Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
Standard view
Full view
of .
Save to My Library
Look up keyword
Like this
0 of .
Results for:
No results containing your search query
P. 1
Interchange fees and their impact on small businesses

Interchange fees and their impact on small businesses

Ratings: (0)|Views: 94 |Likes:
Published by workitrichmond

More info:

Categories:Types, Research
Published by: workitrichmond on Jul 21, 2011
Copyright:Attribution Non-commercial


Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less





Each time a consumer makes a purchase usinga credit or debit card, the merchant is assessedees associated with processing the transac-tion. The largest o those ees is the “inter-change” ee, which is set by the card network that processes the transaction and is ultimatelypaid to the bank that issued the card. Theamount o that ee varies by transaction type,among other variables. The average inter-change ee or debit transactions was about44 cents per transaction, or 1.14 percent o the transaction amount, in 2009, accordingto a 2010 Federal Reserve Board survey.
 By comparison, interchange ees or credittransactions may range rom 1.5 percent to 2percent o the transaction value, according to aseparate 2009 study by Federal Reserve econo-mists Prager et al.
According to this paper, theamount o interchange ees assessed by Visaand MasterCard or debit and credit card trans-actions ranged between $35 billion and $45billion in 2007, perhaps double the levelo 2002.
May 2011, EB11-05
Economic Brief 
EB11-05 - The Federal Reserve Bank of Richmond
The Role of Interchange Fees on Debit and CreditCard Transactions in the Payments System
By Tim Mead, Renee Courtois Haltom, and Margaretta Blackwell 
When consumers use debit or credit cards to make purchases, merchants areassessed fees for processing the transactions, the largest of which is calledan “interchange” fee. Rising interchange fees, along with the growing domi-nance of card transactions in the payments system, have brought increasingscrutiny from regulators on the appropriate level of interchange fees and thecompetitive aspects of card networks. A look at the trends, mechanics, andeconomic role of interchange fees indicates that the issue is more complicat-ed than it may initially appear.
Page 1
 The total value o interchange ees has increasedin recent years due largely to the growth o cardpayments and increasing interchange ee rates. This has led to a growing discussion within theretail payments community and among regula-tors about the administration o interchangeees. Some commentators argue that inter-change ees paid by merchants are exorbitant,while others point to the potential economicbenets o interchange ees.Most recently, the Dodd-Frank nancial regula-tory reorm law, passed in July 2010, includedregulatory actions related to interchange ees. This component, commonly reerred to as theDurbin Amendment, provides the Federal Re-serve Board with regulatory authority overdebit interchange ees and certain other aspectso debit card payment networks. With respectto interchange ees, the scope o the DurbinAmendment is limited to debit cards (as wellas certain types o prepaid cards), but there are
Page 2
many commonalities between debit and credit cardpayments, as discussed below.While remaining agnostic on the outcome o theDurbin Amendment and resultant rulemakings,this Economic Brie provides an overview o themechanics, market structure, and economics o interchange ees.
The Background and Mechanicsof Interchange Fees
 This essay ocuses on three main types o paymentcard transactions used by consumers: signaturedebit, PIN debit, and credit transactions. In bothtypes o debit card transactions, the payment tothe merchant is unded by the consumer’s check-ing account. The dierence, as the names imply, isthat authentication o the transaction is perormedby either a signature or a personal identicationnumber (PIN) entered at the point-o-sale (POS).Additionally, signature debit typically oers greaterconsumer protection with respect to raudulenttransactions. In either type o debit transaction,payment is withdrawn rom the cardholder’s check-ing account within a ew business days. With creditcard transactions, the customer’s signature serves asauthorization, and payment is made to the merchantbased on the cardholder’s credit availability, with thecard-issuing bank assuming some degree o risk ornon-payment. The rst closed-loop charge card—a card that canbe used only at specic merchants and requires ullpayment at the end o each month—was issuedby Diners Club in 1950. Later that decade, Bank o America began issuing to its Caliornia customers arevolving balance credit card, a card that allows usersto carry a balance at the end o a statement period.In the mid-1960s, Bank o America began to allowother banks to license its credit card to expand thecard’s availability to more consumers and to reachretailers outside the bank’s geographic area. This ar-rangement ultimately led to the ormation