Backgrounder on Interchange and Scheme Fees

Overview

When people use their credit or debit card to buy goods and services, there are a detailed set of arrangements between financial institutions and payment service providers (PSPs) that ensure that the merchant is paid and the cardholder’s account is debited as intended. As part of these arrangements, the merchant’s PSP pays fees to the cardholder’s bank (card issuer). These fees are known as ‘interchange fees’. While interchange fees are most common in card transactions, they can also arise in other payment methods. Both the merchant’s PSP and the card issuer also pay fees to the card scheme. These fees are known as ‘scheme fees’. PSPs recoup from merchants the interchange and scheme fees they pay, by charging them fees for the payment services they provide.

This Backgrounder describes interchange and scheme fees and explains interchange fee regulation in Australia as at October 2024.

What is an interchange fee?

A typical card transaction involves four parties – the cardholder, the card issuer,^[1] the merchant and the merchant’s payments provider (the acquirer) (Figure 1). Interchange fees are typically paid by the acquirer to the issuer every time a payment is made.^[2]

Interchange fees are typically set by the operators of payment networks, such as Visa or Mastercard, for payment card schemes. These fees can vary based on factors like the type of card, whether it is an online or in-person transaction, the value of the transaction and the size of the merchant. For example, cards that provide rewards to the cardholder (such as ‘gold’ or ‘platinum’ credit cards) have higher interchange fees. While card schemes publish interchange fees on their websites, many cardholders and merchants are not aware of them. But they have an impact on the fees that cardholders and merchants pay.

Why do interchange fees exist?

Interchange fees can help establish new payment systems. New payment networks or technology often face a classic ‘chicken and egg’ problem when starting out – merchants do not want to invest in accepting new payment type until enough consumers have adopted it and consumers do not want to use a new payment type until enough merchants accept it. Interchange fees can help to rebalance costs between each side of the market and ensure that both sides of the market have an incentive to participate. For example:

• Revenue from interchange gives card issuers more motivation to issue payment cards/accounts on the new network to their customers.
• Revenue from interchange can be used to fund consumer rewards programs that incentivise usage.
• Revenue from interchange helps pay for building infrastructure, operations and new features, such as additional security.

Why do interchange fees matter?

When a card payment is made, interchange fees are paid by the merchant’s payment provider to the cardholder’s card issuer.^[3] This has two effects:

• The merchant’s payments provider passes on the cost of the interchange fee to the merchant. So, the higher the interchange fee, the more the merchant will have to pay to accept a card payment.
• Since the card issuer receives the interchange fee every time its card is used, it does not need to charge its customer – the cardholder – as much. In effect, the merchant is meeting some of the card issuer’s costs, which ultimately benefits the cardholder. With rewards programs, the cardholder may receive more in benefits through rewards than what it costs them to use the card.

Interchange fees can have important implications for the prevalence and acceptance of different cards as well as the relative costs faced by consumers and merchants. A network that increases the interchange fee paid by the merchant’s payments provider to the card issuer enables the latter to pay more generous rewards to cardholders and increase use of its cards. However, if the network is mature (i.e. widely used by consumers and accepted by merchants across the economy), merchants may feel that they have little choice but to continue accepting the network’s cards, despite the higher cost. A logical competitive response from other mature networks is to increase their interchange rates as well. So, in contrast to normal markets for goods and services, competition in well-established payment card networks can lead to the counterintuitive result of increasing the price of payment services to merchants (and thereby leading to either higher retail prices for consumers and/or higher surcharges).

As the major card schemes are mature systems, regulators in many countries have concluded that their cards are ‘must take’ methods of payments – that is, merchants have little choice but to accept their cards if they want to attract and retain customers. In practice, competition between these mature card schemes has driven up interchange fees and costs to merchants. As a result, regulators in many jurisdictions, including Australia, have introduced rules to cap interchange fees.

What rules apply to interchange fees in Australia?

Since the early 2000s, the RBA has introduced several reforms aimed at lowering payment costs.^[4] This has included rules to reduce the size of interchange fees. Other reforms have allowed merchants to surcharge, which has helped to provide accurate price signals to customers and, in turn, increase competitive pressure on the fees charged to merchants.^[5] The reforms have led to a lower cost payment system overall.

