This paper describes the structure of the debit card payment system in Canada.(1) It also outlines the history of the Interac Association and explains the cost to merchants of debit card transactions. It briefly discusses the entrance of MasterCard’s Maestro debit card and the possible entry of Visa into the Canadian debit card market, and makes some comparisons between the Canadian and US debit card systems. A glossary of relevant terms is provided.
The Four-Party Debit Card Model
In Canada, point-of-sale debit card transactions are structured in accordance with what is known as the four-party model,(2) the parties being the cardholder, the merchant (or service provider), the card issuer and the payment processor (or acquirer). A fifth participant is the Interac Association, which provides a network for debit card payments in this country. This section describes how debit card payments are made and details the fees associated with debit card transactions.(3)
To begin a debit card transaction, the cardholder who wishes to purchase goods and/or services presents the merchant with his or her debit card. The merchant sends the cardholder’s debit card transaction information to the payment processor, which forwards it through the Interac Association’s network to the card issuer for payment authorization.(4) Once the payment has been authorized, the merchant charges the purchase to the debit card and provides the goods and/or services to the cardholder. The funds for the purchase are withdrawn from the debit cardholder’s account by the card issuer and are transferred to the payment processor. The payment processor then forwards payment for the purchase to the merchant. These transfers of information and of funds are illustrated in Figure 1.
Figure 1 – The Four-Party Debit Card Model
Source: Adapted by the author from Pacheco and Sullivan (2006), p. 92.
Fees are incurred at various points in the debit card transaction. An interchange fee is a set amount per transaction and/or a certain percentage of the purchase value retained by a card issuer when it settles the bill with a merchant’s payment processor on behalf of a cardholder. In Canada, because the interchange fee for point-of-sale debit card transactions through the Interac Association’s network is zero, the payment processor receives the full value of the purchase from the card issuer. However, in this process, the card issuer transfers information through the Interac Association’s network; for this service the card issuer pays a switch fee, currently $0.008253, to the Interac Association.(5) In the case of shared cash-dispensing services, an interchange fee of $0.75 per transaction is transferred by the card issuer to the ATM operator, often a bank or a white-label ATM provider.(6) This cash-dispensing service interchange fee is designed to promote and pay for the proliferation of ATMs.
The card issuer may charge a transaction fee and/or monthly fee to the cardholder to cover the cost of providing account services, including shared cash-dispensing (automatic teller machine) and point-of-sale debit card transaction services, as well as online, telephone and in-person account and transaction services.(7) In 2004, the typical transaction fee paid by debit cardholders to card issuers in Canada ranged from $0.50 to $0.60 per transaction; however, a number of cardholders paid neither a transaction nor a monthly fee for debit transactions.(8)
When the payment processor deposits the value of the transaction in the merchant’s account, an amount known as the merchant discount fee is withheld.(9) This merchant discount fee covers the payment processor’s fixed costs (such as the capital investment), variable costs (such as the rental cost of the point-of-sale terminal, labour and transaction costs, including the switch fee) and the processor’s profit margin. Much like the card issuer, the payment processor pays the Interac Association a switch fee, currently $0.008253, to transfer information through its network. In 2006, the median merchant discount fee paid by merchants to the payment processor for each debit transaction was $0.12.(10)
The Interac Association receives its income from switch fees, which are paid by the card issuer and the payment processor for each transaction. The switch fee, which is set at the estimated cost-recovery level, is currently $0.008253 per transaction; since the fee is paid by both the payment processor and the card issuer for every point-of-sale transaction, the total switch fee is $0.016506 per debit transaction.(11)
The Interac Association
The Interac Association, a not-for-profit national payment network, operates exclusively in Canada(12) and is essentially the sole provider of domestic debit card network services in this country.(13) It has a relatively broad membership and is open to new members. The payment processors and card issuers that access the Interac Association network compete for merchant acceptance and cardholders respectively.
The Interac Association was founded in 1984.(14) In 1986, the Interac Association’s nine Canadian financial institutions joined together to provide shared cash-dispensing (automated teller machine, or ATM) services. In 1988, Association members agreed also to provide point-of-sale services so that cardholders could purchase goods or services directly from a merchant with their debit card through the Interac Association network; that service became available nationally in 1994.(15)
In July 1992, the Competition Bureau initiated an inquiry to examine the allegation “that the charter members of the Interac Association, as a matter of joint dominance, engaged in three broad categories of anti-competitive acts, namely restricting access to the network, creating barriers to product innovation, and controlling access and service pricing.”(16)
In 1996, the Competition Tribunal issued a Consent Order against the nine respondents.(17) The intent of the Consent Order was to liberalize access to membership in the Interac Association as well as to eliminate price and innovation restraints.(18) Since then, the Interac Association has generated revenue almost entirely from the switch fee, which must be set at the cost-recovery level.(19) In 2005, the Competition Tribunal announced that the Interac Association would be allowed to impose a minimum annual fee on its members.(20)
Following the implementation of the Consent Order in 1996, the Interac Association’s membership restrictions were relaxed. At that time, the Association had 27 members; as at 30 March 2009, it had 62 members, including a number of non-financial institutions.(21) However, debit card issuance has remained “limited to financial institutions that [are] eligible for membership in the [Canadian Payments Association].”(22)
Currently, the Interac Association is discussing its Consent Order, later renamed the Consent Agreement, with the Competition Bureau. The Deputy Commissioner of Competition in the Civil Matters Branch at the Competition Bureau has stated that “Interac has decided to seek the bureau’s consent before it files an application with the Competition Tribunal to be allowed to restructure from a not-for-profit association to a for-profit entity.”(23) Should Interac become a for-profit entity, its governance structure would change and Interac’s management could set its switch and interchange fees.
