The Origins of Interchange Fees

By Phin Upham

feesInterchange fees, which are paid between two banks moving money to complete a financial transaction, have become fairly controversial over the years. Those fees were typically set at around 2%, but it’s been recently suggested that large retailers are able to negotiate their own fees due to the sheer size of their businesses.

Why pay fees at all?

It’s believed that there are two potential reasons for this. Fees mean profits for one side, so it’s believed that fees help to maintain a balance between card issuers and acquirers within banking networks. The second has to do with “Truth in Lending” laws. The thinking goes that the fees helped to eliminate some of the nebulous pricing behind fees, rates and other financial terms.

In ideal conditions, banks are not expected to make much money off late fees and interest charges, although it’s conventionally thought of as the bank’s primary revenue generator. Instead, these fees provide the bank’s income, among other investments, and these fees can vary depending on the kind of card a customer wants to use.

If the customer is using a card with rewards, for example, the banks involved are paying higher fees in order to compensate for what the customer is being given.

In the case of ATMs, where this example is most obvious, fees can be used as a means of discouraging other brands. We see this commonly in a convenience store, where customers might need to make a quick withdrawal when their bank is nowhere to be found. That customer will pay higher fees if the ATM is run by a rival brand.

Phin Upham is an investor from NYC and SF. You may contact Phin on his Phin Upham website or LinkedIn page.