{"id":9383,"date":"2023-12-21T04:51:42","date_gmt":"2023-12-21T09:51:42","guid":{"rendered":"https:\/\/faisalkhan.com\/?page_id=9383"},"modified":"2023-12-21T04:51:44","modified_gmt":"2023-12-21T09:51:44","slug":"interchange-and-how-it-works","status":"publish","type":"page","link":"https:\/\/faisalkhan.com\/learn\/payments-wiki\/interchange-and-how-it-works\/","title":{"rendered":"Interchange and how it works"},"content":{"rendered":"\n

Interchange, in the context of banking, payments, card processing, and cards, refers to the fee typically paid by a merchant’s bank (acquirer) to a customer’s bank (issuer) for card-based transactions. This fee is a key component in the financial operations of credit and debit card networks.<\/p>\n\n\n\n

Official Definition and How It Works<\/h3>\n\n\n\n

The interchange fee is a transaction fee set by card networks (like Visa, MasterCard) that the merchant’s bank pays to the cardholder’s bank whenever a customer uses a card for a purchase. The fee compensates the issuer for the risk and cost involved in handling card payments, including fraud prevention and providing credit.<\/p>\n\n\n\n

Who Offers It?<\/h3>\n\n\n\n

Interchange fees are set by card networks (e.g., Visa, MasterCard) and vary based on the type of card (debit, credit, rewards), the transaction type, and the merchant’s industry.<\/p>\n\n\n\n

Importance and Beneficiaries<\/h3>\n\n\n\n

Interchange fees are crucial for the functioning of the card payment ecosystem. They incentivize banks to issue cards and participate in the network. The primary beneficiaries are the card-issuing banks, as they receive the interchange fee income.<\/p>\n\n\n\n

Expense or Income?<\/h3>\n\n\n\n

Interchange is an expense for the merchant and their bank, as they pay the fee. It’s an income for the card-issuing bank.<\/p>\n\n\n\n

How It Works Between Two Banks<\/h3>\n\n\n\n
    \n
  1. Customer Purchase<\/strong>: A customer uses a debit or credit card to make a purchase.<\/li>\n\n\n\n
  2. Bank Communication<\/strong>: The merchant’s bank requests authorization from the customer’s bank.<\/li>\n\n\n\n
  3. Approval and Transfer<\/strong>: Once approved, the transaction is processed, and funds, minus the interchange fee, are transferred from the issuer to the acquirer.<\/li>\n\n\n\n
  4. Settlement<\/strong>: The merchant receives the payment, less the interchange fee and any additional merchant service charges.<\/li>\n<\/ol>\n\n\n\n

    Benefits for Program Managers and Card Promoters<\/h3>\n\n\n\n

    Program managers or card promoters can benefit from interchange by:<\/p>\n\n\n\n

      \n
    • Offering competitive rates to attract merchants.<\/li>\n\n\n\n
    • Negotiating better terms with card networks.<\/li>\n\n\n\n
    • Providing value-added services to merchants, leveraging interchange income.<\/li>\n<\/ul>\n\n\n\n

      Examples<\/h3>\n\n\n\n

      Debit Card Transaction<\/strong>:<\/h4>\n\n\n\n
        \n
      • A customer buys groceries using a debit card.<\/li>\n\n\n\n
      • The grocery store’s bank pays an interchange fee to the customer’s bank.<\/li>\n\n\n\n
      • The fee is lower than for credit transactions, reflecting the lower risk of debit cards.<\/li>\n<\/ul>\n\n\n\n

        Credit Card Transaction<\/strong>:<\/h4>\n\n\n\n
          \n
        • A customer purchases electronics with a credit card.<\/li>\n\n\n\n
        • The electronics store’s bank pays a higher interchange fee to the customer’s bank, given the higher risk and benefit of credit transactions.<\/li>\n<\/ul>\n\n\n\n

          Rewards Card Transaction<\/strong>:<\/h4>\n\n\n\n
            \n
          • A customer uses a rewards credit card at a restaurant.<\/li>\n\n\n\n
          • The restaurant’s bank pays an interchange fee, part of which funds the rewards program.<\/li>\n\n\n\n
          • The fee is typically higher due to the added value of rewards.<\/li>\n<\/ul>\n\n\n\n

            Let’s go through a calculation for an interchange transaction. I’ll use a hypothetical scenario with a credit card transaction at a retail store to illustrate how the interchange fee is calculated and distributed.<\/p>\n\n\n\n

            Scenario<\/h3>\n\n\n\n
              \n
            • Transaction Amount<\/strong>: $100<\/li>\n\n\n\n
            • Interchange Rate<\/strong>: 2% (This rate varies based on card type, merchant category, and other factors. For this example, we’ll use a simple flat rate).<\/li>\n<\/ul>\n\n\n\n

              Calculation<\/h3>\n\n\n\n
                \n
              1. Total Transaction<\/strong>: The customer makes a purchase of $100 using their credit card.<\/li>\n\n\n\n
              2. Interchange Fee Calculation<\/strong>: The interchange fee is calculated as a percentage of the total transaction amount.<\/li>\n<\/ol>\n\n\n\n
                  \n
                • Interchange Fee = Transaction Amount x Interchange Rate<\/li>\n\n\n\n
                • Interchange Fee = $100 x 2% = $2<\/li>\n<\/ul>\n\n\n\n

