What it is:
How it works/Example:
For example, when you use your debit card or credit card at a store or online, there is a hidden fee that is charged by the card-issuing banks to process this transaction. For debit card transactions processed as “credit,” this fee is 2-3% of the total purchase price; for transactions run as “debit,” it is roughly 1% of the total purchase price. For purchases using a regular credit card, the interchange fee can be as much as 3% or higher, depending on the extended rewards associated with your card.
Banks work out legal agreements with one of the major credit card companies such as Visa, MasterCard or Discover, as well as EFT networks such as Star, Interlink and NYCE, to become a member bank within their network. The banks then charge a fee to merchants to process these debit and credit card transactions -- a certain percentage of which goes to the credit card company and a smaller percentage is paid to the merchant’s bank.
Why it matters:
$20.5 billion in interchange fees were charged to merchants in 2010. Now they are at the center of debate among lawmakers, banks and merchant unions in the U.S. On one side of the argument are the banks, which claim the interchange fees are necessary to cover the costs of processing transactions and providing fraud protection. On the other side are the merchants and vendors, who claim the rising interchange fees are increasingly cutting into their profits, forcing them to raise the prices of their goods and services.
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by Congress, and included in the Act was an amendment to address interchange fee reform (the Durbin Amendment). Under this amendment the Federal Reserve is now authorized to review and reform debit card transaction fees. One such proposal will cap interchange fees at $0.12 per transaction, a 73% reduction from the average charge of $0.44 per transaction. As a consequence, consumers can expect a loss of financial perks like free checking accounts, the end of rewards programs for debit cards and an increase in fees for ATM withdrawals from out-of-network banks.
If interchange fee reform is not passed, the cost of the fees will be borne by the consumer, as merchants continue to increase the prices on their goods and services to make up for profits lost to fees.