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.