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The Wonderful World of Interchange

One of the commonest parts of a, four party model, transaction yet one of the most misunderstood concepts in our industry. Cited by EU politicians as the cause of inflated consumer pricing and pilloried by the, equally ill informed, media in the search for yet another scandal story.

The reality is that acquirers, under scheme governance, remit a small fee (interchange) back to the issuer of the card whose customer made the necessary point of sale transaction. The acquiring entities will, no doubt, recover this fee as part their acquiring fee to the merchant. A common misconception is that the schemes receive part of this fee themselves, this is not so. As a matter of interest the reverse is true for ATM transactions where the card issuer pays a fee to the ATM acquirer, although this aspect is not covered by the EU Commission.

The argument put forward by the EU is that interchange at the prevailing rates are unfair to the consumer and by introducing a cap will enable the merchants to cut prices and pass on the savings to the consumer.

The question is, what are the full ramifications of introducing the interchange cap given that, on a blended rate basis, the cut will be fractions of a percentage? Some would contend that the cut may not be fully passed onto the merchant by the acquirer and, even if so, it is such a small amount it is unlikely that the merchant will drop their prices to follow suit, particularly as there may be a price difference to the detriment of cash in bricks and mortar retail establishments. From an issuer’s perspective, they will lose revenue irrespective of merchant action and may seek to make up lost profit elsewhere. This could be done in a number of ways, increasing the rate of interest on credit, reducing or removing cash back incentives (as has just been announced by Capital One), reintroduce annual card fees, or increase current account bundle fees on debit product. The choices are many.

My opinion is that there will be little, or no, change in any pricing models due to interchange alone. There may well be changes brought about by other, largely demographic, changes taking place. For example credit scoring it being tightened and acceptance rates are down; also the preponderance of consumers to revolve their credit is diminishing as credit cards are increasingly used as a charge card.

In conclusion, one thing’s for sure and that is that these are times of change and it is demonstrably clear that to build a financial model on elements outside of your control is, and always has been, a folly.


Comments: (2)

A Finextra member
A Finextra member 21 May, 2015, 08:12Be the first to give this comment the thumbs up 0 likes

An interesting position.  Many have questioned (over the years) why it is that Acquirers have to pay Issuers for the privilege of accepting their card at their merchants EFT-POS/POI’s (surely Acquirers are providing a service to Issuers in the form of acceptance?).  I doubt very much that consumers will benefit from any dent in Issuer Interchange income – and I agree – the pressure on Issuer Revenue models is likely to see an increase in costs disproportional to any potential benefits in cost reduction at the point of sale.

Being an Issuer-Acquirer with significant On-Us traffic is most beneficial in this instance (both from a rich transactional data and an interchange position) – however – it does create obvious internal cross-charge debates between the retrospective business units (and the schemes are always demanding internally processed statistics).


A Finextra member
A Finextra member 21 May, 2015, 12:29Be the first to give this comment the thumbs up 0 likes

I fully accept and agree with your comments, Matt. As you know my original remarks are only part of the fuller picture.

There is a reverse of the model mentioned, which is that there is interchange paid from issuers to acquirers in the case of ATM transactions. To be absolutely accurate interchange, as discussed, should be called fallback interchange, as it is a scheme determined amount applied in the absence of issuers and merchants/acquirers entering into bilateral agreements and set their own rates of interchange. This could be extremely onerous to do and so fallback interchange has devolved into a default situation.

Clearly ‘on us’ processing, typical within the store card market, circumvents the scheme system by routing the transaction to a closed loop alternative. This can occur with or without any bilateral agreement but having one may ease internal cross charging issues.

A complex system altogether and needlessly so in my opinion, but there it is.

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