Merchant Discount, Interchange, and Other Transaction Fees in the Retail Electronic Payment System

Merchant Discount, Interchange, and Other Transaction Fees in the Retail Electronic Payment System

August 6, 2021
Merchant Discount, Interchange, and Other Transaction Fees in
the Retail Electronic Payment System
Recent policy discussions around faster payments,
information can be processed over the phone or online in
cryptocurrencies, and other financial innovations have
what is called a card-not-present transaction.)
highlighted some of the costs and fees associated with the
retail payment system. In the past, Congress has passed
The card reader sends a signal to the issuing bank to seek
legislation regulating some of the fees associated with
authorization for transfer of funds. Once it is authorized, the
certain electronic transactions (e.g., Section 1075 of P.L.
funds are transferred to the acquiring bank for deposit in the
111-203, known as the “Durbin Amendment,” discussed
merchant’s account.
below). Further, the pandemic highlighted the impact of
transaction costs on small businesses in an economic
Both debit and credit cards are processed over a network.
environment that took its toll on many retailers. This
The four major ones are provided by Visa, Mastercard,
InFocus examines the range of transaction costs associated
American Express, and Discover. The network facilitates
with various retail electronic payments and the fee
the card transaction by providing the connection between
structures for the two most common payment types: debit
the consumer’s and merchant’s banks.
cards and credit cards.
While both debit and credit cards operate in similar ways,
Retail Electronic Payments Structure
the primary exception is the way money is transferred out
Consumers and merchants can transfer money in a number
of the consumer’s possession. In a debit transaction, the
of different ways. Cash, checks, and electronic transaction
issuing bank is the consumer’s bank, and the money leaves
cards such as prepaid, debit, and credit cards are examples.
his or her checking account—in this way debit cards act
The most popular payment types of electronic transaction
more like checks—drawing down the balance. Conversely,
devices for retail payments are debit and credit cards.
in a credit transaction, the issuing bank is the bank that
According to the Federal Reserve’s most recent payments
backs the consumer’s credit, and the consumer will be
study, in 2018 debit and credit cards accounted for 55% and
billed for the amount transferred at a later date. The
34% of noncash transactions, respectively. In addition,
consumer then pays off the credit balance—in whole or in
there has been a recent trend among some retailers toward
part, with interest on any unpaid balance thereafter—after
going cashless, eliminating the costs associated with
the monthly statement is issued using whatever payment
handling cash. Further, the pandemic has created new
options the credit card company allows.
demand for contactless payments.
Transaction Fees
The payment choice a consumer makes determines the
Credit and debit card transactions involve a set of fees
number of financial institutions involved and the range of
typically paid by the merchant to the merchant’s bank to the
costs borne by the consumer, the merchant, and their
participants facilitating the transaction. While these fees are
respective financial institutions.
typically paid by the merchant, the merchant may be able to
pass the cost indirectly to the consumer through higher
There are a few key parties to be familiar with when
prices, if market characteristics allow.
discussing retail electronic card payments: (1) the consumer
who makes a purchase; (2) the merchant that makes a sale;
Merchant Discount Rate
(3) the consumer’s bank that issues the payment card, caled
Networks and processors provide the infrastructure
the issuing bank; (4) the merchant’s bank, called the
necessary to facilitate the transfer of funds from the
acquiring bank; (5) the card or payment network that
consumer’s bank to the merchant’s bank. For this service,
connects the issuing and acquiring banks; and (6) the
the merchant agrees to pay a fee called the merchant
payment processor that provides the infrastructure for a
discount rate (MDR) for each transaction. This fee is paid
transaction, such as card readers.
to the merchant’s bank and then further split among the
other market participants in the form of interchange fees,
To understand how these transactions are completed,
assessment fees, and payment processing fees, as described
consider how a consumer would use either a credit or a
below. The MDR is typically around 1%-3% per
debit card at the point of sale (e.g., in a retail store.) To
transaction. For example, if a consumer pays $100 for a
make a payment, a consumer typically swipes or inserts the
product and the MDR is 3%, the merchant would receive
card, though consumers can also tap or wave certain cards
$97.
that have such capabilities. Additionally, consumers can use
digital wallets such as Apple Pay or Google Pay to access
Interchange Fees
their card information. The card swipe, insertion, tap, or
Interchange fees are paid to the consumer’s bank and
wave is processed on a card reader. (Alternatively, card
represent the largest share of the MDR. This fee is set by
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Merchant Discount, Interchange, and Other Transaction Fees in the Retail Electronic Payment System
the network and is paid to cover the costs of the consumer’s
Policy Considerations
bank associated with approving and handling the
One of the main policy considerations about electronic
transaction and assuming the risk for any bad debt
