Card rewards look like a gift from the issuer, and they are funded by a fee taken out of every transaction before the merchant is paid. Following that money explains most of how the industry behaves.
Every card payment splits the sale
When a card is used, the merchant does not receive the full ticket price. A deduction is taken as the payment moves through the processing chain, and the largest component of it goes to the card issuer.
That component is the interchange fee, set by the card network and paid by the merchant's payment provider to the bank that issued the card.
The issuer therefore earns from every purchase whether or not the cardholder ever pays interest, which is the foundation of the rewards model.
Reward generosity tracks the fee, not the customer
Interchange is not a single number. It varies by card type, with premium products carrying materially higher rates than basic ones.
An issuer offering a rich rewards programme is distributing part of a larger fee, which is why the most generous cards are those merchants pay the most to accept.
This also explains eligibility rules, since a card must reach customers who spend heavily enough for the fee income to exceed the rewards paid out.
Merchants recover the cost in prices
Acceptance costs are an ordinary business expense, and businesses set prices to cover their expenses. The fee is therefore spread across the price list.
Because most merchants charge the same price regardless of payment method, customers paying cash or by low-cost transfer contribute to the same recovery.
The effect is a transfer from customers who do not hold rewards cards toward those who do, which is why the arrangement attracts regulatory attention.
Network rules historically prevented steering
Card networks long required merchants accepting one card to accept all cards from that network, and restricted surcharging or discounting by payment method.
Those rules kept the cost invisible at the till, which prevented customers from seeing that one payment method cost the merchant far more than another.
Legal challenges and regulation have loosened these restrictions in several jurisdictions, and where surcharging is permitted the difference becomes visible immediately.
Caps change product design quickly
Where authorities have capped interchange, the funding available for rewards falls, and issuers respond by trimming programmes or moving revenue to annual charges.
The cost does not disappear; it shifts from a merchant fee toward something the cardholder pays directly, which makes it visible rather than embedded.
Rules on interchange, surcharging and disclosure differ by jurisdiction and change over time, which is why the same card product behaves quite differently across markets.