February 1, 2022

Interchange Revenue Guide

Carla McMorris

How Interchange Fees are Fueling Fintech Revenue Models

Interchange fees have long been in the spotlight for merchant card transactions. The pricing model, administered by the card networks and charged to merchants, supports the infrastructure, operations, and risk involved in processing card payments. Today, interchange revenue is fueling the revenue stream of many successful neobanks or challenger banks. In this guide, get the details on interchange fees, including who controls them, who they affect, and how they work. Learn why interchange revenue is so important to fintechs and plan for some of the most important changes coming up in this dynamic sector.

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What are interchange fees?

Interchange, which is short for “Interchange Reimbursement Fees”, are per card transaction fees that are charged by the card networks to merchants for processing debit or credit card transactions. Every merchant that accepts cards pays interchange fees. These fees are associated with the costs of accepting, processing, and authorizing card transactions including covering fraud, bad debt, and other risks that the card networks incur by approving payment. The interchange fees are paid by the merchant bank (acquirer) to the customer’s bank (issuing bank) which is why they are sometimes called “issuer fees”. According to Bloomberg, merchants pay $100 billion on interchange fees annually.

Who charges interchange fees?

The card networks determine interchange fees. Visa and Mastercard, the two largest card networks, adjust their interchange fees semiannually in April and October. You can find their current interchange rates on their websites here: Visa and Mastercard. Other card networks adjust their fees annually.

How interchange fees are determined is a little more detailed. Merchants who accept debit and credit cards are responsible for three types of fees:

  1. Interchange fee - The largest of the three, it is usually ~2% of the total transaction in the US, sometimes including a flat fee which can be as much as $0.30
  2. Card network fees - Charged for the usage of the network
  3. Acquirer fee - Charged by the acquirer for gaining access to the shopper's funds

Why are interchange fees needed?

Interchange fees help cover the cost of the payment infrastructure which makes it possible for individuals and businesses to enjoy the convenience of paying with cards. When a customer uses a card to pay for products or services at a merchant, it costs money for the bank that issued the card to the customer to transfer money to the merchant, and interchange fees help pay those costs. They also help cover some of the fraud risks involved when a card is accepted as payment. 

How are interchange fees calculated?

There are several factors that influence interchange fees for merchants including the type of business or the merchant category code (MCC), the card type (debit, credit, prepaid, business, etc.), the location (cross-border versus in-country transactions), and the type of transaction (hotel, retail, etc.). Here are a few category highlights:

  • Card-Not-Present versus Card-Present
    In today’s digital world the most important factor is likely card-not-present (CNP) versus card-present (or in-person) transactions. When the cardholder uses the card to buy a product or service online, that is a CNP transaction and the interchange fee is higher because the risk of fraud is higher when the card is not physically present.
  • Card Network
    Each network establishes its own interchange fees, but they usually stay aligned to remain competitive.
  • Line of Business
    The type of business (or their Merchant Category Code - MCC) and the type and frequency of their transactions can affect the interchange fee.
  • Card Type
    Commercial cards command higher fees than individual cards.
  • Credit Cards 
    Credit cards have higher interchange fees than most debit cards and prepaid cards because credit is considered a higher risk than sourcing readily available debit funds.
  • Location
    Domestic transactions, where the merchant and the card issuing bank are in the same country, have lower interchange rates than cross-border transactions.
  • Merchant Size
    Even the size of the merchant can affect the interchange rate as larger companies can often negotiate lower rates.

What’s a common interchange transaction calculation?

There are many variables that affect every card transaction, but here is a straightforward example to consider:

Jade, a new mom of twins, just received her new debit card from a neobank that also promised to help her save money. She uses the card to buy 2 cases of diapers and several other infant necessities and her total comes to $100. Based on the interchange fee of 1.85% + 0.20 (flat fee), the transaction fee would be $2.05. The 1.85% is higher than most fee structures because it was an online purchase. The flat fee will likely go entirely to the card network and the payment processor.

What are interchange++ and blended pricing?

Interchange Plus Plus (interchange++) is a pricing model based on transparency. It is supported by Visa and Mastercard in the US and Europe and it offers a detailed view of the interchange costs broken down by the three categories that we detailed above: interchange fee, card network fees (sometimes called the systems fee), acquirer fee.

