The Never-Ending War

With rate increases expected this month, it’s time for the annual confrontation over interchange. Can this issuer-retailer argument ever be resolved?

In the payments business, nothing gets the attention of the entire industry as effectively as the topic of fees. And no fee wins that attention as much as the interchange fee—the cost acquiring entities pay issuers each time a cardholder taps (slides, waves) his card.

“Tens of billions of dollars are at stake. Lots of parties have an interest in this,” says Eric Grover, principal at the payments consulting firm Intrepid Ventures.

That means the industry’s eyes are typically riveted on the month of April, when the card giants Visa Inc. and Mastercard Inc. implement their latest interchange regimes. This month, U.S. acquirers and their client merchants are watching more closely than ever as hundreds of millions of dollars in increases go into effect after a two-year respite during which the networks largely held off on rate changes.

The immediate prospect of bigger fees paid by merchants for card acceptance has already caught the attention of regulators, with the Consumer Financial Protection Bureau’s director, Rohit Chopra, charging the card networks with feeding an already raging inflation problem.

“It seems like adding insult to injury to a lot of businesses out there,” he told interviewers last month on CNBCs “Closing Bell” program. Since taking over the CFPB last year, Chopra has proven to be an active regulator, launching probes into such popular programs as buy now, pay later services.

‘Quite Substantial’

As of mid-March, Mastercard and Visa were preparing revisions to their interchange schedules that at least one research firm says will cost U.S. merchants an estimated $475 million in additional transaction fees. Though the networks have historically revised their rate schedules each April and October, “this April is particularly significant,” says Callum Godwin, the Atlanta-based chief economist for CMSPI, a global research firm.

The firm’s estimates indicate the changes in Visa’s rate adjustments will add up to a net $145 million in additional cost to acquirers. For Mastercard, the impact will net out to $330 million. While the networks have historically set interchange rates, they do not collect any share of the fees. Merchant processors pay interchange on each transaction to the issuer of the card and then pass the cost along to their client merchants, often with a markup.

In general, e-commerce merchants will feel the heftiest impact, according to the CMSPI estimates, which Godwin says are based on new rate schedules circulating among processors. Meanwhile, Mastercard’s new rates for small grocers will see increases that “are quite substantial,” according to the firm’s review.

On the other hand, Mastercard is lowering rates for passenger transport, travel and entertainment, and day care. And Visa is reducing rates for small businesses. “Individual merchants have a fairly challenging task to figure out how [fee changes] impact them,” Godwin says.

On the whole, after two years in which consumers flocked to e-commerce to avoid in-person shopping, “online retailers are going to be impacted worse than face-to-face” sellers, Godwin says. Still, Godwin avoids theorizing about the business reasons behind any of the new rates. “It’s very difficult to speculate about interchange changes,” he notes.

The new rates represent the first significant set of changes to the interchange schedules since 2019, as the global networks largely left their rates alone in 2020 and 2021 in view of the impact of the Covid-19 pandemic on businesses. The latest round of changes also represents a softer net impact than the one CMSPI estimated for rates the networks originally intended to introduce a year ago.

‘More Than Frustrating’

“Electronic payments have proven even more valuable since the start of the pandemic, and that’s why we’re seeing merchants encouraging their customers to use electronic forms of payment,” says a Mastercard spokesman. He adds Mastercard is reducing rates for hotels, rental-car companies, and casual-dining establishments “to encourage recovery in the merchant categories that were hardest hit by the pandemic.”

For its part, Visa is “lowering key in-store and online consumer credit interchange rates by 10% for more than 90% of American businesses,” according to a spokesman.

As for rate increases, he adds, these are “largely avoidable and apply to transactions that are sent to Visa with insufficient data, are coded incorrectly, carry increased risk, or are processed without using a Visa EMV payment token.” Network tokens mask key data that accompany transaction messages to aid processing.

Merchant advocates and critics of the longstanding interchange system have historically denounced interchange, and some at least are quick to decry the latest round of changes. “What I’m hearing from many merchants is that this game has gone on long enough, and, coming on the heels of two years of Covid, is beyond offensive,” says Steve Mott, principal at BetterBuyDesign, a payments-advisory firm.

The networks respond that the interchange regime supports critical infrastructure at a time when payment risk is rising. “These rates are designed to maintain high data quality and integrity across our network to prevent fraud,” says the Visa spokesman.

But Mott and others argue the latest round of rate changes are at best disingenuous efforts by the card networks to dress up unpalatable costs. Indeed, the actual rate tables “are the tip of the iceberg,” says Doug Kantor, general counsel for
the National Association of Convenience Stores. “Banks issue more and more rewards cards and shift transactions to these more expensive cards.”

And with rising inflation, merchants are paying more still, Kantor maintains, since interchange is computed as a percentage of the sale. “Fees have been inflated with every cent of inflation,” he says.

All told, card-transaction fees for c-stores soared 30% in 2021 alone, according to Kantor, who calls the rise “a pretty dramatic number.” That increase, combined with the new rate schedules from Visa and Mastercard, “is more than frustrating,” he adds.

‘Analog Rules’

Card-industry advocates argue merchants too often confuse higher dollar outlays with higher fees. The basic set of percentage-based interchange fees have actually changed only in small ways over the past 10 years, they say. What has changed, they add, is the total payout, which has risen along with higher sales volumes.

And many rate increases can be minimized with security upgrades that mask transaction data and protect user identities, such as tokenization, says Jeff Tassey executive director of the Electronic Payments Coalition, an advocacy group for the payments industry. Other anti-fraud technologies, such as Secure Remote Commerce and 3-D Secure, offer a shift of fraud liability from the merchant to the issuer, Tassey adds.

Some observers agree many core interchange rates have remained more or less stable over the past decade, but they argue the rate schedules fail to accommodate new technology.

As an example, Don Apgar, director of the merchant services advisory service at Mercator Advisory Group, a Marlborough, Mass.-based financial-service consulting firm, points to mobile wallets such as Apple Pay or Google Pay. These transactions incur a higher, card-not-present fee because the physical card is absent, he says.

“If authenticating through a wallet, that [transaction] should not incur a [higher] fee” since the physical card has been tokenized, Apgar says, adding, ruefully, “we’re living in a digital world with analog interchange rules.”