o the Visa“network.” Early versions o what are now AmericanExpress, MasterCard, and Discover emerged in the1950s, 1960s, and 1980s, respectively. These our re-main the primary credit card networks in the UnitedStates today, with Visa and MasterCard maintainingthe largest market share. The 1960s saw the advent o automated teller ma-chines (ATMs) and the establishment o local and re-gional ATM networks. The economics o this expand-ing network was based on cost reduction (primarilyor labor associated with customer checking and sav-ings accounts) rather than on revenue generation asin the credit card model. ATMs oered customers theability to access their unds ater traditional bankingcenter hours by using their ATM cards and PINs. The debit card concept began in the mid-1980s asbanks expanded the unctionality o the ATM card toserve as a payment guarantee at the POS, and there-ore as an eective substitute or the paper check.Initially these cards were issued only to prioritycustomers with extended histories and high accountbalances since transaction amounts were not imme-diately debited rom the cardholders’ bank accounts. The existing ATM network inrastructure was lever-aged to support national PIN debit card transactionnetworks. These networks were expanded as moremerchants installed the POS technology needed toread the ATM card’s magnetic strip and accept theconsumer’s PIN.In the 1990s, Visa and MasterCard partnered withnumerous banks to issue branded signature debitcards. By leveraging their existing credit card net-works to clear signature debit transactions, and byacquiring PIN debit networks, Visa and MasterCardnow process both signature and PIN debit trans-actions. According to a Nilson Report, based ondebit and credit card purchase volume in 2010, Visamaintained about 57 percent o the market, ollowedby MasterCard at 25 percent, American Express at 15percent, and Discover at 3 percent. In other words,all credit and signature debit card transactions arerouted through one o the our major card networks.PIN debit transactions are routed through regionalor national electronic unds transer networks suchas Star, Pulse, Interlink, or Maestro. The latter two areowned by Visa and MasterCard, respectively.
For the majority o card transactions—those involv-ing the Visa, MasterCard, and, in some cases, Discovernetworks—our parties are involved: the consumerand the merchant, as well as the bank that issuedthe credit card (the “issuer”) and the merchant’s bank (the “acquirer”). The latter is an institution that pro-vides card payment processing services, or which itcharges the merchant.
 Figure 1 depicts the exchange o unds in a typicalour-party card transaction.
The gure depicts onlythe directional ow, not the timing, o the exchangeo unds and ees among the parties. Merchants paywhat is known as a merchant discount ee, whichincludes the interchange ee paid to the card-issuingbank, the network assessment ee paid to the cardnetwork, and the acquiring ee paid to the acquirer.While the merchant discount rate is composed o three separate ees, the interchange ee is the larg-est component. Logistically, while authorization o 
Page 3
transactions (based on the availability o unds orcredit or debit and credit purchases, respectively)occurs in real time, nancial settlement takes placewithin one or two days o the transaction date.
Forsimplicity, Figure 1 represents one transaction. Whena cardholder makes a purchase, the merchant sub-mits the transaction to the acquirer, usually daily. Theacquirer sends the transaction to the issuer or pay-ment through the card network. The issuer subtractsthe interchange ee and submits the net amount tothe acquirer through the card network. The acquirerthen pays the merchant the net o the transactionamount less the interchange ee. While the network assessment ee and acquiring ee are per-transactionees, both are generally billed by the acquirer to themerchant on a monthly basis.
The Economics of Interchange Fees
 The demand or card payment services is otendescribed as a “two-sided” market: a payment card
Note: Fees in this example are typical but not average. Dollar amounts, except network assessment ee, are rom a similarow chart in “Rising Interchange Fees Have Increased Costs or Merchants, but Options or Reducing Fees Pose Challenges,a Government Accountability Oce report rom November 2009.* The card network assesses additional ees on the issuer and merchant.
A –
Cardholder uses cardto make $100 purchase.
D –
Merchant’s bank (acquirer)retains $0.40 acquiring ee and$0.10 network assessment eeand transers $97.80 to merchant.
E –
Cardholder pays $100to card-issuing bank.
Figure 1: Typical Card Transaction
C –
Card-issuing bank (issuer) approvestransaction, retains $1.70 interchange ee,and transers $98.30 to merchant’s bank.
B –
Merchant submits $100transaction or approval.
Cardholder MerchantAcquirerIssuerCard Network*
Merchant absorbsdiscount ee o $2.20.

You're Reading a Free Preview

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->