Card costs: who pays what to whom

So, it's pretty clear to you, this web of fees that's woven around every transaction involving your debit and credit cards? There's your annual fee – if you have a premium card - and the interest you're charged if you don't pay your credit card bill in full every month. That goes to the bank that issued your card. There's more. A lot more.
While credit cards account for 31 per cent of retail transactions, according to the Bank of Canada, only five per cent of merchants prefer them as a method of payment. The reason: higher fees. ((Nick Ut/Associated Press))
So, it's pretty clear to you, this web of fees that's woven around every transaction involving your debit and credit cards?

Changes for card issuers

The federal government brought in new rules for credit-card issuers. They include: 

  • Minimum 21-day interest-free period on new purchases when cardholders pay their balances in full. Currently there is no mandatory grace period.
  • Monthly statements to show how long it would take to pay off balance if account holder only pays minimum balance.
  • Payments must be allocated in favour of consumer when balances are transferred to lower-interest cards.
  • Summary box on statements clearly setting out interest rates and fees.
  • Consumer must consent to credit limit increases.

There's your annual fee — if you have a premium card — and the interest you're charged if you don't pay your credit card bill in full every month. That goes to the bank that issued your card.

There's more. A lot more. It's what has retailers complaining bitterly. There's the merchant discount rate and the interchange fee, which consumers don't see at all.

There's the fee that merchants have to pay to the company that processes your payment when you use your debit card. There's the fee that merchants pay to Interac Direct, the not-for-profit organization that oversees the system that allows for direct payment.

There's even a fee that some retailers will add on to a purchase when you use your debit card. Usually, it's a smaller retailer tacking on the charge for purchases under a certain amount.

And if you're a retailer, there's a cost to accepting cash. If you're a small operator, you have to spend time preparing your bank deposits, which could include rolling coins and reconciling your daily transactions. That takes time. If you've been in the business a long time, you may view it as just the cost of doing business.

A study published by the Bank of Canada in August 2008, found that while all retailers accept cash, 92 per cent of them accept credit cards and 93 per cent accept debit cards.

The study also found that merchants preferred debit cards (53 per cent), followed by cash (39 per cent) and credit cards (five per cent). The reason? Cost.

How we pay

  • Credit cards account for 31 per cent of transactions.
  • Cash accounts for 29 per cent of transactions.
  • Debit cards account for 26 per cent of transactions.

Source: Bank of Canada

Merchants pay two to four per cent of the sale price in various transaction fees whenever they accept a credit card for payment. Money flows to the credit card network (Visa or MasterCard in the vast majority of cases), the company that processes the payments and the merchant's bank.

Jeremy Rudin, an assistant deputy minister with the department of finance, described the process this way at the Senate hearings into credit and debit card systems on March 25, 2009:

The Retail Council of Canada says basic credit cards are rapidly being replaced by premium cards that carry higher fees that retailers must pay per transaction. ((CBC photo))
"Suppose that a consumer and a merchant agree to a $100 transaction. The consumer will owe the financial institution that issued his or her credit card $100. The merchant will receive less. In our example, the merchant receives $98. The $2, which is sometimes called 'the merchant discount rate,' is shared by two other parties: The merchant's payment processor, sometimes called 'the acquirer,' which provides payment processing services to the merchant, retains 50 cents in our example; and the consumer's financial institution which issued the credit card retains $1.50 in our example for what is known as the interchange fee."

Anatomy of a credit card transaction

1. Consumer presents credit card for payment.

2. Merchant swipes card through point of sale (POS) terminal. An electronic message, including card information and authorization request, is sent to the merchant's acquirer (the financial institution that the merchant deals with).

3. Acquirer sends authorization request to the card network (Visa or MasterCard in the vast majority of cases).

4. The card network contacts card issuer (the financial institution that approved you for your credit card).

5. Card issuer (your bank) verifies whether sufficient funds are available, whether security levels are checked, and whether the transaction is within cardholder limits. Authorization response is routed back along the same path to complete transaction.

6. Consumer signs receipt.

Source: Bank of Canada

Rudin explains that the 50-cent fee retained by the payment processor is negotiated between the merchant and the payment processor. The $1.50 interchange fee is set by the credit card network — Visa, MasterCard, American Express, etc. — but it is retained by the financial institution that issued the card to the consumer.

