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The Role of Interchange in Credit Card Transactions

Interchange represents a fee paid by a merchant’s acquiring bank to a credit card holder’s issuing bank as component of the normal electronic payment process. The origin of interchange can be traced back to the practice of having merchants compensate card-issuing banks for lost interest brought about by cardholders taking advantage of their credit card bill grace period. The credit card processing industry characterizes the role of interchange as a means of maintaining an equitable balance of incentives between the credit card holder’s bank (the issuing bank), and the retail merchant’s bank that processes the transaction.

Interchange enables merchants to enjoy the benefits that come with credit card acceptance. These benefits include security in the form of fraud protection, guaranteed payment and speedy remittance of funds. Today, retail merchants are able to negotiate credit card acceptance costs with their acquiring banks, while merchant’s banks are likewise able to negotiate their costs with credit card issuing banks. This ability to negotiate costs helps keep the balance of incentives intact, but it often creates “friction” and inefficiencies within the system. To offset these inefficiencies, the credit card processing industry sets “default” interchange rates for use in the absence of formally negotiated processing arrangements. For the purposes of transparency, the industry may disclose default interchange rates on publicly available websites.

The Credit Card Payment Process

Whenever a credit card transaction occurs, the cardholder’s bank pays the retail merchant’s bank for their cardholder’s purchase minus the interchange fee. The merchant’s bank then pays the merchant from what remains minus a markup for the financial service of credit card processing, merchant accounts processing. The merchant ultimately receives an amount of money equal to the sale price of the item plus the sales tax minus a series of fees and markups that include interchange fees and other costs. Interchange represents the largest component of all the various fees that merchants can pay for the liquidity and privileges provided by credit card processing, merchant accounts. Interchange fees are non-standard. They will vary according to what category any individual credit card transaction can be placed in. Different factors determine how credit card transactions are categorized.

Some of the factors relied upon to categorize credit card transactions are under the control of the retail merchant and some are not. Such factors include the processing method — was the charge card present at the time of the sale? The interchange “card present” category is assigned a lesser fee than the “card-not-present” category. Other factors influencing interchange categories and fees include card type (debit or credit), card brand and how cardholder data is captured.

The process of analyzing and adapting a merchant’s processing polices as a means to incur the lowest interchange costs is known as “interchange optimization.” Since interchange costs account for the bulk of a merchant’s card processing overhead, ensuring that the maximum number of credit card transactions qualify for the lowest-cost categories as often as possible is a good way for retail merchants to fatten their bottom lines.

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