To understand the situation, you have to identify all the players in a credit card transaction and the risk each take.
In a typical credit card transaction, there are usually six participants (Might be less, if say 4 and 5 are the same entity):
1) The Customer
2) The Issuing bank (The bank that backs the credit card the customer uses)
3) The network (Mastercard, VISA, Amex, Discover, etc.)
4) The Payment Processor (Chase Paymentech, etc.)
5) The Acquiring bank (The merchant's bank)
and lastly,
6) The merchant
Everyone sandwiched between the customer and the merchant takes on various risk and each takes a cut of the transaction.
The details are complicated and most of it covered with private business agreements.
Most people think that most of the fees go to VISA, Mastercard, etc. But this is incorrect.
Let's start with the issuing bank. If you have a Chase credit card, the issuing bank would be Chase. In credit card transactions, they usually take most (~60-80%) of the transaction fee. Why? Because they take on the risk of offering the customer a line of credit. The customer could default on payment, the card could be fraudulently used, etc. In addition to taking a big cut of the transaction, they also charge the customer interest on credit not paid back in full.
Next you have the network. They operate the network that binds all the banks together. They also take a cut of the fees.
Next you have the payment processor. They are responsible for verifying and checking payment details received by the merchant from the customer. They might also operate point of sale systems if it is a physical transaction. In either case, they make sure the transaction goes smoothly and the merchant is protected.
So finally, you have the acquiring bank. They are the bank the merchant uses to get paid. They also get a cut of the fees. Why? Because they take on the risk of the merchant's business. If charge backs happen often enough, the acquiring bank is fined by the network. This fine usually gets passed to the merchant by the acquiring bank, as in the case here.
So generally, the interest the customer pays goes to the issuing bank, the transaction fee is paid by the merchant, which is usually split between four entities, with the issuing bank taking the by far the biggest cut.
So why is this complicated system needed?
Simply because banks don't trust its customers and banks don't trust other banks. Everyone takes on risk and demands to be compensated for it. Think of all the thousands of banks in the world. They all do business differently, and they might not trust each other. The network provides the glue that binds them together, and the fees allows banks to take on the risk of doing business.
What about alternatives?
What if you want to cut out the middlemen? What if the merchant wants to deal with the customer directly? If you are a bigger company, this is indeed possible with 'store cards'. You are basically providing line of credit directly to the customer.
Yes, you skip paying fees to the banks and the network. However, you take on the big risk of providing customer credit. They can default, credit be used fraudulently, etc. Additionally, you would need underwriters to do credit checks on potential clients. This both impacts the customer's credit score and extra hoop to jump to purchase something on credit. Since the transaction fee is transparent to the customer for credit card transactions, you would need to provide incentive to the customer to jump through the hoop. This is usually done through attractive financing terms, gifts, rewards etc.
What about debit cards? There's still fees to the merchant because there is still risk involved in the process. Yes, the customer is not buying on credit, but all other risks are still present. Additionally, there is also infrastructure cost that must be compensated. From the merchant point of view, if customers are restricted by how much money they have presently, they might be less likely to make a purchase, resulting in lost sale.
So what about cash? That's surely perfect, right? No transaction fees?
This is not entirely true. If you operate a large retail company, you have tens and hundreds of stores that end up with thousands of dollars of cash at the end of the day. Where does the cash go? How does it get to the bank? For larger businesses, this usually means hiring a security company to transport the money. This results in significant cost to your business just to handle cash.
But what about small businesses that handles small amount of cash themselves? You still risk losing or getting the cash stolen, not to mention the possibility of the cash being counterfeit.
Lastly, cash is hard to use as a currency online.
Now i feel like i am mumbling and might have made some mistakes. In no way am i defending banks and various financial institutions, all i want to say is that handling payment is risky and hard and the existing infrastructure and fees for a reason.
Could it be better? Absolutely.
You can, and many people do, live a no-credit-card lifestyle. Need something from an online store? Amazon and other retailers offer store accounts with direct billing (search for "Amazon.com Store Card") and more favorable terms.
If you find the practice shady, you as a customer can choose not to use a credit card. Use a debit card, or just pay cash. The problem is that customers like credit cards: it lets you buy stuff now!
Merchants would lose business if they didn't accept cards, and card companies were basically able to squeeze them until such loss of business was barely more painful than just going through with it.
A slight market correction came in the form of competition between card companies to give cash-back deals. This essentially rebated some of the fee back to the consumer (if an Ayn Rand nutjob saw a government bureaucratic scheme half as complex they would explode with anger).
People with cash couldn't opt out; they still had to pay the same as card users, but now those merchant agreements have been restricted by law.
Typically only in states that had their own law enforcing that restriction on merchant agreements.
In my opinion, every credit card should have an e-paper tag on it with a 6 digit code that changes once every 10 minutes or so (to reduce power requirements). Code should be required for all in person and online transactions.
However, since they make money off fraud, they have no incentive to reduce it.
2) People love credit cards and buying shit they can't afford.
I know that Dwolla is trying to get into this by allowing transactions directly from bank accounts (no credit) with very low fees ($0.25/transaction).
Their FiSync product is vaporware. They won't give out the documentation. Veridian, whose system they're already specially linked to, is the only user.
Actually, I like the abstraction layer. I don't even have the ability to carry a balance on my credit card: every month, the balance is due in full. In exchange, I'm spending the bank's money, so if there's a problem, it's their money that's gone, and they pay their lawyers to get it back. (And I get "rewards", but I know I'm just paying for those myself.)
Interestingly, I use my brokerage for checking, and they let me write checks to borrow against the securities in my account. So checks can be borrowing money, and credit cards might not be. Some people might like borrowing money, but I like credit cards because they are very convenient and easy to use.
Also, although the gains are pretty trivial, I find it satisfying to leverage the grace period.
This is a HUGE problem. The oligopoly that runs banking now is never going to innovate in certain ways because its contrary to their profit incentive, because they have no competitors willing to implement better feature sets (because newcomers are basically disallowed).
Our currency is hard linked to banking processes. There are some things that are nearly impossible to extract even if we do get competition going (which won't happen).
The only way out of this is something like Bitcoin and/or total collapse of today's banking system.