What are interchange fees?

This article discusses the composition of the discount rate. Credit card processing involves risk for issuing banks and there needs to be compensation for this risk.

When you compare discount rates, you’ll notice that they don’t go below a certain level. This is because the interchange fee is the largest part of the discount rate. Interchange fees are paid by the merchant bank to the customer’s credit card bank. This pays for the cost of converting a credit card charge to a cash deposit at the merchant’s business checking account. Other costs elements include billing, fraud risk, and profit.

The interchange is a network of issuing banks and acquiring banks. Issuing banks take on the credit risk of cardholders. They are motivated to do this by using a percentage of each card transaction to make a profit. This interchange fee provides incentive for issuing banks to market and issue credit cards. It is obvious from the number of credit card offers people receive in the mail, that banks and processors such as Visa, Discover, and Mastercard are making substantial revenues. Acquiring banks (merchant banks) work with merchants and charge a percentage on top of the interchange fee. Merchant banks also charge equipment fees, monthly fees, and a whole host of other fees to make their profits.