4 minutes
Understanding how this income stream works will help credit unions properly manage and make the most of it.
Visa, Mastercard, Pulse, Star. Most people in the financial industry would recognize these routing networks. After all, debit card transactions are the primary payment method for our customers. Consequentially, the interchange fees associated with debit transactions should also be easily understood and properly managed by financial institutions. Realistically, though, not every credit union executive understands how this revenue stream works from start to finish, which could be costing them thousands per year.
The Basics
To give you a basic understanding of interchange fees, we’ll focus on a common merchant transaction: one of your members uses their debit card at Walmart. The interchange fee is a payment by the merchant on a transaction. Every merchant knows that they will need to pay this fee to one of the networks.
These fees cover the expenses associated with the transaction … securing the network, fraud protection, verifying the funds are available and posting the transaction to the member’s checking account.
Now, larger merchants are continually negotiating with the networks to get the best transactional rates available (to pay the least they can). So, if you were to look at your raw fee revenue data, you would notice that a $50 flower purchase at a large retailer pays less than $50 in flowers purchased at a local flower shop. This is because the larger retailers pay less for many transactions because they have negotiated lower fees with their network providers.
Types of transactions: When a consumer completes a transaction at a merchant with their debit card, they either enter a personal ID number or sign for the transaction. The option to sign at the merchant generally creates a higher interchange fee on that transaction. Often the net interchange fee resulting from a signature transaction is higher than the fee created by entering a PIN.
Types of networks: There are primary and secondary routing networks. Primary networks include Visa and Mastercard, and all signature-based transactions will be managed by the primary networks only.
When it comes to PIN transactions, the merchant can route to a secondary network (think Star, Accel, Maestro, Pulse) to try to lower the fees it pays. As a credit union, you must have at least one secondary network to allow the merchants to route to. This ensures competition amongst the network providers.
If your primary network is Mastercard, and Mastercard’s merchant rates are higher than the secondary provider’s rates for that same PIN transaction, the merchant can send the transaction to the secondary provider. If you opt for a third provider, the merchant can shop all three for the best rate before routing the transaction.
What is gross vs. net interchange revenue?
When we discuss net interchange revenue, what we mean is that each of the networks pass revenue to you. Your statement each month is likely consolidated so that the primary and the secondary merchant fees may come on the same statement along with ATM fee revenue pass-throughs. This interchange summary statement likely comes to you from your debit provider each month.
You will not have the ability to negotiate the gross revenue that the network providers receive from the merchants. That is an ongoing negotiation between those two parties.
You should, however, be aware of the charges you receive from your network providers and your core provider, which is posting these transactions to the customer accounts. These fees can quickly reduce the share of the interchange fees you receive.
How can I maximize my net interchange revenue each month?
Here are a few tips for improving that interchange remittance.
Incentivize customers to use a certain type of transaction. For members that sign rather than use a PIN for a merchant debit transaction, you are paid almost double the amount you are when a customer uses a PIN transaction. Some debate whether using your PIN while standing in line at Walmart might be exposing you to ATM or other fraud. A member marketing campaign on the security of using a PIN versus signing when making a purchase could lead to an increase of your member signature transactions at the retailer.
Only use two networks. Reg. II requires financial institutions to utilize a minimum of two unaffiliated routing networks, essentially to avoid a monopoly in the industry. If, however, your credit union is utilizing more than two networks, you’re giving the merchant more routing choices and thus more opportunity for it to reduce its costs (and your profits).
Review your contracts. Your primary network, your secondary network and your core provider all charge fees which reduce your gross interchange fees. Each of these providers takes care not to make these fees obvious to you. They may be figuring that if you can’t find them, you won’t analyze and perhaps negotiate them.
Do you know what those fees are, how they are structured (flat expense, a percentage, per transaction), and whether they are reasonable compared to your peers? If you don’t know, it could be worth some time to research this.
To facilitate further understanding on interchange revenue, listen to BankTalk Podcast Episode 3, where Daneen Cady, who manages Accel and debit payment networks at Fiserv, a CUES Supplier member, offers her insights and provides an in-depth discussion of interchange fees, fraudulent activity and negotiation strategies.
Charlie Kelly is a partner at Remedy Consulting and host of BankTalk Podcast. Remedy Consulting helps financial institutions thrive through specialized consulting services in system selections, core contract negotiations, outsourcing/in-house advisory, bank mergers & acquisitions, and strategic planning. As a trusted advisor to banks and credit unions, Remedy Consulting has executed more than 700 system selection and vendor negotiations since 2016. Clients receive cost reduction on their vendor contracts and increased efficiency with Remedy’s Price Repository.
