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July 10, 2017 • Issue 17:07:01

Getting a handle on

interchange – Part 1

Building the rails
Terminalization – the migration from paper receipts to
electronic card authorization and draft capture – began
in the late 1980s and early 1990s, as electronic settlement
gradually replaced merchants' daily trips to local banks.
"To help incent merchants, [card brands] lowered
interchange for those who went electronic," noted Mark
Dunn, President of Field Guide Enterprises LLC.

Visa and Mastercard built state-of-the-art networks
to support electronic card payments, while assigning
merchant category codes (MCC) to different merchant
segments based on risks and opportunities. The card
brands perceived some merchants (for example, jewelers)
as inherently riskier than others (grocers, for example),
By Patti Murphy and Dale S. Laszig and adjusted interchange rates accordingly to account for
these different levels of merchant risk. Merchant size was
nterchange is the economic engine that powers the also a consideration. "The large retailers generated a lot of
bankcard business. And like any other mechanical transactions; they were the bread and butter. They were
engine, interchange's power and functionality have able to command lower rates," Martaus said.
I evolved over the years. This two-part series will
explore how payment card interchange has influenced the So began the stratification of interchange. What started
payments ecosystem, global markets and, more impor- as a simple means of encouraging banks to issue and
tantly, acquirer and merchant relationships. merchants to accept credit cards evolved into a complex
set of rules and objectives. Actual rates can vary by several
Despite efforts by retail trade groups and others to dumb- percentage points depending upon merchant categories;
down interchange with catch phrases like "swipe fees,"
interchange is not easy to understand or calculate. It hasn't
always been this way, however.
Contributed articles inside by:
"Originally, there was just one interchange rate, and you
could calculate it," said long-time payments industry Brandes Elitch ........................................................................................27
consultant Paul Martaus. The calculation included an Steven Feldshuh ...................................................................................29
interest charge (based on the overnight Fed Funds rate) and
a risk component (assessing the likelihood of cardholder Aaron Nasseh .........................................................................................42
default) that compensated card-issuing banks, plus a Don Bush .................................................................................................44
network processing fee that compensated the bankcard Adam Atlas ..............................................................................................46
brands for making the transaction possible. "When they
terminalized everything, that calculation went out the TOC on page 3
window," Martaus said.

Continued on page 40