Interchange Fees Explain Who Pays For Rewards

Reward points and cashback look like a gift from the issuer. They are mostly funded by a fee that flows from the merchant to the issuer every time the card is used.

Money moves the opposite way to the purchase

When a card is used, the merchant receives the sale amount less a charge from its acquirer. Part of that charge passes to the card scheme and part to the card's issuer.

The portion reaching the issuer is the interchange fee. It is set by scheme rules by card type and transaction type rather than negotiated by the parties involved.

Because it arrives with every transaction, it is a revenue stream tied to spending volume rather than to borrowing, which makes it available to fund benefits for people who never pay interest.

Card type determines the fee

Scheme rules distinguish categories of card, with premium and commercial products generally attracting higher interchange than standard consumer cards.

Issuers therefore have an incentive to place customers on categories that earn more, and to attach benefits that make those categories attractive to hold and use.

The relationship runs both ways: the benefits exist because the fee supports them, and the fee is justified by the acceptance and spending the benefits generate.

Regulation of the fee changes the products

Several jurisdictions have capped interchange on consumer cards. Where caps have been introduced, reward programmes have generally been reduced or moved behind annual fees.

This is not a coincidence of timing. The fee is the funding source, so a lower cap removes the money that paid for the benefit.

Because caps differ by market and by card category, the same brand of card can carry generous benefits in one country and minimal ones in another.

Merchants price the cost back in

Merchant service charges are a cost of doing business, and businesses recover costs through prices. In most markets that recovery is spread across all customers rather than charged at the till.

Where surcharging is permitted, the cost becomes visible on the transaction. Where it is restricted or banned, it stays inside the shelf price and is paid by cash and card users alike.

The transfer is therefore from the general customer base to the reward-earning cardholder, which is the redistribution that sits behind the marketing.

Rewards are worth less than the interest they can attract

The value returned on spending is a small fraction of the amount spent, while interest on a revolved balance is charged at a far higher proportion.

An account that earns benefits and carries a balance is therefore paying out more than it collects, which is the arrangement the product economics anticipate.

Reward structures, expiry rules and the conditions attached to redemption are set by the issuer and can be changed, usually with notice, during the life of the account.