (R-UT) introduced the "Credit Card Fair Fee Act" on March 6, 2008. which would create a panel of judges, appointed by the Department of Justice Antitrust Division and Federal Trade Commission to oversee interchange fees.[18]

In October 2010, Visa and MasterCard reached a settlement with the U.S. Justice Department in an antitrust case focused on the issue of competitiveness in the interchange market. The companies agreed to allow merchants displaying their logos to decline certain types of cards, or to offer consumers discounts for using cheaper cards.[19]

[edit] European Union

In 2002 the European Commission exempted Visa’s multilateral interchange fees from Article 81 of the EC Treaty that prohibits anti-competitive arrangements.[20] However, this exemption has expired on December 31, 2007. In the United Kingdom, MasterCard has reduced its interchange fees while it is under investigation by the Office of Fair Trading.

In January 2007, the European Commission issued the results of a two-year inquiry into the retail banking sector. The report focuses on payment cards and interchange fees. Upon publishing the report, Commissioner Neelie Kroes said the "present level of interchange fees in many of the schemes we have examined does not seem justified." The report called for further study of the issue. [21]

On December 19, 2007, the European Commission issued a decision prohibiting MasterCard's multilateral interchange fee for cross-border payment card transactions with MasterCard and Maestro branded debit and consumer credit cards. The Commission concluded that this fee violated Article 81 of the EC Treaty that prohibits anti-competitive agreements. [22] MasterCard has appealed the Commission's decision before the EU Court of First Instance; while the appeal is pending MasterCard has temporarily repealed its multilateral interchange fees.

On March 26, 2008, the European Commission opened an investigation into Visa's multilateral interchange fees for cross-border transactions within the EEA as well as into the "Honor All Cards" rule (under which merchants are required to accept all valid Visa-branded cards).[23]

The antitrust authorities of EU Member States other than the United Kingdom are also investigating MasterCard's and Visa's interchange fees. For example, on January 4, 2007, the Polish Office of Competition and Consumer Protection fined twenty banks a total of PLN 164 million (about $56 million) for jointly setting MasterCard's and Visa's interchange fees.[24]

[edit] Australia and New Zealand

In 2003, the Reserve Bank of Australia required that interchange fees be dramatically reduced, from about 0.95% of the transaction to approximately 0.5%. One notable result has been the reduced use of reward cards and increased use of debit cards. Australia also removed the "no surcharge" rule, a policy established by credit card networks like Visa and MasterCard to prevent merchants from charging a credit card usage fee to the cardholder. A surcharge would mitigate or even exceed the merchant discount paid by a merchant, but would also make the cardholder more reluctant to use the card as the method of payment. Australia has also made changes to the interchange rates on debit cards, and has considered abolishing interchange fees altogether.

As of November 2006, New Zealand is considering similar actions, following a Commerce Commission lawsuit alleging price-fixing by Visa and MasterCard. In New Zealand, merchants pay a 1.8% fee on every credit card transaction.[dubious ]

[edit] Notes

  1. ^ United States Securities and Exchange Commission FORM S-1, November 9, 2007.
  2. ^ Martin, Andrew (January 4, 2010). "How Visa, Using Card Fees, Dominates a Market". New York Times. http://www.nytimes.com/2010/01/05/your-money/credit-and-debit-cards/05visa.html?em=&pagewanted=all. Retrieved 2010-01-06. "The fees, roughly 1 to 3 percent of each purchase, are forwarded to the cardholder's bank to cover costs and promote the issuance of more Visa cards." 
  3. ^ The Interchange Debate: Issues and Economics James Lyon, Jan. 19, 2006.
  4. ^ A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments? Fumiko Hayashi, March 2006.
  5. ^ "Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges", U.S. Government Accountability Office, November 2009
  6. ^ Visa Interchange Rates
  7. ^ MasterCard Interchange Rates
  8. ^ Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints', 55 UCLA Law Review, 1321 (2008).
  9. ^ The World's Most Exclusive Credit Cards Forbes, July 3, 2007.
  10. ^ Merchant account
  11. ^ Visa Hikes Overall Interchange 0.6%, Effective April 14 Digital Transactions, April 12, 2007. Retrieved May 22, 2007.
  12. ^ Card issuers, retailers at odds Los Angeles Times, April 2, 2007. Retrieved May 22, 2007.
  13. ^ Merchants, pay attention to rising credit-card fees Indianapolis Star, May 22, 2007. Retrieved May 22, 2007.
  14. ^ Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges, U.S Government Accountability Office, November 2009.
  15. ^ Sen. Coleman statement, Senate.gov, March 7, 2007. Retrieved May 22, 2007.
  16. ^ MasterCard Alters Fee Structure, Wall Street Journal, March 1, 2007. Retrieved May 22, 2007.
  17. ^ U.S. lawmaker wants proof credit card fees don't harm Reuters, July 19, 2007. Retrieved July 20, 2007.
  18. ^ Cannon taking on credit card companies, Salt Lake Tribune, March 7, 2008.
  19. ^ http://marketplace.publicradio.org/display/web/2010/10/04/pm-visa-mastercard-settlement-means-more-flexibility-for-retailers/
  20. ^ EUROPA - Rapid - Press Releases
  21. ^ EUROPA - Rapid - Press Releases
  22. ^ EUROPA - Rapid - Press Releases
  23. ^ EUROPA - Rapid - Press Releases
  24. ^ http://www.uokik.gov.pl/en/press_office/press_releases/art72.html. See also the press release concerning the Hungarian investigation at http://www.gvh.hu/gvh/alpha?do=2&st=2&pg=154&m129_doc=4413
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