The credit card network whose logo appears on the card operates the proprietary network that manages the information systems that handles the transaction. It makes its money through franchise and service fees from both card issuers and acquirers for access rights to that network. The fees are based on the volume of transactions and on other services provided to these organizations.

Fees for accepting a debit card are substantially lower. In order to accept debit cards, a merchant must be a member of the Interac Association, currently a not-for-profit organization. It manages the network that links members together in order to deliver direct payment services across the country. Merchants pay an annual membership fee based on the number of transactions they process. The current fee per transaction is $0.008253 — or $82.53 for 10,000 transactions.

There's also a fee that goes to the acquirer. You can tell which company that is by checking the top of the pad the cashier hands you when you make a debit card purchase — the pad you use to enter your PIN. The merchant normally pays a flat fee, negotiated with the acquirer.

It's the interchange fee involved in credit card transactions that's making retailers angry. The Retail Council of Canada claims Canadians paid $4.5 billion in "hidden" credit card fees alone last year.

It currently costs retailers about 12 cents to process a debit card transaction. But they're worried that cost will escalate if companies like Visa and MasterCard enter the debit card business in Canada. ((Bill Sikes/Associated Press))
On March 3, 2009, the Senate committee on banking, trade and commerce announced that it would study the credit and debit card systems "and their relative rates and fees." Three weeks later, the deputy commissioner of the Competition Bureau of Canada — Richard Taylor — told the committee that the bureau is investigating Visa and MasterCard to determine whether they breached the Competition Act by abusing their dominant position in the industry.
Visa Canada says its fees are transparent.

However, the trail of fees for using plastic seemed to befuddle several members of the Senate banking committee on the afternoon of March 25, 2009. The following exchange involves Rudin and Senator Pierrette Ringuette and Senator Céline Hervieux-Payette:

Ringuette: You have not clarified this issue in your presentation. Who determines the interchange fees?

Rudin: The fee is set by the card network — Visa, MasterCard, American Express. The fee is remitted to the financial institution that issued the card to the consumer. For example, I might set a price for something without being the seller of the item and, therefore, the one who receives the revenue. That is the notion.


Hervieux-Payette: I do not understand. Who keeps the money? Does it go into the bank's earnings or Visa's? I would like this to be clarified. It is not because you are the one setting the fee that you get to keep the money. This will therefore have to appear in the bank's financial statements as $1.50 in income, just like when I go to the ATM. And you are saying that it is Visa or MasterCard that sets the amount, but who keeps it? That is what interests us.

Rudin: It is the financial institution of the card holder that retains the fee.  

Ringuette: Visa and MasterCard — we always use these two companies because they hold 80 per cent of the market — remit the fees that have been set by the banks?

Rudin: No. They establish the fee, but I would not say they remit it.

Ringuette: You just told us that the financial institutions establish the fees.

Rudin: I hope I did not.

Ringuette: That is what I understood.

Hervieux-Payette: I asked who keeps the fee? I did not ask who sets it. I understood that it is Visa and MasterCard that set the fee at $1.50, but that it is the bank that issued the card that kept the money.

The Deputy Chair: We all agree on that.

What's angered retailers is the push by the credit card companies to issue new premium cards.

"In March 2008, Visa-issuing financial institutions began issuing the Visa Infinite card that is targeted at a specific sub-set of cardholders," Visa spokesperson Amy Cole told CBC News. "Visa Infinite transactions attract an interchange rate that is one-fifth of one per cent (0.2%) higher than other card products."

The debit wrinkle

Interac is currently in talks with the Competition Bureau of Canada about changing from a not-for-profit structure to a for-profit operation.

Interac says it has to do this in order to compete with Visa and MasterCard, which are expected to enter the Canadian debit card market soon.

The Retail Council of Canada argues the credit card companies are flooding the market with premium cards that cost more to process — because they can. The council says as many as half of credit card transactions now involve premium credit cards.

The council wants the federal government to limit the amount of merchant fees that the card companies can charge, just as the Australian government does. Fees in that country  are based on actual costs and a reasonable return.

So what does it cost to process a transaction? The Bank of Canada survey looked at the estimated cost of processing a $36.50 transaction, which was the median cash transaction in its survey. Costs broke down like this:

  • Debit card: 19 cents.
  • Cash: 25 cents.
  • Credit card: 82 cents.

The study notes that the overall cost of electronic transactions falls as the volume increases, which the authors suggest, may encourage greater use of electronic payments.