The Pain of Interchange Rates: What? Who? Why?
Few things boil a business owner’s blood faster than credit card interchange rates. Even WalMart Canada got so pissed off that they stopped accepting VISA cards for a while. That Goliath vs. Goliath battle, plus a push by Diane Brisebois, CEO of The Retail Council of Canada led to an interchange rate freeze. (read Diane’s articles here and here. The French version is here.)
What Diane didn’t mention was that we consumers and merchants play a big role in the current sorry state of affairs vis a vis interchange.
Retailers and restaurateurs know interchange rates are bad. That’s about the extent of it.
As they say, what you don’t know can hurt you.
What are Interchange Rates anyway?
Interchange rates are the base rate taken by the issuing bank when a card is used. The logic behind interchange is to account for the risk associated with different cards and processing methods. To make thing fun for guys like me who analyze this stuff, there are over 900 such rates in North America.
For example, corporate cards have two problems: They rarely carry a balance and they are the largest source of contested billings. The issuing bank needs a higher fee up front to compensate. Corporate purchasing cards are the most expensive to process. Corporate cards with built-in rewards are just plain nasty.
At the other extreme, there's the plain-vanilla personal card with no rewards at all. Contested charges are minimal. Balances are carried more often than not. They have the lowest interchange rates.
Rewards cards are spread along the middle. Somebody has to pay for your air miles, charitable donations, tree planting, or cash-back, and it ain't the bank. The merchant picks up the tab. The issuing bank just takes the applause while hanging on to the cash until you redeem a reward.
Every reward card carries a higher interchange rate to fund those rewards.
The pain doesn't stop there. How you process a card affects the interchange.
Insert a chip-card or tap-to-pay and you pay one rate. Key in the info or accept it online and you pay another. That makes sense. An inserted or tapped card is obviously present. Its info is transmitted electronically with no chance of error. Key it in and you may goof. That risk is built into the interchange rate.
How often you close out your sales also affects the interchange rate. You must batch within 24 hours or face a surcharge. Let it slide 72 hours and you face a bigger one.
Twenty-four business types qualify as "Everyday Spend" and have their own set of rates. Gas stations also have their own lower rates. So do charities. So do grocery stores. Everyone else uses the regular rates.
Interchange rates are not a closely guarded secret. They’re publicly available on the card-brands' websites. They vary by country so check yours.
Who Sets Interchange Rates?
The credit card brands do not share in the interchange. All they get is about 10 basis points on every transaction. That's the assessment fee you may see on your statements if it isn't lumped in with other fees. That itsy-bitsy 0.1% adds up over the hundreds of billions of dollars of transactions.
The credit card brands set the interchange but don’t collect it.
The issuing banks collect the interchange but don’t set it.
The method is very Solomonesque, at least in theory. I cut the cake in half, you choose first. The Card Brand can veto by simply setting an interchange that is too low to cover the issuing bank's costs. Otherwise, you’d get some insane rewards programs.
Let’s pretend that a bank fell on its head and came up with the Ultimate Reward Card. Their pitch is simple, “Get 20% back, in cash, on everything you buy.” They approach VISA with the idea and ask for an interchange rate.
VISA: “Wow! Did you guys fall on your heads?”
BANK: “Hey, keep your comments to yourself. Just give us the interchange.”
VISA: “Ok. . . 1.51%”
BANK: “C'mon!! We need something over 20%. How about 21.51%?”
VISA: “How about. . . . HELL NO! Don’t let the door hit your butt on the way out.”
Card Brands set the interchange rates. Issuing banks collect them and get the applause for the rewards. Merchants pay the interchange rates. Merchants pay for your rewards.
Applaud the merchants every now and then.
Why are we in this mess?
The more we insist on extra perks and rewards, the more we push banks to deliver those perks, the more we force the card brands to approve them, the more we screw the merchants over.
I’m a big believer in small business, retail, hospitality, and food service. That’s why I destroyed my rewards credit cards and replaced them with the plain-vanilla variety.
I just don’t feel right enjoying a reward off a retailer’s bowed back.
Who's to blame?
It's easy to point the finger at the card brands. They set the interchange rates so the current mess must be their fault, right?
Everybody involved in a credit card transaction is responsible
Banks and consumers drive part of the interchange rates. For banks, part of interchange is free money until you actually redeem your rewards. Consumers like the "something for nothing" thing.
Merchants must also accept their share of the blame.
Merchants want their money in their accounts the next business day. Think about that for a minute.
If I buy $1,000 on my MasterCard today, it'll be in your bank account tomorrow. That deposit will match my $1,000 but it isn't my money. I won't pay that $1,000 for at least a few weeks. The issuing bank won't even charge me interest until my next statement due date.
The funds that get deposited are a short-term loan from the issuing bank to the merchant's bank on the merchant's behalf. Interchange rates fund that loan.
If there were a merchant program where interchange rates were slashed by 1.25% to 0.26%, but funding was on a 30-day basis, would you enroll?
There ain't no such thing as a free lunch. Someone always picks up the tab.
Now you know more about interchange rates than 95% of merchants. The next post will deal with what a payment processor can and can't do for you. We save you dollars by counting pennies.
My promise to you
If you accept plastic, reach out. If I can help, I will. If you need help, but I can’t provide it, I’ll point you to who can. If you’re well served as is, I’ll tell you.
We’ll stay friends.
It’s like the insurance lizard says, “15 minutes can save you thousands.”