Rewards on a credit card are not a gift from the issuer. They are a share of a fee collected from merchants on every transaction, redistributed to cardholders.
Four parties sit behind each swipe
A card payment involves the cardholder's issuing bank, the merchant's acquiring bank, the card network that routes the message, and the merchant itself.
The acquirer pays the issuer a fee, called interchange, out of the transaction amount. The merchant receives the remainder and the network charges its own smaller assessment.
The merchant therefore bears the cost, embedded in a total charge often described as the merchant discount rate, which also covers the acquirer's own margin.
Interchange varies by card and transaction type
Networks publish schedules with many categories. Premium rewards cards carry higher interchange than basic cards, and commercial cards higher still.
Transaction context matters too. Card-present payments with a chip generally attract lower rates than online transactions, reflecting differences in fraud risk.
Merchant category also affects the rate, with grocery, fuel and some other sectors negotiated or regulated at lower levels than general retail.
The reward is a share of that fee
An issuer receiving a higher interchange rate can afford to return more of it to the cardholder while still covering fraud losses, servicing costs and funding.
This is why the most generous rewards sit on cards with high annual fees and strict eligibility. Those cards generate the interchange that pays for the benefits.
It also explains why reward rates fall when interchange is capped by regulation. The pool the benefits were drawn from has shrunk.
Merchants respond in visible ways
Some merchants set minimum transaction amounts for card payments, since a fixed component of the fee makes very small payments uneconomic to accept.
Others apply surcharges where permitted, or steer customers towards debit and bank transfer options that carry lower costs.
Where surcharging is prohibited or impractical, the cost is spread across prices generally, which means it is borne partly by customers who pay in cash.
Why the model is under pressure
Regulators in several jurisdictions have capped interchange on consumer debit and credit cards, arguing that the fee is set collectively rather than competitively.
Account-to-account payment systems bypass the card networks entirely and carry far lower costs, which gives merchants an alternative they previously lacked.
As those alternatives grow, the funding available for rewards narrows, and the economics that made generous cashback possible become harder to sustain.