payments is the costs associated with each transaction. One
associated with the payment. The networks typically adjust
specific concern is the impact these costs have on retailers,
interchange fee schedules semi-annually. They set these
who bear the direct costs of most transaction fees. Some
prices to attract issuing banks to their networks. Interchange
policymakers argue that regulating fees, as interchange fees
fees are typically billed to merchant banks as one fee but
have been, can alleviate some of the economic strain on
actually represent several smaller fees rolled into one.
small businesses and allow savings to be passed on to the
Interchange fees vary based on the type of card used and
consumer. However, opponents argue that regulating
whether the card is swiped, keyed in, or processed
interchange fees is ineffective, as the merchant discount
remotely. Fees are typically a percentage of the transaction
rate can be adjusted to compensate. Additionally, regulation
plus a fixed amount. For example, a credit transaction may
can have unintended consequences such as reducing or
carry an interchange fee of 2.3% plus $0.10.
eliminating card benefit programs, which consumers shop
for when choosing a card.
In 2011, the Federal Reserve issued Regulation II,
implementing what is commonly known as the Durbin
Congress continues to debate the merits of regulating
Amendment, which required the Fed to set debit
payment fees. For example, in 2017, the Financial Choice
interchange fees for large banks based on the cost of
Act (H.R. 10, 115th Congress) originally included a
providing the services, capping debit card interchange fees
provision to repeal the Durbin Amendment. More recently,
at 0.05% plus $0.21 per transaction for large issuers. This
policymakers have revisited a number of aspects of
was the first time transaction fees were required to be
merchant fee issues. The pandemic has highlighted some of
regulated. Credit card interchange is generally not covered
the pressure merchant fees place on retailers. In April 2021,
by Regulation II.
retailers in North Dakota sued the Federal Reserve to
challenge its debit card interchange rule, asserting that the
As discussed in more detail in CRS Report R41913,
Fed set the fee too high above costs.
Regulation of Debit Interchange Fees, by Darryl E. Getter,
interchange fees are charged only in four-party networks
Another issue is competition. In a market where retailers
such as Visa and Mastercard, where there is an issuing
increasingly need to accept card payments, network pricing
bank, an acquiring bank, a consumer, and a merchant.
could incentivize issuing banks to direct payments to
Alternatively, in three-party networks, such as American
networks with the highest interchange rates. In May, the
Express, the network provider’s bank also acts as the issuer
Federal Reserve issued a proposed rulemaking to clarify
and acquirer.
that debit card issuers cannot direct payments through a
preferred network—preventing issuers and networks from
Assessment Fees
colluding.
A smaller portion of the MDR goes to the network. This is
sometimes referred to as a card brand, network access, or
While the card networks have delayed updating fee
brand usage fee. Typically this is a relatively small fee,
schedules during the pandemic, with the growing popularity
around 0.1%-0.2% of a transaction, but markups can be
of credit cards, policymakers may also be interested in
added depending on the location of the consumer and
regulating fees associated with credit cards, perhaps in a
merchant banks, the currency used, or other variables. For
way similar to debit interchange fees. (This was done in
example, on a $100 credit card transaction, a network may
Europe in 2015.) One potential unintended consequence of
charge a base assessment fee of 0.14% (14 cents) per
such a policy could be the elimination of rewards programs,
transaction.
which are generally paid for with interchange fee revenue.
However, it is not clear how costly or detrimental
Processing Fees
consumers would view this, because while rewards
The remaining amount of the MDR is paid to the payment
programs for U.S. debit cards and European debit and credit
processor, which accepts the card payment and sends the
cards effectively disappeared after interchange regulation in
transaction to the payment network either through a
those markets, card use nevertheless continued to increase.
physical card reader or an online payment gateway. Fee
structures vary from per-transaction fees to flat service fees,
Related CRS Products
and unlike the interchange and assessment fees over which
CRS Legal Sidebar LSB10604, North Dakota Merchants
merchants have little or no opportunity to negotiate,
Sue Fed, Claiming Debit Card Swipe Fees Exceed Those
processing fees are often negotiated between the merchant
Allowed by the Durbin Amendment to the Electronic Funds
and the service provider. There are a variety of pricing
Transfer Act, by M. Maureen Murphy
schemes among hundreds of processors. Commonly known
payment processors include PayPal and Square, both of
CRS Report R41913, Regulation of Debit Interchange
which charge standard processing fees ranging from 2.6%
Fees, by Darryl E. Getter
to 2.9% of the transaction plus $0.10-$0.30 per transaction.
Alternatively, some processors charge flat rates for services
Andrew P. Scott, Analyst in Financial Economics
(e.g., $50 per month) or comparatively lower transaction
fees, around 0.35% per transaction.
IF11893

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Merchant Discount, Interchange, and Other Transaction Fees in the Retail Electronic Payment System

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