he card Associations and debit networks announced changes to their interchange rate programs, effective April 2005. In my previous article, I addressed changes to offline, or signature-based, debit ("A Note on Visa Interchange Rates," The Green Sheet, Feb. 28, 2005, issue 05:02:02). This article will focus on issues concerning online, or PIN-based, debit interchange.

Interchange rates for credit cards came about primarily as a mechanism to reimburse issuers for the credit risk they assumed and to cover the cost of funds on "transactors." Transactors pay off their balances in full every month but still have use of the money without an interest charge from the time of the transaction until the time of the payment.

The acquirer pays interchange to the issuer, and passes none of the amount to the card Associations or networks for enhancements or system costs. Theoretically, acquirers pay issuers for issuing cards and benefit from increased sales at their merchant locations.

There is little credit risk in online debit because funds are not loaned to cardholders; rather, funds are debited directly from cardholders' accounts. For the same reason, there is no cost of funds.

Certainly there are costs in maintaining the system, but again, interchange does not cover that. Instead both acquirers and issuers pay separate network and switch fees. These fees vary by network; combined, they range from $0.025 and $0.0475 for acquirers. (Issuers have a separate schedule of network and switch fees.)

Be wary of businesses indicating that they offer interchange pricing as cost; there is more here than simply interchange.

Since little to no credit risk is associated with online debit and zero cost of funds, why does interchange vary so much between networks, and why is it increasing so rapidly?

The answer: Because the market will bear it. Online interchange is still less than credit and offline debit (for now). Additionally, the larger debit networks such as STAR and Interlink have monopolistic powers because their coverage is so much greater than the smaller networks'.

Neither Humboldt Merchant Services LP (HMS) nor any other acquirer can afford not to accept STAR or Interlink. Is it any wonder that these networks charge among the highest interchange rates in the industry?

Because the acquirer pays interchange entirely to the card issuer, networks such as STAR and Interlink attract issuers to issue cards with their logos by increasing the interchange rates. Cardholders don't care which network routes the transaction as long as it happens efficiently.

Consequently, in an effort to attract more issuers, Interlink announced what amounts to an 18.4% increase on a $40 transaction. This increase goes into effect April 2005.

Additionally, the basis points or percentage is now so high that pricing to merchants should reflect both the percentage plus the transactional fee.

No longer are debit networks thought of as sleepy co-ops. Instead they are money-making machines owned by First Data Corp. (STAR), Metavante Corp. (NYCE) and Discover Financial Services (PULSE).

Though STAR has not announced a 2005 increase, it will not allow its customer base to be skimmed by a higher paying interchange network. How much longer before PULSE and NYCE follow?

Merchant statements have become so convoluted that merchants often believe they are only being charged $0.15 per transaction. Upon closer examination, that $0.15 is the cost of the debit authorization, and interchange is billed separately.

At HMS, we combine our debit and credit statements; we have also designed our system so that when merchants "batch out" credit, online debit batches out as well. This eases the daily reconcilement and decreases phone calls to us.

The card Associations and networks also increase the number of interchange tiers as they create separate categories for larger merchants, supermarkets, and quasi-cash. As these increases take effect, the business case decreases for merchants to accept online debit. Become educated about these changes and the reasons behind them to better inform and assist merchants with their online debit needs. Ken Musante is President of Humboldt Merchant Services. E-mail him at kmusante@hbms.com .