Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Interchange Rate

What it is:

Without interchanges, there would be no electronic banking. The advent of the Internet has increased its use and prevalence, and card issuers get a considerable portion of their revenues from interchange fees.

Interchange fees are more than just money for transferring data. They're also compensation for the risk that a transaction is fraudulent and that the bank will have to "eat" the transaction. Interchange fees can sometimes be negotiable when competition among financial institutions is heavy; they also vary by transaction size. The important thing to remember is that if interchange fees get too high, retailers will receive less from their credit card transactions and thus will be more reluctant to accept credit cards (or certain credit cards, as interchange fees vary by issuer) from customers. Customers, seeing that they can't use the credit card in enough places, begin to reduce their demand for the credit card.

How it works (Example):

An interchange is an electronic transfer of information. In the business world, this usually involves financial data.

Banks are common users of interchange data because they issue credit cards and debit cards. When a customer uses his or her credit or debit card, information about the purchase is transmitted through an electronic data interchange (called an EDI) that exists between retailers and banks. This interchange activity is necessary for retailers to receive payment for the sale of goods and services, but it is not free. Banks usually charge an interchange fee, which is usually a combination of a percentage of the transaction size (around 2%-3%, depending on the card issuer and the size of the transaction) plus a flat fee.

Let's say a customer makes a $50 purchase at store XYZ with his Visa card. How does the retailer get its $50? First, it uses the interchange system to send the transactions to the card issuer. Sometimes the retailer does this immediately, some retailers do it at the end of the business day, and some retailers do it every few days. Once the retailer has sent a "batch" of transactions to the card processor via the interchange, it incurs an interchange fee. On our $50 purchase, the interchange fee might be, say, 2% of the purchase price (so $1) plus a flat fee of $0.35. The retailer uses the interchange to process the transaction and receives $50 less the interchange fee (so, $48.65).

Why it Matters:

An interchange rate is a bank fee for executing credit card and debit card transactions.