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The bankcard industry has a love-hate relationship with interchange. Issuers that receive it love it; acquirers that pay it hate it.
As an executive at a bank that is both an issuer and acquirer, I could argue the pros and cons of interchange for hours. Simplifying the structure of interchange, however, would make life easier for both sides of the card equation.
The bankcard associations that evolved into MasterCard and Visa designed interchange to reimburse issuers for the costs associated with card issuance, including credit risks, fraud losses and marketing. To some degree, this definition still is true, but the interchange rates are growing higher and the system much more complex.
Twenty years ago, interest income represented approximately 85% of an issuer's total revenue. The rest was from other fees. In today's world, that ratio is 65% interest and 35% other fees.
To be fair to issuers, data breaches at some of the merchants that acquirers serve have driven up the cost to issue cards, as issuers must reissue compromised cards and absorb some fraud losses.
Most of the early breaches occurred because merchants were capturing and maintaining information from card magnetic stripes in their databases to use for marketing purposes. But they were supposed to use the information only to authorize and process the transaction.
Merchant data breaches led Visa and MasterCard to adopt more security-related rules and then to the creation to the Payment Card Industry Data Security Standard, both of which created more expenses for acquirers and their merchants.
Interchange rates also began climbing as many banks exited the acquiring business and the growth of independent sales organizations began. The boards of Visa and MasterCard were composed of bank executives. All were issuers, but a shrinking number were acquirers.
That resulted in the two card associations raising interchange rates to the benefit of issuers and the detriment of acquirers and their merchant customers.
With Visa's and MasterCard's recent initial public offerings, the makeup of their boards has changed considerably, and we will see many changes in the upcoming years.
My biggest concern as both an issuer and acquirer is how card networks will satisfy their shareholders. Will there be another major generator of revenue, or will Visa and MasterCard increase the quarterly dues and assessments they charge participants in their networks?
My bank incurs daily revenue as an issuer from interchange and daily charges as an acquirer from interchange. We have faced increasing pressure from unhappy merchant customers as the average interchange we must pass along to them has increased a few basis points every quarter for the past few years.
One change that could improve efficiency for all would be to simplify the structure of interchange. Last month, our own merchant base processed transactions at 65 different Visa interchange tiers and 88 MasterCard tiers.
Acquirers assume huge expenses from their processors reprogramming transaction software every time Visa and MasterCard make quarterly interchange-rate changes and add new interchange tiers.
I do not profess to know what would constitute the ideal interchange rate or tier structure, but I would prefer to work with a simpler set of only four to six interchange tiers that do not constantly change and, therefore, create more programming costs for acquirers.
However interchange is structured, if issuers, acquirers and card networks do not work out our differences on interchange among ourselves, federal lawmakers will step in. And that would be costly to the card industry as a whole. CP
(William W. Shaw is group vice president of the credit card division at First Citizens Bank in Raleigh, N.C. He can be reached at bill.shaw@firstcitizens.com.)
