Interchange income, often referred to as interchange fees or revenue, is a fee collected by banks that issue credit cards during card transactions. When a customer makes a purchase with a credit card, the business’s bank pays a fee to the cardholder’s bank. This fee is typically a percentage of the transaction amount plus a fixed fee, and it compensates the issuer for the risk and cost involved in handling the transaction.

Considering that Visa’s networks alone processed more than 212 billion transactions in 2023, interchange income can add up for both card issuers and businesses that accept card payments. Below, we’ll explain how interchange income works, the factors that can affect it, and how issuers and businesses can best handle it.

What’s in this article?

• What are interchange fees?
  
• How does interchange income work?
  
• Factors that can affect interchange income
  
• Ways to refine interchange income as a card issuer
  
• Ways to lower interchange income costs as a business
  

What are interchange fees?

Interchange fees are transaction fees that the business’s bank account must pay whenever a customer uses a credit or debit card to make a purchase from its store. Card networks (e.g. Visa, Mastercard, Discover) set these fees, and the business pays them to the card-issuing bank. The fees compensate the issuer for the costs of handling the card transaction, including the risk of fraud and bad debt (i.e. debt that won’t be repaid). They also fund some credit cards’ rewards schemes.

How does interchange income work?

The business’s bank (the acquiring bank) usually pays interchange fees to the cardholder’s bank (the issuing bank). When a customer uses a credit or debit card to make a purchase, the business processes the card transaction and the payment data is sent through the payment network to the customer’s bank. For each transaction, the issuing bank charges an interchange fee. Card networks set this fee, which varies based on several factors including the type of card used (e.g. credit, debit), the business type, the transaction size, and whether the transaction is processed in person or online.

Although the business’s bank pays these costs, it often passes them on to businesses in the form of service charges. Consequently, interchange fees influence the overall cost for businesses of accepting card payments.

Factors that can affect interchange income

Here are some factors that can affect interchange fees:

• Card type: Credit cards generally have higher interchange fees than debit cards, as they involve higher processing costs and credit risks for issuing banks.

• Card network: Each card network has its own interchange fee schedules, which can vary based on market competition and network policies.

• Card issuer: The size and type of the issuing bank can influence interchange fees. Larger banks might have more bargaining power to negotiate lower fees.

• Rewards schemes: Cards with rewards schemes often have higher interchange fees to offset the cost of providing benefits to cardholders.

• Merchant category code (MCC): The MCC designates the type of business the merchant operates. Some industries (such as travel and luxury goods) have higher interchange fees because of higher perceived risk or transaction value.

• Transaction type: Card-present transactions (i.e. in-person swipes) typically have lower fees than card-not-present transactions (i.e. online or over-the-phone transactions) because of reduced fraud risk.

• Transaction size: Interchange fees are often a percentage of the transaction amount plus a small fixed fee, so larger transactions generally yield more interchange income.

• Region: Interchange fees can vary based on the geographic location of the transaction, based on local market conditions and regulations.

• Fraud prevention: Businesses with additional security measures such as 3D Secure might qualify for lower interchange fees.

• Level of transaction detail: Providing more detailed transaction information (Level II or Level III data) can sometimes lead to lower fees, especially for business-to-business transactions.

• Economic conditions: Inflation or economic downturns can indirectly affect interchange income by influencing customer spending habits and overall transaction volumes.

• Regulatory changes: New regulations or legal rulings that affect interchange fees can have a substantial impact on income for issuing banks and card networks.

Ways to refine interchange income as a card issuer

Card issuers earn interchange income through the fees businesses pay for each card transaction. Here’s how you can refine this revenue stream:

• Focus on lucrative categories: Launch targeted marketing campaigns that highlight the benefits of using your card for higher interchange categories such as travel and dining. Consider partnerships with airlines and popular restaurant chains to offer attractive rewards points or cash back specifically when customers use your card for these transactions.

