Welcome back to another week of financial literacy for those of us in the industry still learning about what makes credit unions tick. Last week, I took a look at allowance for credit losses and CECL, a heady topic that can be so complex even the most veteran of us can find confusing.

This week, I’m taking a look at something far less complicated, but—according to my colleague Emily Claus—the topic of much discussion at the 2024 Governmental Affairs Conference: interchange.

If you are familiar with the term, but not entirely sure what it is and why it is important to credit unions, buckle up. In this two-part series, I look at what interchange is, why it exists, and the legislation over the last fifteen years that has sought to disrupt the status quo.

Interchange income in a nutshell

Before we get into why interchange was causing a stir at GAC this year, let’s first get a firm grasp of what it is, why it’s important, and why still others are dialing in on it.

The players in this saga are the consumer with a credit card (e.g. you), the merchant (i.e. the business you’re buying from), the payment network (e.g. Visa, Mastercard, American Express, Discover, etc.), and lastly the credit card’s issuing financial institution (e.g. your mega bank, local credit union, or sometimes even the payment network itself).

In our example, you go to the store and want to buy $100 worth of disc golf discs—it’s a great sport and I encourage you to check it out. When you go to check out, you decide to use the credit card you got from your credit union because you want the rewards points. You are charged $100, but the store/merchant does not get the full $100. Instead, a small percentage (typically 1-3% and sometimes in addition to a flat per transaction fee of $0.05-0.65) is charged to the merchant by the payment network (e.g. Visa).

This is the interchange fee, also called a swipe fee, and it’s the cost to the store for using that payment network. It’s the reason you may visit a small store and they only allow credit cards to be used for purchases of $5 or more, for example. Or why if you use your credit card to make charitable donation, the charity may ask for you to cover the 3% processing fee too.

But not all of that interchange fee goes to the payment network. Some of it goes to the card issuer.

Why they exist and who sets the rate

Now that you know what they are, you might be wondering why they exist. Part of it is because of the inherent costs of managing the payment networks. There’s also the associated costs of credit risk—the fraud prevention programs that networks and issuers must have to deal with prevention and settling fraud. And in the case of issuers, interchange is a piece of the pie from your credit union can offer and fund credit card rewards.

What can be confusing though is that the rate and/or fee is not necessarily the same across a single payment network. Mastercard, for example, might have four different rates depending on the type of card (debit card vs. credit card), type of transaction (e.g. charities vs. utilities payments), and even credit card tier.

These rates are set by the payment networks, and are generally non-negotiable. But for the biggest retailers with the most transactions, they have enough clout of their own to negotiate a lower interchange with the payment networks.

Still, when all these things are taken into consideration, the idea of interchange is quite reasonable! The network and the issuer have costs and they have to come from somewhere. So in this case, part of it comes from the merchant for the privilege of using the payment network. And while this is technically the merchant’s burden to bear, what’s to stop them from baking those costs into the price of their goods and passing it along to the consumer?

Durbin and debit cards

This question was essentially the impetus for U.S. Senator Richard Durbin (D-IL) to introduce the Durbin Amendment as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.

In the amendment, Durbin sought to restrict interchange fees specifically for debit cards. At the time, interchange fees averaged $0.44 per debit card transaction. The amendment would eventually settle on reducing transaction fees to $0.21 plus 0.05%, but only for banks over $10 billion in assets.

Though 44 cents per transaction doesn’t sound like a ton, when you consider the volume of transactions being performed annually by Americans, as much as $15 billion was being collected through this interchange.

Durbin’s hope was that by capping interchange fees, the savings to merchants would be passed on to consumers in the form of lower prices. The results, however, have been hotly debated.

Next week we will learn about the results of the Durbin Amendment on debit card interchange the last 15 years, the new legislation Durbin has put forth to tackle credit card interchange, and cover why opponents suggest the legislation is a bad idea that will not benefit merchants or consumers.