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The silent revolution of fees, but what fees?

Republished by Plato
Republished by Plato

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From Canada and the United States to the United Kingdom, a wave of changes in the Interchange Fees for Visa and Mastercard card payments promises to rewrite the rules of the game. But what exactly are these commission costs, and why is it important to understand their pricing model? I explain this in this post.

When we talk about economics and finance, we often focus on large numbers and abstract figures. However, it’s in the small variations, like the interchange fees applied to international card payments, where we find the most tangible impacts on the daily lives of businesses and consumers.

This statement perfectly introduces us to the world of interchange fees, a topic that is receiving considerable attention globally. Is something beginning to change?

In this post, I explain the commission models that international schemes like Visa and Mastercard apply and tell you what is happening in the world in terms of fee reduction, following what the European Union managed to do with
Regulation EU 2015/751 (known as IFR – Interchange Fee Regulation).

The Pricing Models of International Visa and Mastercard Cards

For businesses handling card transactions, understanding the pricing models adopted by international card schemes like Visa and Mastercard is crucial. These pricing structures determine how much businesses pay for each transaction.

We will examine two common models: Interchange Plus Plus (IC++) and
Blended Pricing. 

Interchange Plus Plus (IC++)

The Interchange Plus Plus model is often considered more transparent than others. It details the various costs involved in a transaction, which typically include the interchange fee, Scheme fees, and the Acquirer’s markup.

  • Interchange Fee (IF): this is a fee paid to the
    Issuer     by the Scheme. The fee varies depending on the type of card used (credit, debit, etc.), the transaction method (online, in-store, etc.), and the cardholder’s bank. These fees are set by the Schemes (Visa, Mastercard) but go to the issuer.
  • Scheme Fees: this is the fee that card schemes like Visa or Mastercard charge for using their network. These fees are generally fixed and the same for all merchants.
  • Acquirer Markup: This is the fee that the business’s
    Acquirer     (retailers, online stores, professionals, etc.) charges for their complete services. This economic component typically also includes the fees for processing services operated by Payment Gateways (for e-Commerce and m-Commerce) and, only in Italy, by the so called “Gestore Terminali”.

The IC++ model is transparent because it shows the merchant where every cent of their transaction fees goes. However, it can also be complex because interchange and Scheme fees vary, making it difficult for businesses to predict exactly how much they will be charged for each transaction.

It’s important to remember that IF (Interchange Fee) and
MSC (Merchant Service Charge) are not the same thing. While the Interchange Fee is the only fee that, if established on multilateral agreements within the policy of the International Card Scheme (in which case the Interchange Fee is called Multilateral Interchange Fee, or MIF), the MSC is obtained by calculating the sum of the following economic components: 1) the Interchange Fee; 2) the Scheme Fee; 3) the Acquirer’s markup.

That said, in an IC++ pricing model, it’s not always easy to understand how much weight the Acquirer’s Markup has in the MSC. This observation is particularly important for EU/EEA regions where the Interchange Fee Regulation (IFR) is in force, as set out by EU Regulation 2015/751.

In the EU/EEA, where interchange fees are capped at at least 0.2% of the receipt amount for debit/prepaid cards, and at least 0.3% of the receipt amount for credit cards, having the opportunity to clearly see the actual amount of the MSC gives merchants the chance to better understand the true Markup of the Acquirer, allowing them to negotiate the best MSC value, where possible.

Blended Pricing

Blended Pricing is a simplified pricing model where the merchant is charged a fixed rate for each transaction. This rate includes all costs involved in processing a payment (interchange, Scheme fee, Acquirer’s markup, any costs attributable to processing), unified into a single fee.

The advantage of unified pricing is its simplicity. Merchants know exactly how much they will pay for each transaction, making accounting and forecasting easier. However, the disadvantage is the lack of transparency. Merchants do not see the breakdown of fees and may end up paying more for certain transactions, especially if their customers primarily use payment methods that would otherwise have lower interchange fees.

Government and legislative action worldwide to lower Interchange Fees

Having clarified the pricing structure that defines the fee charged to businesses that decide to accept card payments, let’s now discover what is happening in the world by Governments and legislators to cap at least one of the cost components: the Interchange Fee.

