What are Interchange Fees? How Do They Work?

Every time a customer pays by card, a small, invisible fee moves between banks before the money ever reaches your account. Most merchants have heard of it. Far fewer actually understand what it is, why it exists, who sets it, or how it affects fees.

This fee is known as an interchange fee - one of the costs of modern card payments. In simple terms, interchange fees are transaction fees paid by a merchant's acquiring bank to the cardholder's issuing bank whenever a credit or debit card payment is processed.

Merchants on blended pricing may not see interchange fees listed separately, although businesses using interchange++ pricing typically see them in detail. Either way, they typically make up the largest portion of the card processing fees businesses pay to accept card payments - often accounting for a significant portion of the total cost. The amount is often estimated at 70-90% depending on the pricing model and transaction mix.

So, what are interchange fees? This guide provides a detailed answer including how interchange fees work within a card transaction, how they are calculated, and what current UK regulations mean for businesses that accept card payments.

Why Do Interchange Fees Exist?

Interchange fees are a fundamental part of the electronic payments ecosystem, helping ensure that card transactions can be processed securely and reliably.

When a customer pays with a credit card or debit card, multiple organisations are involved in completing the transaction. These include the merchant, the acquiring bank (which processes payments for the business), the issuing bank (the customer's bank), and the card networks that route the transaction between them.

Interchange fees compensate the issuing bank for the costs and risks associated with issuing payment cards and authorising card transactions. These responsibilities include fraud prevention, credit risk management, customer support, and maintaining the infrastructure required for secure processing technologies such as point-to-point encryption and 3D Secure authentication.

Credit cards typically attract higher interchange fees than debit cards. This is largely because issuing banks assume greater risk when extending credit to cardholders. Premium and rewards cards often carry even higher interchange rates, as these credit card fees help fund customer incentives such as cashback, loyalty points, and air miles programmes.

Debit card transactions usually incur lower fees because funds are drawn directly from the cardholder's bank account, meaning the issuing bank faces less credit risk.

Card networks such as Visa and Mastercard enable payment requests to move between financial institutions by providing the underlying infrastructure and routing systems.

These networks set interchange fees to provide the infrastructure that allows acquiring banks, issuing banks, and payment processors to route transactions securely and authorise payments in seconds.

To Summarise:

Interchange fees help cover the operational costs and financial risks involved in processing card payments, while supporting the infrastructure that allows businesses to accept electronic payments worldwide.

How Does an Interchange Fee Flow Through a Transaction?

When a customer makes a card payment, the transaction passes through several organisations before funds reach the merchant.

Understanding how interchange fees work requires looking at the full transaction flow between the merchant, the acquiring bank, the card network, and the issuing bank.

The process generally follows these steps.

Throughout, payment processors and card networks ensure secure routing, fraud prevention, and compliance with card scheme rules.

Step 1: Customer Initiates Payment

The payment journey begins when a customer uses a payment card, either in person or remotely.

Transactions generally fall into two categories:

Card present payment typically attracts lower interchange fees because they involve lower fraud risk and rely on secure authentication technologies such as chip-and-PIN and point-to-point encryption.

Card-not-present transactions generally incur higher interchange fees because they carry greater fraud and chargeback risk.

The transaction value and transaction method also influence interchange fees. Most interchange pricing models include a percentage of the transaction amount plus a small, fixed fee per transaction.

Step 2: The Acquiring Bank Contacts the Card Network

Once the payment is initiated, the merchant's acquiring bank or payment provider forwards the payment request to the relevant card scheme.

Card networks such as Visa and Mastercard act as intermediaries, routing the transaction data between the acquiring bank and the card issuing bank.

Payment processors assist by ensuring transactions comply with card scheme rules and security requirements, while also helping merchants process card transactions efficiently and securely.

Step 3: The Issuing Bank Approves or Declines

The issuing bank (the customer's bank) evaluates the transaction request.

To approve or decline the transaction, the bank typically:

If the transaction is approved, the issuing bank sends an authorisation code back through the card network.

Step 4 - The Interchange Fee is Applied

Once a transaction is authorised, the applicable interchange fee is determined and later applied during clearing and settlement.

In practice, the interchange fee is paid by the acquiring bank to the issuing bank as compensation for authorising the transaction and making funds available to the merchant.

These interchange fees work using multilateral interchange fee structures, which usually include:

The interchange fee amount varies depending on several factors, including:

Business, corporate, and international cards often carry higher, uncapped interchange rates compared with domestic consumer cards.

Merchant Receives the Payment

Once the transaction is settled, the acquiring bank transfers the funds to the merchant's account.

However, the merchant receives the transaction value minus several processing fees, including:

• Interchange fees.
• Scheme fees charged by card networks.
• Payment processor fees.

Together, these charges form the Merchant Service Charge (MSC) - the total fee merchants pay when they accept card payments and process card transactions.

Who Sets Interchange Rates?

Typically, Interchange fees are set by card networks within the limits imposed by regulation.

These organisations publish interchange rate tables, which define how interchange fees are calculated across different transaction types.

The structure is complex and varies depending on:

Card networks periodically update interchange rates twice a year - commonly in April and October.

Interchange Fee Rates in the UK

In the UK, interchange fees for consumer cards are regulated under the Interchange Fee Regulation.

