Thought leadership – An interchange primer

It’s imperative for credit unions to understand interchange – the biggest component of non-interest income.

One of the most misunderstood, and possibly the most misaligned topic in the credit and debit card world is interchange. At a summary, it is a fee paid by a merchant, paid to the issuer, each time a credit or debit cardholder uses a card, in a store or online. The fee covers the cost of processing the credit or debit card; for a credit transaction the fee reimburses the issuer for the interest on carrying the balance during the cardholder’s debt repayment grace period; and the fee is intended to address the cost for zero fraud liability, which reimburses the cardholder in case of fraud. In addition, higher interchange is charged for signature rewards credit cards, to cover the cost of additional cardholder benefits such as cash back or auto rental collision damage waiver. The practice of a merchant paying the issuer interchange was established in 1971, when Bank Americard set 1.95% as the standard rate as compensation for the risk of card-issuing banks. Interchange is also paid to the ATM owner each time a cardholder gets cash out. Seems simple enough, but there’s much more complexity to it.

To understand interchange, its first necessary to get to know the “players” in the space. The merchant has an account with a bank, called the acquiring bank. The card holder was issued her card from an issuing bank. So there are two banks involved. Since there are thousands of merchant acquiring banks around the world, and even more issuing banks, the many to many relationships is simplified by having a card “brand” in the middle. The most common “brands” in the U.S. are Visa, MasterCard, American Express, Discover, and they form the networks that connects all the acquiring banks with all the issuing banks. Interchange “flows” through the network, from acquirers to issuers, and can be reversed in case of credits (for example when the cardholder returns an item) and for chargebacks (for example, fraudulent charges). Thus, interchange is bi-directional. Also, there is not just one interchange rate; there are literally thousands of rates. Each network brand sets their own rates based on market forces, and rates vary by merchant, card types, purchase volumes, and several other factors. What the merchant pays for the ability to accept cards

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