Merchant Cost of Interac Transactions
According to the Bank of Canada, in 2006, the median merchant discount fee paid by merchants for each debit card transaction was $0.12.(24) These fees cover the cost of the payment processor’s switch fee paid to the Interac Association (which is the same for all processors) as well as other debit card service costs incurred by payment processors, including the rental cost of the terminal, customer service costs as well as the profit margin.
In 2006, the Interac Association processed approximately 3.29 billion debit card transactions.(25) Using a median merchant discount fee of $0.12 per transaction and subject to certain assumptions, the total estimated merchant cost for these transactions in the 2006 calendar year can be estimated at approximately $395 million.(26) Because point-of-sale debit card transactions on the Interac Association’s network do not incur an interchange fee, none of the revenue from the merchant discount fees related to debit card transactions is transferred to the card issuer. As a basis for comparison, and subject to certain assumptions, in the fiscal year ending 31 October 2006, the estimated merchant cost of credit card transactions was approximately $4.3 billion.(27)
Visa and MasterCard Debit Cards in Canada
Although Visa debit cards have not been issued in Canada, Visa has published its debit card interchange rates, effective as of 28 May 2009; unlike the interchange fee of zero set by the Interac Association, interchange rates for each Visa debit transaction will range from 0.15% of the transaction value plus $0.05 per transaction for grocery store or gas station purchases, to 1.15% of the transaction value for transactions that take place without the presence of the debit card (such as online purchases).(28) Visa has not published the switch or network access fees that would be paid by card issuers and payment processors on Visa debit transactions.
MasterCard reported that it has already entered the Canadian debit card network market. MasterCard’s Maestro debit card incurs a network access or switch fee of $0.005 per transaction, which is paid to MasterCard by both the card issuer and the payment processor – there is no associated interchange fee.(29)
The Debit Card Market in the United States
In the United States, several debit card networks compete for card issuers and payment processors. There are two categories of debit card networks: (1) networks using PIN (personal identification number) debit cards, of which there were 13 in 2006 (including Interlink, Star, Pulse and NYCE); and (2) networks using signature debit cards, of which there are two (Visa and MasterCard).(30) In 2003, Dove Consulting found that the average interchange fee in the United States was US$0.19 per transaction for PIN debit cards and US$0.38 per transaction for signature debit cards.(31) Between 1998 and 2003, the average interchange fee for PIN debit card transactions in the United States increased from US$0.08 to US$0.19.(32) The average switch fee(33) is also higher in the United States than in Canada; it ranged from US$0.03 to US$0.06 per transaction in 2004.(34) However, because card issuers generate revenue from interchange fees, many cardholders may not be charged for debit card transactions.(35)
||Uses the debit card to make point-of-sale purchases; the funds to cover those purchases are withdrawn from the cardholder’s account once the card issuer has given authorization.
||Issues debit cards to the cardholder, debits his or her account and settles point-of-sale debit card transactions with the merchant’s payment processor. It pays a switch fee to the Interac Association. The card issuer is generally a bank or credit union.
||At present, a not-for-profit organization that operates Canada’s debit card network. Its membership sets the interchange fees for transactions processed through its network. The switch fee is set at the cost-recovery level.
||A portion of the debit card transaction retained by the card issuer when it pays the payment processor. It is set by the debit card network, in this case the Interac Association.
||Accepts the debit card as payment from the cardholder and receives debit card processing services from the payment processor, for which the merchant discount fee is paid.
|Merchant Discount Fee
||At present, a flat per-transaction fee paid by the merchant to the payment processor for the services it provides to the merchant; it includes the cost of the payment processor’s switch fee.
||Transmits information and payment between the card issuer and the merchant to which it provides debit card processing services and charges the merchant discount fee. It pays a switch fee to the Interac Association. Payment processors include Chase Paymentech, Desjardins Group, First Data, Global Payments, Moneris Solutions, Peoples Trust, and TD Merchant Services.
||A flat per-transaction network access fee (currently $0.008253) paid by the payment processor and by the card issuer to the Interac Association to cover its costs for debit card transactions.
† Library of Parliament Background Papers provide in-depth studies of policy issues. They feature historical background, current information and references, and many anticipate the emergence of the issues they examine. They are prepared by the Parliamentary Information and Research Service, which carries out research for and provides information and analysis to parliamentarians and Senate and House of Commons committees and parliamentary associations in an objective, impartial manner. [ Return to text ]