• Chase big spenders: Develop a suite of premium card products with tiered benefits including concierge services, access to exclusive clubs, or special rates on luxury travel. Use data analytics to identify potential customers who already spend large amounts in these categories and suggest a customised upgrade path.

• Dive into business and corporate cards: Create specialised offerings for business expenses such as travel, office supplies, and technology upgrades. Offer flexible rewards that increase with spending, along with tools for expense management and reporting that add value for business owners and finance departments.

• Push for digital adoption: Implement incentives for using digital wallets and mobile payments, such as small bonuses for the first few mobile transactions. Educate customers on the security and convenience of these payment methods through workshops or online tutorials.

• Expand acceptance: Identify key markets or sectors where card acceptance is low and partner with local business associations to offer introductory processing fee discounts. Support smaller businesses with technology upgrades that facilitate easy card acceptance.

• Strengthen security: Invest in state-of-the-art fraud detection algorithms and secure transaction technology. Regularly update your customers on how these technologies protect their transactions and personal information and how they reinforce the security benefits of using your card.

• Use data to your advantage: Use advanced data mining techniques to analyse spending patterns and dynamically adjust interchange fees based on industry, region, or even time of year. Share insight with businesses to help them understand the benefits of accepting your card.

• Add more value: Bundle your cards with insurance products such as travel insurance and product warranties that activate when purchases are made with your card. Draw attention to these added protections in customer communications to demonstrate the card’s value.

• Forge strategic partnerships: Develop co-branded cards with retailers or service providers that include instant rewards at the point of sale, exclusive access to sales, or special financing options. Feature these partnerships prominently in your marketing efforts.

Ways to lower interchange income costs as a business

Businesses try to limit their interchange costs because these fees directly affect their profitability. Here are some tactics for lowering these costs:

• Negotiate better rates with your service provider: If your business has a high transaction volume or has been with the same provider for a long time, consider renegotiating lower interchange rates. Review agreements periodically and compare rates from different providers to ensure you’re getting the best deal.

• Encourage alternative payment methods: Promote the use of payment methods that usually carry lower fees than credit cards such as debit cards, direct bank transfers, mobile payment apps, and digital wallets. You can incentivise these through discounts or loyalty points.

• Set a minimum card transaction amount: To offset the cost of smaller transactions, consider setting a minimum purchase amount for credit card use. This can discourage small transactions that disproportionately raise interchange fees relative to the transaction size. Make sure you comply with network rules and clearly communicate this policy to customers.

• Use an address verification service (AVS): Implementing AVS can help lower the risk of fraudulent transactions, which in turn can qualify your business for lower interchange rates. This service checks the cardholder’s address with the card issuer and adds an extra security layer to transactions.

• Batch process transactions: Instead of processing transactions one by one, batch them at the end of the day. This can reduce processing fees and lower your total transaction costs, depending on your merchant agreement.

• Opt for less expensive card networks: Different card networks charge different interchange fees. When possible, encourage customers to use cards from networks that cost you less. Educate your staff on these networks, and consider programming your payment terminals to suggest these options when customers pay.

• Train staff to ask for PIN on debit transactions: Whenever possible, have customers enter their PINs for debit transactions. PIN debit transactions usually come with lower fees compared to signature debit transactions.

• Regularly update your payment technology: Keeping your payment technology up to date can minimise the risk of fraud and chargebacks, which can lead to lower interchange fees. Updated technology is also often more efficient, which can speed up transactions and reduce costs.

• Improve your card acceptance practices: Review and improve how your business handles card transactions. This involves training staff on best practices for card acceptance, ensuring all equipment is functioning optimally, and regularly updating signage and customer communication to promote the most cost-effective payment methods.

• Analyse your sales data: Review your transaction data regularly to identify trends and areas where you can reduce costs. Understanding your transaction mix by card type, transaction size, and consumer preferences can offer insight into how to better manage interchange fees.