The regulation caps interchange fees at:

These caps were originally introduced to limit the cost burden on merchants and encourage competition in the payments industry.

However, following Brexit, cross-border transactions between the UK and the European Economic Area are no longer covered by the same caps. This has led to higher interchange fees for some international payments.

The Regulatory Picture: What's Changing?

Regulators focus on interchange fee regulation to promote transparency, fairness, and competition. Key developments include:

These changes aim to lower fees, enhance security, and encourage a competitive payments market.

Interchange Fees vs Scheme Fees: What's the Difference?

When merchants review their processing statements, they may see several different charges.

Together with payment processor fees, these charges form the total charge.

Can Businesses Reduce Your Interchange Fees?

Interchange fees themselves are usually fixed by card networks, which means there is no real scope for merchants to reduce interchange fees.

However, businesses can still reduce their overall card processing costs by optimising how payments are processed.

Common strategies include:

Businesses processing high transaction volumes may also be able to negotiate lower overall processing fees with their payment processor or acquiring bank. Such agreements often depend on setting minimum transaction fees or volumes.

Regularly reviewing processing statements can also help merchants understand all the fees being charged and identify opportunities to lower payment costs.

Encourage Debit Card Payments

Encouraging customers to use debit cards is a highly effective way for merchants to reduce interchange fees, as debit card transactions typically incur lower fees than credit card transactions.

This is because debit payments draw funds directly from the cardholder’s bank account, reducing the issuing bank’s risk and associated costs. Merchants can promote debit card use by displaying signs, offering small incentives or discounts for debit payments, and training staff to inform customers about the benefits of using debit cards. Simplifying the payment process for debit cards and educating customers on their security and convenience further encourages their use.

By shifting the card mix towards debit cards, merchants can lower transaction costs, improve cash flow, reduce fraud risk, and ultimately enhance profitability.

Use 3D Secure for Online Transactions

Technologies such as 3D Secure can help transactions qualify for lower-risk interchange categories.

This security protocol requires customers to verify their identity during checkout, which helps protect merchants from fraudulent chargebacks and shifts liability for certain fraud cases to the issuing bank.

Card networks offer reduced interchange rates for transactions authenticated with 3D Secure because the enhanced security lowers the risk associated with card-not-present payments, which typically carry higher fees.

By adopting 3D Secure, merchants not only improve transaction security but also qualify for lower interchange fees, ultimately reducing overall payment processing costs.

Provide Complete Transaction Data

Providing complete and accurate transaction data is essential for merchants aiming to qualify for lower interchange fees. Card networks use detailed transaction information to assess the risk and legitimacy of each payment. When merchants submit data such as the customer’s addresses, order numbers, merchant category code (MCC), contact details, etc, they help issuing banks better verify transactions and reduce perceived fraud risk.

This can result in the transaction being classified under a lower-risk category, attracting reduced interchange rates. Incomplete or inaccurate data, on the other hand, may cause transactions to default to higher fee brackets, increasing costs for merchants.

To maximise savings, merchants should ensure their payment systems capture and transmit all relevant details, train staff to collect accurate information, and regularly audit transaction data to identify and correct gaps.

By prioritising complete transaction data, businesses can lower interchange fees, improve payment security, and enhance overall profitability.

Review Your Card Mix

Reviewing your card mix involves analysing the types of payment cards your customers use and understanding how each impacts interchange fees. Since different card types and transaction methods carry varying fee rates, identifying the proportion of higher-cost cards in your sales can highlight opportunities for savings.

By encouraging the use of lower-fee cards, such as debit cards, and reducing reliance on premium credit or cross-border cards, merchants can significantly lower their overall interchange costs.

Consider Alternative Payment Methods

Considering alternative payment methods is a practical strategy for merchants aiming to lower interchange fees and reduce overall transaction costs. Unlike traditional credit and debit card payments, many alternative options, such as direct debit, digital wallets, bank transfers, Buy Now, Pay Later (BNPL), and Open Banking payments, often carry lower or no interchange fees.

For example, direct debit allows merchants to collect payments directly from customers’ bank accounts, bypassing card networks and reducing fees, making it ideal for recurring payments.

Digital wallets like Apple Pay and Google Pay enhance security and may offer bundled pricing that can lower costs.

By integrating these alternative methods, merchants can diversify payment options, lower interchange fees, and improve overall payment processing efficiency.

Transparent Interchange Pricing Starts With the Right Acquirer

Choosing the right acquiring bank or payment provider is essential for understanding and managing interchange costs and merchant fees.

The acquirer processes payments and manages the transfer of funds between the cardholder's issuing bank and the merchant's account.

Because interchange fees make up the largest share of card processing costs, having clear visibility into how these fees are structured can make a significant difference to a merchant's bottom line.

Working with the right payment provider can help businesses better understand interchange rates, identify opportunities to reduce transaction fees, and optimise how they accept card payments.

DECTA offers transparent pricing models, detailed reporting, and a secure payment infrastructure that helps merchants take control of their payment processing costs.

If your business wants clear insight into interchange fees - and practical ways to reduce overall card processing costs - speak with a Payment Expert to learn how a more transparent payment setup can help master your payments.