The UK’s £500m Interchange Fee Gold Rush
Mastercard’s major changes to Bank interchange fees may unlock up to £500m in additional revenue for UK payments businesses.
What are interchange fees?
Your card payments aren’t free. Whenever you make a card purchase, someone has to pay for all the technology running in the background to make it happen.
The retailer you buy from pays a set percentage of the purchase price back to your Bank, this is called an interchange fee. It varies in amount based on the region you spend in and even the type of transaction (grocery store vs airline).
The main takeaway is that it’s a fee set by the card processor (Mastercard or Visa), and for the most part retailers have no option but to accept and is why sometimes they may charge you an extra fee to cover the cost.
The fees are contentious, with the EU introducing a cap in 2015 due to concerns they unfairly punished merchants and pushed up prices for customers. While the UK was a member of the EU, Mastercard’s interchange fee set for payments made in the EU was capped at 0.3% on credit card payments and 0.2% on debit card payments.
Due to Brexit, Mastercard is no longer bound by the EU caps and will be increasing the interchange rate to 1.5% for credit cards and 1.15% for debit card payments from 15 October, 2021.
The UK has also recognised the issue of high interchange fees, with the Supreme Court upholding the Sainsbury’s v Mastercard claim that interchange fees merchants paid on card payments restricted competition and awarding £68m in damages.
This has opened the floodgates for consumer claims, with Mastercard facing a landmark £14 billion class action lawsuit brought against it by 46 million consumers. This is the UK’s largest class action lawsuit in the High Court to date and definitely one to watch as it could have global repercussions for Mastercard.
The rise of the Challenger Bank
There was over £40bn spent on UK debit cards and £22bn on credit cards internationally in 2019 (UK Payment Markets 2020), the majority of which was spent within the EU. Traditionally high-street banks in the UK charged fees of between 2% and 3% of transaction value to their consumers spending overseas. Their customers love to travel however, with Europe's major cities just one budget airline flight away.
Early Challenger Banks such as Monzo, saw this user segment as a growth opportunity, with many of their early customers drawn by the offer of free overseas transactions and card withdrawals. Since Monzo’s success, fee-free transactions abroad have become table stakes for new Challengers. This has enabled the Challenger segment to capture an outsized share of the total UK overseas spend, with many customers using the products solely as travel cards, although this behaviour is slowly changing.
With travel for Brits, likely confined to the EU for most of 2021 (if opened up at all), the increased revenue from this announcement is an important lifeline for loss making banks who have built their models around interchange revenue.
Starling, one of the few Banks who separate customer spend by currency, reported in excess of €1bn of Euro payment volume in their 2018/19 annual report. To put this in context, if the new interchange rates been live for this period their total card revenue would likely have doubled, despite Euro spend only representing less than 30% of total card volumes. International retail spend fell to below 20% of total card volumes in Q1 20, due to success in growing primary account usage for domestic spend. Despite representing only a small portion of total spend, the almost 6x revenue opportunity that Europe now represents expect will supercharge card revenues.
The next payments gold rush
The UK Challengers were able to grow an outsized share of overseas card spend, primarily because the incumbent high streets had no incentive to give up lucrative transaction fees they were making from Brits love of travel.
Brits spent over £62bn on overseas holidays alone in 2019 (likely lower in 2020 for obvious reasons). Of this £39bn was spent holidaying in Europe with Spain alone benefiting from £11bn, most of which I can assume was spent on tanning oil and cerveza in the Canary Islands.
It is hard to find an exact figure for the volume of spend by UK card-holders in Euros, but factoring in holidays and the 11% share of UK ecommerce from EU retailers, the total volume is likely between £40bn to £50bn.
Assuming Visa follow suit with similar changes, there is an additional £400-£500m in interchange revenue from the EU up for grabs, up to £200m for credit and almost £300m for debit transactions. It’s a gold rush.
More money, more problems
The U.S is a good case study to see the impact of high interchange fees on the market. Typical interchange ranges from 1.25% on debit cards and up to a whopping 2% for credit card spend. Cost of acquisition for card products skyrockets as issuers outcompete each other by offering increasing levels of cashback and reward points to consumers. We are also likely to see increased marketing activity both from high-street banks and issuers like Amex in the coming months to try and regain a slice of this pie before travel restrictions hopefully ease in Summer.
Strong competition is likely to come from within the existing Challenger market. Those who have built up large war chests of VC funding may simply outspend everyone with marketing or cashback offers. Those who were first movers and managed to acquire large numbers of customers at much lower CAC’s, now have the opportunity to monetise a previously unprofitable customer segment.
Those who rely on freemium models, may see customers willingness to pay for features fall as increased competition (and transaction revenue to pay for it) results in premium features offered to consumers for free.
In a gold rush, you want to be selling the shovels
Cumbersome and expensive banking infrastructure previously made it difficult for new businesses to enter the card issuing space. The rise of banking-as-a-service providers such as Railsbank and open banking platforms like Truelayer, mean that it has never been easier, cheaper or faster for Fintechs to issue cards. Now that the rewards on offer have increased substantially, I’m betting on more innovation to come from startups enabled by these infrastructure layers.
The Challenger banks of today are also likely to face a new wave of competition from the next generation of UK Fintechs like Curve or the ever present threat of Big Tech, who are free from the the regulatory capital and compliance burden of being a licenced bank.
If you’re an investor in this space, the more than 5x increase in potential revenue will create plenty of space for new players and enable existing business to monetise previously unprofitable customer segments.
I’m big on travel and big on finance, this is my worlds colliding. I will be following the action closely. Stay tuned.
If you’re thinking about any of this, message me on Linkedin.