Interchange is the most scrutinised fee in payments and the least understood. This episode takes it apart: where the money actually goes, why the fee exists, why the original justifications no longer hold, and why it is now declining for structural reasons rather than political ones.

Start with the flow. On a €100 card payment in regulated Europe, the merchant keeps €98.65-99.30. The acquirer takes €0.20-0.40, the card network €0.10-0.15, the issuer €0.20-0.30, the gateway €0.30-0.50. Total merchant cost: €0.70-1.35. Run the same $100 through an unregulated US credit card and the issuer alone takes $1.50-2.50. Total merchant cost: $2.10-3.55. Same infrastructure, 2-5x the price.

Four justifications, examined.

Fraud risk is real, but it is 0.05-0.15% of volume. It justifies roughly 0.10%, not 0.30%, and certainly not 2%.

Infrastructure was a real cost in 1975. Those authorization systems are depreciated. Marginal cost per transaction is near zero. Bank account maintenance runs €2-10 per customer per year, while US interchange on €10,000 of annual card spend extracts $150-300.

Credit risk and float is defensible for credit cards, where banks already charge 15-25% APR for the same risk. It is indefensible for debit, where no credit is extended, no float exists, and interchange applies anyway.

Rewards is circular reasoning. Banks charge merchants to fund programmes that make cards attractive, then cite the programmes as the reason for the charge. Premium cards cost merchants the most precisely because they pay customers the most.

What actually explains fees running 5-20x cost is network lock-in. Cards became mandatory, alternatives did not exist, and pricing moved to what the market would bear.

Then the correction. Europe's 2015 regulation capped consumer interchange at 0.2% debit and 0.3% credit, down from 0.8-1.2%, saving merchants €1.5 billion annually. The US Durbin Amendment capped debit for banks over $10 billion and left credit untouched. Australia started in 2003 and has twenty years of data showing lower interchange does not kill card payments, it just ends their economic advantage.

Regulation is no longer the main story. Five structural forces are compressing interchange everywhere: A2A payments at 0.5% flat give merchants a real alternative; regulatory momentum runs one direction only; merchants on thin margins have found leverage and stopped being price-takers; instant payment infrastructure (SEPA Instant, FedNow, Faster Payments, PIX, UPI) removed the last technical reason cards were the only instant option; and 70%+ mobile banking adoption removed the consumer barrier that existed in 2010.

The bank strategy split, with the arithmetic. A regional bank earns €1M a year in interchange from 500 merchants. It defends the fee, loses 10% of those merchants to a competitor offering A2A, and preserves €100K of interchange while losing €300K in business banking and €400K in lending. €800K destroyed to protect €100K. The bank that enables A2A at 0.6% instead takes a 15% hit to payment revenue, retains every merchant, attracts 50 more, and is up 10% overall inside 18 months. Defending interchange is profitable quarterly and disastrous strategically.

Also covered: why small merchants subsidise large ones for identical infrastructure, what happens to acquirers and PSPs when the interchange-plus model stops working, and the 10-year outlook to an equilibrium 40-60% below today where interchange still exists but reflects cost plus a reasonable margin rather than pricing power.

For anyone in payments who has been told that interchange is simply how the industry works.

Full source material and the complete breakdown: https://go.payware.eu/p-interchange-101-f

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