Interchange Fees and Credit Card Rewards

It might be difficult to understand how fees paid from card providers to banks and retailers can affect you as a consumer. However, as these fees are inextricably linked to the level of credit card rewards, changes in so-called ‘interchange fees’ can affect your potential rewards and the fees you ultimately end up paying.

What are ‘interchange fees’?

An ‘interchange fee’ is a term that is often used in the payment card industry. It describes the fee that a retailer or merchant’s bank pays a customer’s bank (the ‘issuing bank’) when merchants and retailers accept cards using card networks such as Visa and MasterCard for purchases.

For example, if you used your Commonwealth Bank Visa card at Woolworths, Woolworths’ bank would pay an ‘interchange fee’ to Commonwealth Bank based on the amount of this transaction.

In a credit card transaction, the card-issuing bank (Commonwealth Bank in this example) in a payment transaction deducts the interchange fee from the amount it pays the retailer/merchant’s bank that handles a credit or debit card transaction for a merchant.

Credit card interchange fees are around 0.5% of the transaction amount.

Regulation of ‘interchange fees’

The Reserve Bank of Australia (RBA) has already succeeded in reducing interchange fees over recent years whilst admitting it is a ‘reluctant regulator’ of credit cards.

In a recent speech, RBA Assistant Governor Malcolm Edey said he was not in a position to predict what the RBA board's next decision on credit card fee regulation would be, but he said that good progress was being made in promoting competition.

"The Reserve Bank is a reluctant regulator," Dr Edey told the Cards and Payments Australasia 2010 Conference in Sydney. "We'd prefer to see fees being held down by competition than by direct regulation. We believe there's been good progress in promoting competition over recent years. But it’s not yet clear whether that will be sufficient."

A review of card payment reforms the RBA undertook in 2007-08 found that the reforms to date had delivered lower costs to merchants and increased competition.

How ‘interchange fees’ affect credit card rewards

In conventional markets, competition generally puts downward pressure on prices because players generally lose market share after raising their price.

However, with card payments, there are significant pressures going the other way.

As Dr Edey explains, ‘‘A rise in the interchange fees charged to acquirers (the merchant’s bank) can allow issuers (the customer’s bank) to increase their reward points to cardholders, thereby encouraging use of the card. In other words, a rise in price can lead to an increase, rather than a decrease, in the effective demand for the service.’’

What this means is that if banks are earning more money through interchange fees, they are able to award more credit card rewards to customers based on this spending. If you were offered more points, you’d probably use your credit card more, and not less.

This creates a ‘natural tendency’ for average interchange fees to rise over time, rather than fall. This reduces competition and ultimately increases costs for consumers.