What’s happening in Canada

In Canada, the Government has recently finalized a significant agreement with Visa and Mastercard. This agreement is a breath of relief for small businesses, which will see reduced interchange fees on credit card transactions. This is a
reduction of up to 27% compared to the current weighted average. In particular, in-store transaction fees will be lowered to the weighted average
annual rate of 0.95%, while online transactions will see a cut of 10 basis points.

The agreement not only reduces costs for businesses but also includes free access to fraud prevention and cybersecurity resources. The new rates, which will come into effect in the fall of 2024, are expected to save about $1 billion over five years for eligible businesses. 

What’s happening in the United States

In the United States, the Federal Reserve has proposed a nearly 30% cut in interchange fees
for debit cards. Currently, merchants pay banks 21 cents plus 0.05% of the transaction cost for each debit card payment.

The new proposal suggests reducing the base component to 14.4 cents and the
ad valorem to 0.04% of the transaction, with an increase in the fraud prevention adjustment to 1.3 cents. This reduction will lead to an overall decrease of 28%.

The Fed also intends to update this limit every two years, based on data from its biennial survey of large debit card issuers. The proposal is currently in the public comment phase.

What’s happening in the United Kingdom… post-Brexit

In the United Kingdom, the Payment Systems Regulator (PSR) is proposing to cap cross-border interchange fees on credit and debit cards. This move is motivated by the increase in fees by Mastercard and Visa for transactions with EEA cards accepted by British businesses after the Brexit vote.

The Regulator’s proposal includes an initial temporary cap of 0.2% for UK-EEA consumer debit card transactions and 0.3% for credit card transactions. It also envisages a lasting cap on these fees in the future, after further analysis.

The goal is to protect British businesses that have suffered an increase in costs, estimated between £150 and £200 million last year due to these increases.

The PSR’s proposal to cap interchange fees reflects a clear alignment with the EU Regulation 2015/751, known as “IFR Interchange Fee Regulation” (IFR). This regulation, adopted by the EU, aims to limit IFs to ensure fairness and transparency in the payment market.

The adoption of a similar approach by the UK, post-Brexit, signals an attempt to maintain some consistency in market practices and to protect both consumers and small retailers from excessive fees.

Conclusions

To summarize the international card pricing models, I’ve explained in this post, the Interchange Plus Plus (IC++) model offers unique transparency, detailing various costs such as the interchange fee, Scheme fees, and the Acquirer’s markup. Although this model can be complex, it provides a clear view of where costs go for each transaction. On the other hand, Blended Pricing simplifies the process but at the expense of transparency. In both cases, it’s crucial for businesses to understand these cost structures to negotiate the best possible terms.

The “silent revolution” of interchange fees is taking hold globally, with significant impacts for both businesses and consumers. This movement is not just an isolated phenomenon but rather a trend that is consolidating in different parts of the world, demonstrating a growing focus on fairness and transparency in transaction costs.

The initiative of the Canadian Government and the proposals of the United States Federal Reserve and the United Kingdom’s Payment Systems Regulator are examples of how authorities are responding to the needs of an evolving market, seeking to balance the interests of large card networks with those of small businesses. These efforts reflect a growing commitment to reducing transaction costs and offering more favourable conditions for trade.

The European model, in particular, emerges as a benchmark in regulating interchange fees, showing how well-considered regulatory intervention can actually influence market behavior to the benefit of a broader spectrum of economic actors.

Looking to the future, it’s reasonable to expect further developments and perhaps new policies aimed at regulating this sector. As merchants and consumers adapt to these new realities, it will be essential to monitor the effectiveness of such changes and their ability to promote a more equitable and transparent commercial environment. The hope is that these changes not only lighten the financial burden of small businesses but also stimulate greater innovation and competitiveness in a sector crucial to the global economy.

This post, authored by Roberto Garavaglia, was posted in original language (Italian) on Decembre 18, 2023 on the CloseToPay blog: https://bit.ly/3RKeQvM 

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