In short, the current interchange fee regulations:

• cap credit card interchange fees to a weighted average of 0.50 per cent of transaction value, with a ceiling on individual interchange rates of 0.80 per cent^[6]
• cap debit card and prepaid card interchange fees to a weighted average of 8 cents per transaction (for all debit and prepaid cards) with a ceiling on individual interchange rates of 10 cents, or 0.20 per cent if specified in percentage terms.^[7]

What is a scheme fee?

Scheme fees are charged by card schemes – such as Visa, Mastercard and eftpos – to acquirers and issuers for the services they provide (Figure 1). These fees can include:

• Assessment fees – used to cover the costs of operating and maintaining the card network’s infrastructure.
• Processing fees – charged for processing and authorising transactions.
• Licensing and access fees – charged for use of the network and its brand.
• Other fees – charged for discrete services such as chargebacks, security features, new technologies, compliance and currency conversion.

Why do scheme fees matter?

Scheme fees matter because they are an important component of the overall costs faced by merchants to accept card payments, as well as the costs borne by issuers for providing card services to their customers. These costs are ultimately passed on to consumers.

Scheme fee schedules are often complex with fees being set based on commercial considerations. and are currently not directly regulated in Australia. The RBA is not aware of scheme fees being directly regulated in other countries.^[8] However, following the RBA’s Review of Retail Payments Regulation in 2021, the RBA has been collecting information and data on scheme fees and exploring possible scheme fee disclosure requirements to provide greater transparency of scheme fees to participants in the payment system.^[9]

The size of interchange and scheme fees in Australia

Interchange fees and scheme fees explain around half of the debit card costs for merchants and most of their credit card costs. The remainder is the gross margin that acquirers and other PSPs charge merchants (Graph 1).^[10]

Merchant fees have decreased over the past 20 years, supported by regulatory interventions by the RBA. However, the cost of card payments is substantial for small businesses, which pay much higher fees per transaction than large businesses. Large merchants have the bargaining power to directly negotiate much lower ‘strategic’ interchange rates from the networks. They also benefit from lower payment costs due to economies of scale (Graph 2).

Net scheme fees of around $1.8 billion were paid by Australian acquirers and issuers to the card networks in 2023/24 (Table 1). The fees paid by issuers are much lower than those paid by acquirers because issuers receive significant rebates from schemes competing for their card issuing business. As a result, most of the burden of scheme fees falls on acquirers, which then gets passed on as higher costs for merchants.

Endnotes

The issuer is usually a bank but can sometimes be a non-bank financial institution. [1]

An alternative card scheme model is the ‘three-party’ scheme, which involves the merchant, the cardholder and scheme. In this model, the scheme fulfils the role of both issuer and acquirer, providing card acceptance services and charging merchant service fees to merchants while collecting funds from – and charging fees, interest (if applicable) and offering rewards to – cardholders. In such a three-party scheme, no interchange fees apply. As a result, three-party schemes, such as American Express, are not subject to the RBA’s interchange regulation. [2]

RBA (2019), ‘Box A: Interchange Fees and Surcharging: Key Concepts’, Review of Retail Payments Regulation Issues Paper, November. [3]

Bullock M (2010), ‘A Guide to the Card Payments Reforms’, September. [4]

For further information on surcharging, see RBA (2024), ‘Backgrounder on Payment Surcharges in Australia’, October. [5]

RBA (2016), ‘The Setting of Interchange Fees in the Designated Credit Card Schemes and Net Payments to Issuers’, Standard No 1. [6]

RBA (2016), ‘The Setting of Interchange Fees in the Designated Debit and Prepaid Card Schemes and Net Payments to Issuers’, Standard No 2. [7]

In 2002, the People’s Bank of China imposed a ‘8:1:1 rule’ cap, setting the division of the merchant fee between interchange, switch fees and acquirer fees respectively: see Federal Reserve Bank of Kansas City (2024), ‘Public Authority Involvement in Payment Card Markets: Various Countries’, August. [8]

RBA (2021), ‘Chapter 5: Scheme Fees’, Review of Retail Payments Regulation Conclusions Paper, October. [9]

Connolly E (2024), ‘Online Retail Payments – Some Policy Issues’, Speech at the Merchant Risk Council Conference, Melbourne, 18 June. [10]