There are several businesses near me that either only take cash or highly encourage the use of cash via heavy discounts. One of them even takes pesos if that’s all you’ve got, but they prefer you don’t use credit cards. And it’s all about avoiding interchange fees.
That’s because every time you swipe, tap, or dip, the merchant has to pay for the privilege of accepting plastic payment methods. And that can add up fast for small businesses already operating on razor-thin margins.
Even if businesses take debit and credit card payments, those interchange fees impact your shopping experience long before you check out in the form of higher prices. That’s why it’s important to understand interchange fees and how they impact the businesses you frequent.
What Are Interchange Fees?
Interchange fees are the fees card networks like Visa, Mastercard, and American Express charge for processing and settling payment transactions. These (usually) invisible costs help compensate the various parties involved in the payment card ecosystem.
Card issuers like banks and credit unions collect these fees from the merchants who accept the card as a form of payment. They help facilitate the smooth transfer of funds between the merchant’s bank (the acquiring bank) and the bank that issued the payment card.
Interchange fees may seem like an additional burden, but they help keep the payment card system functioning smoothly. For example, the card networks and issuers use the revenue to cover the costs of maintaining the payment infrastructure, ensuring fraud-prevention measures, and providing customer support services.
How Interchange Fees Work
When it comes to interchange fees, there are a lot of moving parts and hands in the pot — which is only a mixed metaphor if you don’t consider how modern manufacturing works. Fortunately, they’re fairly straightforward to understand.
Structure & Calculation of Interchange Fees
Interchange fees aren’t arbitrary. Payment technology companies like Visa and Mastercard determine them through a structured process that takes various factors into account, such as:
- Transaction type. Online purchases, in-store payments, or international transactions may have varying fee structures. For example, you might pay a foreign transaction fee if you use your card overseas.
- Card type. Whether it’s a credit card, debit card, or rewards card can impact the interchange fee applied to a transaction. For instance, debit cards tend to have lower transaction fees than credit cards.
- Merchant category. The industry or sector in which the business operates is also a consideration. For example, transactions made at a grocery store might have different interchange fees compared to those at a gas station or a restaurant.
Regardless of the factors involved, the calculation methods typically involve a percentage of the transaction amount, a flat fee, or a combination of both.
The specific calculations depend on the card network and region. Card networks like Visa and Mastercard have intricate fee schedules that consider multiple factors to arrive at the appropriate interchange fee for each transaction. They update these schedules regularly.
Participants in the Interchange Fee Ecosystem
To understand interchange fees fully, you must take a closer look at the key stakeholders. These participants play crucial roles in determining and collecting interchange fees.
- Card issuers: Financial institutions like banks and credit unions issue payment cards, including credit, debit, or prepaid cards. They collect interchange fees from merchants on behalf of the payment networks they partner with.
- Payment networks: Payment networks like Visa, Mastercard, American Express, and Discover act as intermediaries between merchants, card issuers, and acquiring banks (merchants’ banks). They facilitate transaction authorization, clearing, and settlement and establish fee rules and structures.
- Merchants: Merchants are physical stores, online retailers, or service providers that accept payment cards. They have agreements with (acquiring) banks to process their card transactions and pay interchange fees to card issuers through those banks.
How Interchange Fees Impact Consumers
Interchange fees are as important to consumers as they are invisible. That’s perhaps a bit strange in a country where retailers calculate tax at the register and have a line on the receipt for it (it’s included in the tag’s sale price in other countries). And it impacts everything from the cost of your rewards card to the cost of the products you buy.
Funds Secure & Ever-Larger Payment Card Systems
Payment networks invest some interchange revenue in the technological infrastructure needed for seamless transactions, including secure processing, fraud-prevention, and data security. Those are vital to consumers’ trust in the network and the merchants who use them.
The fees also provide crucial revenue that helps cover the costs associated with expanding, ensuring more options available to Americans nationwide (and potentially abroad).