Blended pricing bundles all three fees plus processor charges, gateway fees, and PCI compliance fees into one lump sum. Merchants see a bundled view of their fees for each transaction with the blended model.

Why do challenger banks rely on interchange as a revenue source?

Challenger banks introduced themselves to customers as the alternative to big traditional banks without the high overdraft fees, deep restrictions, and low-interest rates on savings accounts. To pay for those exceptional services challenger banks collected interchange revenue from the merchants that their customers shopped with. The Dodd-Frank Act and the Durbin amendment did not cap interchange fees for small banks, only large banks which enabled fintechs who issued cards with smaller banks to collect higher interchange fees and make more revenue.

How did interchange become a major revenue driver for neobanks?

In the 2010s, neobanks offered customers services for free which were offset by interchange revenue made from the merchants. The Dodd-Frank Act and the Durbin amendment fueled revenue streams for fintechs by capping the interchange fees that large banks could charge merchants, but not capping those fees for small banks. Fintechs now partner with small banks to issue cards which enables them to charge higher fees than they would be able to if they had partnered with larger banks.

How does interchange revenue benefit neobanks and challenger banks?

The card programs that often accompany neobanking and credit builder applications can be a significant source of revenue. While providing convenience and value to their customers, and boosting power to their brand, these card programs also bring a significant share of interchange revenue every time a customer uses their card to make a transaction. The percentage of interchange revenue for each transaction depends on many factors but interchange fees have become a significant share of total revenues for most fintechs today.

The best way to think about the potential of interchange revenue is to take one real-world example and amplify it across a larger audience. For example, say you have a debit card program in place and your average customer is spending $200 a month on your card. If we estimate the interchange revenue at 1.5%, then that one customer would bring your fintech $3.00 in one month. 

Depending on the revenue share agreement with the BaaS provider or partner bank, it is possible for your fintech to receive 80% of that interchange revenue or $2.40. If you multiply that across a customer base of say 30,000, that would bring $72,000 per month. The more your customers use your card to make transactions, the more they spend on the card, and the more your customer base grows, the higher the interchange revenue.

What’s the best way for a neobank or a challenger bank to maximize interchange revenue?

Promote card usage

It seems obvious that promoting your card program would be the best way to foster card usage and loyalty, but it isn’t always the priority when there are other parts of your services that are competing for brand voice. Remind your customers of the best features of your card program, reward them for making it their primary card by embedding high-value services when they set up direct deposit, and give high users special rewards or cashback. 

Choose the right card type: credit over debit

Credit cards can deliver up to 2X higher interchange rates than debit cards and they have other features that you can leverage to enhance both your product offering and customer experience. 

Guide card usage to high interchange categories

You’ve chosen your target audience carefully, it’s important to guide their purchases to the categories where you can gain the most interchange revenue. Not all business types have the same interchange fees, for example, Grocery may have 1.05% but online shopping 1.90%. Through partnerships and marketing, promote the categories that are best suited for your products and services.

What’s the future of interchange?

According to Deloitte, the payments industry is one of the most dynamic ecosystems in financial services. Interchange is one of the most dynamic components in that system. Interchange is evolving at an accelerated pace, impacted by technology and operational efficiencies and pressure from influential parties like banks, card networks, merchants, and consumers. Here’s what the industry sees as the next big developments: 

  • Visa is a major player in interchange revenue and they are gearing up to overhaul their rates, changing the balance for merchants across the board. In their plan, online purchases will go up, but some services businesses will decrease. 
  • Big banks are pressuring regulators to cap the interchange fees of small banks so they can’t profit as much and pass those profits on to neobanks and challenger banks who they see as competitors.
  • Ever the disruptors, fintechs are ready to help merchants lower their interchange fees with creative new payment models, blockchain technology, and offering consumers alternative ways to pay.

Here at Synapse, we are the only Banking-as-a-Service provider that enables builders to launch feature-complete finance products in weeks. Our BaaS platform empowers industry-compliant payment, card issuance, deposit, lending, credit, and investment products through simple APIs. If you’d like to learn more please visit our website and chat with us.

Interchange Revenue Guide

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Carla McMorris
February 1, 2022

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