What is interchange?
Interchange is a fee the store, or “merchant,” pays every time you swipe your card.
Most of the money from the fee the merchant pays goes to your bank, or the “issuing bank,” and a little goes to the merchant’s bank, or the “acquiring bank.”
Because interchange fees include a percentage of the transaction plus a flat fee, small purchases can cost merchants a lot of money. For merchants, interchange is like a tax they pay to provide consumers the convenience of paying via debit or credit card. The price of interchange varies from card to card and is set by payment networks like Visa® and MasterCard®. Certain payment networks charge a higher interchange fee, which is why they are not as widely accepted as others.
While the origin of interchange fees is debatable, interchange is a steady revenue stream for banks. Most banks make money through interchange, interest margin, and bank account fees, such as minimum account balance fees, ATM fees, and overdraft fees.
(Simple makes its money through interchange and net interest margin, not overdraft and maintenance fees—learn more about that here.)
Since interchange fees affect profit margins for merchants and banks, there’s been a huge legal tug-of-war over these cents-for-swipes on both credit cards and debit cards.
Let’s dive into how interchange plays a role in rising bank account fees, and what to look out for when choosing a bank.
Interchange and credit cards
Interchange fees became considerably more problematic for merchants once banks started offering credit cards with rewards programs. From points to frequent flyer miles, credit card companies began issuing competing rewards program credit cards to consumers, vying to be the most generous bank in all the land.
Unfortunately, this “generosity” came at an almost-zero expense to the credit card companies themselves, and was funded by merchants through colossal interchange fees on rewards program credit cards. Yep, you read that right: Banks offered rewards to consumers and paid for them by raising merchant fees, with no additional benefit for the merchants.
Of course, merchants were not happy about these unnecessarily high interchange rates, which in part led to a 2005 class-action lawsuit filed by merchants and trade associations—the Payment Card Interchange Fee and Merchant Discount Antitrust Litigation. While the settlement reduced interchange fees, it also protected credit card companies from similar future lawsuits, and still left credit card companies with the power to dictate what they can charge merchants.
Interchange and debit cards
With the 2010 Dodd-Frank financial reform legislation came the Durbin Amendment, which capped interchange fees for debit card swipes in an effort to make interchange fees by banks “reasonable and proportional to the actual cost” of a transaction. The Amendment lowered the interchange fee for big banks from an average of 44 cents to a maximum 21 cents per transaction, plus 0.05% of the transaction amount and a 1-cent fraud charge.
Because banks had to charge fair amounts for processing transactions on debit cards (what a novel idea), this stream of revenue took a huge hit. To make up for money lost, many banks increased insufficient funds fees, eliminated free services, and decreased debit cards rewards programs in favor of more flexible credit card rewards programs. Since the Durbin Amendment went into effect, it’s debatable whether or not the law did what it was intended to do—help consumers pay less.
If you are asking yourself, “What’s a few cents here and there?”, now you know: Interchange has a huge effect on merchants, banks, and even income inequality. Next time a shopkeeper frowns at your rewards program credit card or you see a sign that says “$10 minimum for credit cards,” you’ll know why. Check out this article for more info on how banks make money, even when they don’t charge fees.
And for more guidance on what to look for when choosing a bank, check out this post.
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Disclaimer: Hey! Welcome to our disclaimer. Here’s what you need to know to safely consume this blog post: Any outbound links in this post will take you away from Simple.com, to external sites in the wilds of the internet; neither Simple nor our partner bank, BBVA USA, endorse any linked-to websites; and we didn’t pay/barter with/bribe anyone to appear in this post. And as much as we wish we could control the cost of things, any prices in this article are just estimates. Actual prices are up to retailers, manufacturers, and other people who’ve been granted magical powers over digits and dollar signs.