Interchange fees--what are they and what they mean to you

Interchange fees. Mean anything to you? You probably didn’t pay much attention to the term until recently. However, a new EU General Court ruling has now deemed that the fees that a merchant pays to his acquiring bank in a transaction are unacceptably high due to the interchange fees, and that MasterCard has unfairly inflated the service fees paid by retailers for processing payments. As a result, both MasterCard and Visa are being investigated under antitrust evaluation. Already five of the largest UK retailers, including Next Retail Ltd and Wal-Mart Stores Inc’s Asda, have filed lawsuits in London against MasterCard.

Since the ruling, my phone hasn’t stopped ringing with merchants wanting to know how this could affect them and, more importantly, if it could ultimately lead to a reduction in their operating costs.

So let’s boil it down to the essentials and what it could mean…

What is an interchange fee?
Interchange fee is a term used in the payment card industry to describe a fee paid between banks for the acceptance of card based transactions. It is a fee that a merchant's bank (the "acquiring bank") pays a customer's bank (the "issuing bank"). Depending on the industry, a merchant pays between 1 and 3 percent in service fees to his acquiring bank for every credit-card payment he receives. This service fee includes an interchange fee, which can vary between 0.3 to 2 percent that the acquiring bank has to pay to the issuing bank that provided the cardholder with its credit cards. The exact interchange depends upon the industry, type of card, type of transaction and how card data is delivered (for example, Chip and PIN, ecommerce, or manual entry).

Why the controversy?
This has been an issue globally for some time. In the United States, it was investigated and settled with the US Government Accountability Office in 2009; however, it is still a burning issue in Europe and for anyone wanting to do business here.

The EU Court found that MasterCard interchange fees for European cross boarder payments have been much too high and, due to their strong market position, this is an antitrust issue. This decision will also have an effect on outstanding domestic European law suits with Visa.

Both Visa and MasterCard had been warned that this was a possibility and reduced their fees after the antitrust investigations began in 2009. However, the burning questions now are what interchange fee levels are acceptable for the EU anti-trust agency--and have they done enough? The answers, I suspect, will be lower than they are now and no, they have not done enough. However, the interchange is only a part of the story as Visa and MasterCard also add transaction fees on the interchange, which are a cost factor especially for interregional transactions. These, however, are not affected in the current antitrust case.

The effect of this ruling on trading?
In the US, Visa and MasterCard already settled the case with the antitrust agency by explaining the interchange-fee level with their cost situation. However, according to EU antitrust officials, referring to costs won’t be good enough for the EU antitrust agency. They expect to see a fee level that relates to the financial advantage merchants have by using card instead of cash.

The ruling will mean that we start to see changes in the price calculation of European merchants’ exports and will also affect European consumers when they import goods and pay with credit cards.

Reduced interchange fees for cross-border payments in Europe could lead to a lower export price level in European online stores selling abroad. From the consumers’ perspective that means buying from European neighbours might be cheaper in the future.

I also suspect that a lower price for card payments won’t stop the increasing success of alternative payments; because they are not used for lower price levels, they fit well into local payment habits of users in different countries. However, retailers would have a good reason to negotiate their European cross-border card fees down with their acquirer as soon as the interchange-fees are lowered for good.

What will this ruling mean for multichannel payments and the consumer?
Multichannel retailers, both large and small, will be affected by the fallout from this ruling. Nothing is set in stone yet, the process is still ongoing and MasterCard has already announced plans to appeal. However, the likelihood is that changes are afoot and they will have a direct impact on retailers and cardholders alike. Although, remember that a substantial reduction of the merchants’ costs and price calculations will be focused on cross-border payments in Europe only, for example, a French consumer using his credit card in Spain. Domestic payments are yet to be investigated.

There’s no doubt, this is good news for European retailers. The European Union will most likely limit the fees to the actual financial advantage cards offer a merchant, compared to cash. I also expect that there is a chance that we could see the big card providers forced to reduce fees further, while at the same time losing market share to new payment schemes at the point of sale (PoS) as well as online.

However, there are unanswered questions: Will these cost savings be passed on to consumers or absorbed into the merchant’s profit margin? In the most difficult trading environment experienced in many years, I suspect it will be the latter. This combined with a predicted increase in annual fees and reduction in benefits such as air miles or cash-back to compensate card providers for their losses, means that it would be the consumer who is left most out-of-pocket by the ruling.

Even more important: Will the European antitrust case motivate domestic antitrust agencies to evaluate domestic interchanges, which represent around 90 percent of credit-card business? I suspect it might.

Ralf Gladis is chief executive of payment service provider, Computop.