                  Distribution of Payment<\/strong>:<\/h4>\n\n\n\n
                    \n
                  • The merchant’s bank (acquirer) will pay the $2 interchange fee to the card-issuing bank (issuer).<\/li>\n\n\n\n
                  • The merchant receives the transaction amount minus the interchange fee. Therefore, the merchant gets $100 – $2 = $98.<\/li>\n<\/ul>\n\n\n\n

                    Flow of Funds<\/h3>\n\n\n\n
                      \n
                    • Customer’s Bank (Issuer)<\/strong>: Receives $2 as the interchange fee.<\/li>\n\n\n\n
                    • Merchant’s Bank (Acquirer)<\/strong>: Pays out $100 initially, then gets reimbursed $2 from the issuer, effectively paying $98.<\/li>\n\n\n\n
                    • Merchant<\/strong>: Receives $98 from their bank after the interchange fee has been deducted.<\/li>\n<\/ul>\n\n\n\n

                      Impact<\/h3>\n\n\n\n
                        \n
                      • For the Merchant<\/strong>: This fee is part of the cost of accepting credit cards. Merchants might factor this cost into their pricing strategies.<\/li>\n\n\n\n
                      • For the Customer<\/strong>: The customer pays $100; they are typically unaffected directly by the interchange fee.<\/li>\n\n\n\n
                      • For the Banks<\/strong>: The issuer benefits from the interchange fee, while the acquirer facilitates the transaction and ensures the merchant is paid.<\/li>\n<\/ul>\n\n\n\n

                        This example simplifies the process for clarity. In real-world scenarios, additional fees like assessment fees by the card network and processing fees by the merchant’s bank might also apply.<\/p>\n\n\n\n

                        Conclusion<\/h3>\n\n\n\n

                        Interchange fees are a fundamental aspect of the card payment system, balancing the interests of various parties involved. Understanding these dynamics is crucial for anyone dealing with card-based transactions, be it from a merchant, bank, or consumer perspective.<\/p>\n","protected":false},"excerpt":{"rendered":"

                        Interchange, in the context of banking, payments, card processing, and cards, refers to the fee typically paid by a merchant’s bank (acquirer) to a customer’s bank (issuer) for card-based transactions. This fee is a key component in the financial operations of credit and debit card networks. Official Definition and How It Works The interchange fee […]<\/p>\n","protected":false},"author":1,"featured_media":0,"parent":3611,"menu_order":0,"comment_status":"closed","ping_status":"closed","template":"","meta":{"_uag_custom_page_level_css":"","_lmt_disableupdate":"","_lmt_disable":"","footnotes":""},"blocksy_meta":[],"featured_image_urls":{"full":"","thumbnail":"","medium":"","medium_large":"","large":"","1536x1536":"","2048x2048":"","gb-block-post-grid-landscape":"","gb-block-post-grid-square":"","yarpp-thumbnail":""},"post_excerpt_stackable":"

                        Interchange, in the context of banking, payments, card processing, and cards, refers to the fee typically paid by a merchant’s bank (acquirer) to a customer’s bank (issuer) for card-based transactions. This fee is a key component in the financial operations of credit and debit card networks. Official Definition and How It Works The interchange fee is a transaction fee set by card networks (like Visa, MasterCard) that the merchant’s bank pays to the cardholder’s bank whenever a customer uses a card for a purchase. The fee compensates the issuer for the risk and cost involved in handling card payments, including…<\/p>\n","category_list":"","author_info":{"name":"Faisal Khan","url":"https:\/\/faisalkhan.com\/author\/nomismad\/"},"comments_num":"0 comments","featured_image_urls_v2":{"full":"","thumbnail":"","medium":"","medium_large":"","large":"","1536x1536":"","2048x2048":"","gb-block-post-grid-landscape":"","gb-block-post-grid-square":"","yarpp-thumbnail":""},"post_excerpt_stackable_v2":"

                        Interchange, in the context of banking, payments, card processing, and cards, refers to the fee typically paid by a merchant’s bank (acquirer) to a customer’s bank (issuer) for card-based transactions. This fee is a key component in the financial operations of credit and debit card networks. Official Definition and How It Works The interchange fee is a transaction fee set by card networks (like Visa, MasterCard) that the merchant’s bank pays to the cardholder’s bank whenever a customer uses a card for a purchase. The fee compensates the issuer for the risk and cost involved in handling card payments, including…<\/p>\n","category_list_v2":"","author_info_v2":{"name":"Faisal Khan","url":"https:\/\/faisalkhan.com\/author\/nomismad\/"},"comments_num_v2":"0 comments","yoast_head":"\nInterchange and how it works<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/faisalkhan.com\/learn\/payments-wiki\/interchange-and-how-it-works\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Interchange and how it works\" \/>\n<meta property=\"og:description\" content=\"Interchange, in the context of banking, payments, card processing, and cards, refers to the fee typically paid by a merchant’s bank (acquirer) to a customer’s bank (issuer) for card-based transactions. 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