Interchange fees can impact the prices consumers pay, even if they don’t use payment cards for their transactions.
To offset these fees, merchants factor them into their pricing strategies. That means that even if a consumer pays with cash or another non-card method, they still usually pay slightly higher prices for goods and services.
By incorporating interchange fees into their overall cost structure, merchants distribute the expenses across all customers, regardless of their payment method. That helps ensure the business can cover the fees without cutting into their desired profit margins.
The extent of the price adjustment varies across businesses and industries. Small businesses with tighter profit margins may feel the impact of interchange fees more significantly and may adjust prices accordingly. Larger businesses with higher transaction volumes have more flexibility to absorb these fees without significant price adjustments.
Limit or Discourage Card Payments
A relatively small number of merchants and service providers have taken to charging the interchange fees directly to the customers who use plastic payment methods as a way to disincentivize them. For example, my local government services, such as the Department of Motor Vehicles, charge you for swiping.
Still others positively reward customers who pay in cash. I buy all my appliances from local secondhand appliance places, and they give you a discount that amounts to at least free delivery for paying in cash. And there used to be a pizza place near me that would even accept Mexican currency to avoid having a customer tap or dip.
Some are even more forceful about it. The only plastic their employees will touch are bags — maybe utensils. A restaurant down the street, also a pizza place, only started taking credit or debit cards during the pandemic. And they’re not alone.
This type of avoidance keeps their prices in check, but it could also limit their foot traffic or growth to those willing to carry or go get cash. Government services can pull it off because they’ve cornered the market. Small-business owners are often compelled to comply or risk losing their livelihood.
Funding Rewards Programs
Controversially, interchange fees play a role in supporting cardholder benefits, such as rewards programs. Card issuers use them to fund incentives like cash-back rewards, travel miles, loyalty points, and exclusive discounts at partner merchants.
To some, these benefits enhance the overall cardholder experience and incentivize card usage. They may have several cards in their wallets for various purposes, including cash-back credit cards, travel credit cards, and gas rewards cards.
To others, they’re at best an expensive nuisance. You spend your own time and money trying to earn rewards you already paid for via higher prices due to interchange fees that would be lower if there were no rewards cards.
Still others think they’re part of an overall trend of reallocating money from the have-nots to the haves. People with lower incomes often can’t afford rewards cards’ steep yearly fees if they even qualify in the first place. But nonetheless, they pay extra for products — even those they pay cash for — thanks to interchange fees. Yet they reap no rewards.
Interchange Fee Impacts on Small Business
Interchange fees can present significant challenges for merchants, especially small businesses, making it harder for them to compete effectively. These challenges ultimately become a problem for consumers too.
Creates a Financial Burden
Small businesses typically operate on thinner profit margins compared to larger enterprises. As such, interchange fees can significantly impact their bottom line, especially for businesses with high transaction volumes or lower average transaction values.
They can make it more challenging for them to allocate resources to other essential areas of business growth.
Increases Pricing Pressure
To offset the interchange fees, small businesses must adjust their pricing strategies. That can result in slightly higher prices for their goods and services compared to cash-only businesses and larger competitors who can spread the costs over a higher volume of transactions — and may even pay lower fees because of that volume.
Higher prices can potentially deter cost-conscious consumers and make it more challenging for small businesses to compete. This pricing pressure can affect customer acquisition and retention for small enterprises.
Limit Negotiating Power
Large merchants and national chains may have more leverage due to their higher transaction volumes, allowing them to negotiate more favorable terms.
In contrast, small businesses may face less favorable fee structures or have fewer options to negotiate better rates. That puts them at a disadvantage in terms of managing their interchange fee expenses.
Requires Technological Investment
Implementing payment card acceptance infrastructure and staying updated with evolving technologies can be costly for small businesses. They must invest in point-of-sale systems, security measures, and training to ensure smooth card transactions.
Interchange fees further strain their financial resources, making it challenging for them to invest in the latest technology and stay competitive with larger, more financially equipped players in the market.
