Interchange Fees and whose fraud is it anyway?

The Interchange Fee is part of the Merchant Service Charge (MSC) paid by a card acceptor (merchant) to a card issuer. Some reports state that the Interchange Fee can be 66% - 80% of the MSC  and  that Interchange Fees in the UK average around .79% of the transaction value, 1.35% for Belgium, 1.75% for U.S.,  2% for Canada, 0.45% for Australia, 0.90% for Sweden. 

What we do know is that card schemes attribute the interchange fee to three cost components : 1) cost of payment guarantee where the card issuer guarantees to cover the costs of fraudulent use of cards, 2) cost of processing cost and 3) cost of funding of interest-free period (for credit and deferred debit cards) 

The largest card scheme publishes the breakdown of its interchange fees as such:

· For Credit & Deferred Debit: - Cost of payment guarantee 48% - Cost of processing 28% - Cost of free-funding period 24%

· For Immediate Debit: - Cost of payment guarantee 51% - Cost of processing 49% - Cost of free-funding period nil

This shows that card security should be an issue for Card Issuers since this payment guarantee (cost of fraud) cost component of the Interchange Fee is in effect also revenue for card issuers.

In 2007, APACS reported a total transaction value of almost £224 billion (223,995 mil) for debit card spending, and £124 billion (123,855 mil) for credit card spending. 

By February 2008, total debit and credit cards issued in the UK is said to be a total of 68,683,000.  

Given the 2007 card transaction values (£348 billion), interchange fee revenue averages out to £40.03 earned per issued card. 

Almost half of which (49.9%), £19.99 per card is attributed to the cost of payment guarantee (cost of fraud) of the interchange fee paid by merchants to UK card issuers. 

APACS, the fraud reporting body in the UK, published reports of Credit and debit card fraud losses on UK-issued cards in 2007 amounted to a total of £535.2 million, roughly amounts to £7.79 per card. 

I’ve had the chance to look into the MIF (Multilateral interchange Fees).  What I recall is that card schemes contend that interchange fees are advantageous for both merchants and consumers, for example in terms of fostering innovation such as improving the security of payments to combat card fraud. 

I’m not claiming that the fixed interchange fees are high. In fact, if revenues from Interchange fees do not motivate card issuance, then it’s probably set too low. I don't know. It's an interesting study. Revenue from Interchange fees of £40.03 per issued card for a year (2007) is understandably uninspiring for a bank especially if its cardholders do not pay card annual fees*. 

If I’m running a bank, my priority would understandably be on products that I can control and grow. This would be credit card issuance, not debit card issuance. I can earn more interchange fees with credit cards and from interest charges (average of 15.9%) on credit card outstanding balances. 

But whose Fraud is it anyway?

Because the interchange fees were explained to be based on three components, a big portion of which is attributed to the payment guarantee (cost of fraud), I think it’s reasonable to say that Issuing Banks are responsible for securing card transactions. 

Most card transactions require online authorizations. Majority of fraudulent card transactions required online authorizations. Regardless of chip and pin, ATM transactions, card-not-present transactions, most cross-border transactions, local card-present transactions with amounts over the floor limit require online authorization. With debit card usage, the cardholder’s account is checked to see if he/she has money in the account by doing an online authorization. This, I think, shows that the most effective security solutions can be implemented only with the Issuing Banks’ authorization systems and perhaps provides a good reason why Issuing Banks should be responsible for card security.

OFT and the European Commission should also take another look at Interchange Fees to study if the setting is serving its purpose and if it's really advantageous for merchants and consumers.

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*compared to £153.70 per account for bank charges and interest earned on balances in accounts; and £241.33 per credit card with outstanding balance for interest charges. (from the Office for National Statistics and BBA); Banks in other countries such as France do charge their cardholders annual fees.