As globetrotting consumers in the modern era, we have a lot of tools to help us transfer and exchange money for use in foreign countries. Each method comes with its own benefit, and can be utilized in different scenarios. While it’s getting more convenient to conduct these international transactions, the ease of doing so sometimes masks the complexities in the systems of moving money across borders and the costs associated with it.
To become savvy consumers, we should be aware of not only the fees that we are being charged for these service, but also what these fees buy us, so we can judge if the costs are worth the convenience. Therefore, in this new series of “International Transaction 101”, I aim to open the “black box” that exists between our bank accounts and us, and explore the system and underlying cost associated with different types of international transactions. Hopefully this will give you a new understanding of why you are paying the fees, and how you can avoid them.
So for the part one of this series, let’s talk about credit cards.
Credit card has become one of the easiest ways for you to transact in a foreign country because it bypasses the cash exchange. As long as the store accepts VISA, MasterCard, or American Express, you can make purchases in a foreign country without worrying about bringing cash or exchanging money. It is especially helpful when you first move to a country, before you have the credentials to open a local bank account or to earn paychecks in local currency.
Of course, such convenience comes with cost. Or more specifically, the companies behind these transactions need to maintain an infrastructure and network to facilitate the movement of money, and on top of that earn a profit. The following graph illustrates this network and who gets charge what in the process.
Before any transaction has been made, the bank that issues your card and the acquirers that connect the merchants need to pay a fee to participate in the VISA or MasterCard networks. The merchant also has to pay merchant service provider to have access to the VISA and MasterCard networks and collect payments. This structure is the same whether you are using your card in the US or in another country.
(In the following example, I’ll use VISA as the payment network provider. If you have American Express or Discovery Card, it acts as the card issuer, network provider, and acquirer, which means that the fees you pay go entirely to the card companies. In some instances, it is possible that acquiring bank and card issuing bank are the same, and the bank could bypass the independent payment network. However, this happens mostly in domestic transactions.)
While you are in a foreign country, VISA’s global network enables you to go through its system as well. The only difference is that VISA exchanges the foreign currency into US dollar using its daily-updated exchange rate table, and charges your card issuer a small fee (usually 1%) for it. Your card issuer may choose to use the exchange rate from VISA and absorb the fee, charge you the fee, or add another international transaction fee on top of the 1% as a way to recuperate some of the cost from participating in VISA network. (This is the reason why more cards with annual fee may offer zero international transaction fees, because you already pay for the service. Even though the card issuers may charge an international fee, there is no additional cost that makes international transaction with VISA more expensive than domestic ones, except the 1% International Service Assessment.)
For example, if you bought a 75 Euro ticket in Germany on your Bank of America VISA Card, the merchant would go through its service provider to charge you 75 Euros. Assuming the exchange rate is 1:0.75, VISA will ask Bank of America to authorize $100 USD plus $1 transaction fee. Instead of posting the $100 and the $1 transaction separately on your account, Bank of America may add another 2% transaction fee, and simply post $103 for this purchase on your statement.
You may wonder, if your card issuer has to pay VISA to participate, and you have card with no fees, then how does the card issuer make money? The answer is from the merchant. In addition to a service fee, the merchant also has to pay a per transaction fee to accept your VISA payment. This per transaction fee includes a fixed acquirer fee charged by VISA to the acquirers and a transaction fee that is split between the issuing bank and the acquirer. Using the previous example, the merchant in Germany would only receive 73 Euro from its service provider, even though you paid 75.
In the US, the merchants usually just absorb the credit card transaction fees. However, in many countries it is conventional for merchants to charge you more if you pay with credit card, precisely because this extra cost to them. Another common way to deter you from paying with credit card is offering a “discount” if you pay with cash. This may become a hidden cost to you in a foreign country, even though credit card is accepted.
Lastly, you may be offered a service when using your US-based credit card in another country called “Dynamic Currency Conversion (DCC).” Using the example above, if the merchant in Germany offers DCC, on the card swiping console there will be a prompt asking you if you want to pay $105 USD instead of 75 Euros. Without keeping track of daily exchange rate, you may be tempted to choose this option.
As a matter of fact, using DCC is almost always more expensive than opting out. DCC is a value-added service offered by the local service provider and acquirer, and they would like to be compensated for it, usually from a small percentage of commission plus using the less favorable retail exchange rate. VISA and your card issuer have no share in this profit so you most likely will not be able to contest the additional charge with them if you proactively chose to pay in USD. Therefore, make sure you always decline the option to pay in US dollars in a foreign country.
In summary, paying with credit card overseas is most beneficial when most places take them, when merchants don’t charge you extra to use it, and when you don’t pay the “artificial” international transaction fee to your US card issuer. You can find a card without international transaction fee here. If you can find a card that absorbs the 1% International Service Assessment, even better! Another benefit of using credit card is that due to large volume of international transactions, the financial institutions involved use wholesale currency exchange rate, which is usually more favorable then what you can get from walking into a bank with paper cash.
One more caution, however, the modern fraud prevention technology is so powerful that your card issuers can often identify legitimate overseas transactions as “suspicious activities”, and sometimes cut off your card without your knowledge because they couldn’t reach you on a US phone number. This happened to us even after we’ve used our card everyday in the same foreign country for a year. Make sure you notify your card issuer that you will be using your card in certain countries, and always have a back up credit card.
Another good back up plan is to have a debit card that can both act as ATM card and can access VISA network. After all, there are still a lot of countries that you might move to where cash is still the dominant form of transaction. In the next post I will cover the ways and costs involved to get cash in another country.
What is the diffrence between clearing, settlement and reconciliation of Visa and MasterCard? What this operations means in practice?
Sorry for the late reply. Was on a long trip out of town. In short, clearing is information exchange: making sure you have enough credit limit to pay; settlement is when the parties involved actually debit and credit their accounts. Clearing happens at point of sales so you can have a quick transaction; settlement can happen later, sometimes at the end of the day so the parties can aggregate their account balance. Reconciliation is conducted after the settlement has occurred to verify that the funds have actually been moved as detailed in the settlement data. Read page 14 of this document for more information on clearing and settlement, and this for reconciliation.