Causes Cash Preference
To avoid interchange fees altogether, some small businesses may prefer cash transactions or even incentivize cash payments.
This preference for cash can limit their customer base and pose challenges in an increasingly cashless society. It can create inconveniences for consumers who prefer or rely on card payments, potentially leading them to choose competitors that offer more flexible payment options.
Those secondhand appliance places I told you about can get away with it because their closest national competitors are big-box retailers like Lowe’s and Best Buy. Those charge about three times as much for brand-new appliances, often only a year model or two newer (for better or worse) and with only a slightly better warranty. People are willing to run to an ATM for savings like that.
A mom-and-pop stationary or hardware store doesn’t have the same luxury. Only a select few people who want exactly what they have and nothing else are going to bother with that.
Interchange Fee Regulation & Evolution
Just as interchange fees haven’t always existed, they won’t always be the same as they are now. Regulations and new technologies are bound to change them somehow — if payment network and banking policies don’t get there first.
Regulatory Efforts & Policies
Payment networks have implemented voluntary initiatives aimed at increasing transparency and competition. For example, some networks have adopted standardized fee disclosure practices, enabling merchants to have better visibility. These initiatives also promote fair competition by ensuring that all participants in the payment card ecosystem have access to essential information regarding fee structures and terms.
But industry efforts seem to have fallen short if Congressional action is anything to go by.
For instance, the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, named for Sen. Dick Durbin (D-IL), introduced regulations on debit card interchange fees for issuers with over $10 billion in assets, aiming to provide relief to merchants.
In 2022, Durbin was at it again, this time taking aim at credit cards. The Credit Card Competition Act, which he introduced with Republican co-sponsor from Kansas Sen. Roger Marshall, would set similar limitations on credit card interchange fees. The bill has yet to pass, but they plan to reintroduce it.
This is the bill everyone says would kill your credit card rewards. And maybe they’re right, though there are other revenue streams that can fund those — streams that come from bills only credit card users pay rather than costs everyone bears whether they pay with plastic or not.
And if you’d still rather not pay extra for goods and services just to get those rewards, you’d also be forgiven.
These regulatory actions, along with other measures implemented globally, demonstrate the ongoing efforts to address interchange fee practices and ensure fair and equitable outcomes for all participants in the payment card ecosystem.
Technological Advances & Future Trends
Technological advancements have significantly transformed the payment landscape, paving the way for new possibilities and potential changes in interchange fee structures.
- Digital payments, including mobile wallets, contactless payments, and peer-to-peer payment platforms, have brought increased convenience. Interchange fee models have to adapt and may have to accept getting cut out altogether.
- Alternative payment methods like cryptocurrency have taken a big hit lately. But they’re not down for the count. Blockchain is (probably) the future. These innovative payment methods operate outside traditional card networks and will almost certainly challenge the traditional interchange fee models, given that they already charge interchange-like fees to keep them operational.
- Open banking initiatives enable the integration of various financial services and promote increased competition within the payment ecosystem. That could drive the exploration of alternative fee models tailored to specific transaction types, consumer segments, or payment scenarios.
- Artificial intelligence offers new opportunities for personalized pricing and risk assessment. That could lead to the development of dynamic interchange fee structures that consider individual consumer behavior, transaction history, and risk factors, resulting in more tailored and optimized fee models.
As the payment landscape continues to evolve, interchange fees are likely to adapt to accommodate technological advancements and emerging trends. The future of interchange fees may involve greater flexibility, transparency, and customization, allowing for a more dynamic and efficient payment ecosystem.
Whether you’re all for interchange fee limits or you want them to keep their filthy paws off your rewards program, one thing’s for certain: We could use more transparency around interchange fees in the United States.
By learning more, consumers gain valuable insights, allowing them to take practical steps to navigate their financial choices more effectively. At the very least, you know you might be able to get a better deal from small businesses on higher-dollar goods and services by offering to pay in cash.