It isn’t necessary to have intimate knowledge of the inner-workings of the bankcard system in order to find the best credit card processor. But, it’s a good idea to have a general understanding of how credit card processing works because fees are incurred at various stages of the system.
Knowing the lay of the land will help you to isolate areas of possible savings. Once you’re done reading this article, check out our more detailed breakdown of where credit card processing fees come from. For now, let’s dive in to how credit card processing works.
The bankcard networks that ferry billions of transactions between merchants, processors and banks are truly modern marvels. In just a matter of seconds, your terminal passes transaction information to a processor, and then through the card network to the issuing bank for approval. The issuing bank then sends an authorization back through the card network to your processor before it finally ends up back at your terminal or software.
As involved as the system sounds, obtaining an authorization for a transaction is just the first step. Authorizations must be settled before sales can be deposited into your business’s bank account. Credit card transaction happen in a two-stage process consisting of authorization and settlement. This is important because different fees are incurred at each stage, and a failure (or partial failure) in either step can result in increased costs and/or credit card sales not being deposited.
How Credit Card Processing Works: Key Players
Let’s take a look at each of the key players involved in authorizing and settling a credit card transaction, and then we’ll move on to examine each process individually in more detail. The key players involved in authorization and settlement are the cardholder, the merchant (business), the acquiring bank (the merchant’s bank), the issuing bank (the cardholder’s bank), and the card associations (Visa and MasterCard.)
Cardholder
If you have a credit or debit card (as most of us do), you’re already familiar with the role of the cardholder. But just to be thorough — a cardholder is someone who obtains a bankcard (credit or debit) from a card issuing bank. They then present that card to merchants as payment for goods or services.
Merchant
Technically, a merchant is any business that sells goods or services. But, only merchants that accept cards as a form of payment are pertinent to our explanation. So with that said, a merchant is any business that maintains a merchant account that enables them to accept credit or debit cards as payment from customers (cardholders) for goods or services provided.
Acquiring Bank (Merchant’s Bank)
An acquiring bank is a registered member of the card associations (Visa and MasterCard). An acquiring bank is often referred to as a merchant bank because they contract with merchants to create and maintain accounts (called merchant accounts) that allow the business to accept credit and debit cards. Acquiring banks provide merchants with equipment and software to accept cards and handle customer service and other necessary aspects involved in card acceptance. The acquiring bank also deposits funds from credit card sales into a merchant’s account.
Interestingly enough, many merchants don’t recognize their acquiring bank as the primary provider of their merchant account. Acquiring banks are playing an increasingly hands-off role as the bankcard system evolves. Acquiring banks often enlist the help of third-party independent sales organizations (ISO) and membership service providers (MSP) to conduct and monitor the day-to-day activities of their merchant accounts.
Issuing Bank (Cardholder Bank)
As you’ve probably guessed, an issuing bank issues credit cards to consumers. The issuing bank is also a member of the card associations (Visa and MasterCard).
Issuing banks pay acquiring banks for purchases that their cardholders make. It is then the cardholder’s responsibility to repay their issuing bank under the terms of their credit card agreement.
Card Associations (Visa and MasterCard)
Visa and MasterCard aren’t banks and they don’t issue credit cards or merchant accounts. Instead, they act as a custodian and clearing house for their respective card brand. They also function as the governing body of a community of financial institutions, ISOs and MSPs that work together in association to support credit card processing and electronic payments. Hence the name, “card associations.”
The primary responsibilities of the Card Association are to govern the members of their associations, including interchange fees interchange fees and qualification guidelines, act as the arbiter between issuing and acquiring banks, maintain and improve the card network and their brand, and, of course, make a profit. That last one has become even more important now that Visa and MasterCard are public companies.
Visa uses their Visanet network to transmit data between association members, and MasterCard uses their Banknet network.
· Credit card authorization
· Cardholder
· Merchant
· Acquirer
· Card Network
· Issuer
· Card Network
· Merchant
Cardholder
A cardholder begins a credit card transaction by presenting his or her card to a merchant as payment for goods or services.
Merchant
The merchant uses their credit card machine, software or gateway to transmit the cardholder’s information and the details of the transaction to their acquiring bank, or the bank’s processor.
Acquirer
The acquiring bank (or its processor) captures the transaction information and routes it through the appropriate card network to the cardholder’s issuing bank to be approved or declined.
Visa / MasterCard Network
MasterCard transaction information is routed between issuing and acquiring banks through MasterCard’s Banknet network. Visa transactions are routed through Visa’s VisaNet network.
Issuer
The credit card issuer receives the transaction information from the acquiring bank (or its processor) through Banknet or VisaNet and responds by approving or declining the transaction after checking to ensure, among other things, that the transaction information is valid, the cardholder has sufficient balance to make the purchase and that the account is in good standing.
Visa / MasterCard Network
The card issuer sends a response code back through the appropriate network to the acquiring bank (or its processor).
Merchant
The response code reaches the merchant’s terminal, software or gateway and is stored in a batch file awaiting settlement
Credit card clearing and settlement
· Merchant
· Acquirer
· Card Network
· Issuer
· Cardholder
Merchant
A merchant begins the settlement process by sending their batch of approved authorizations to their acquiring bank (or the bank’s processor). Authorization batches are typically sent at the close of each business day.
Acquirer
The acquiring bank (or its processor) reconciles and transmits the batch of authorizations through interchange via the appropriate card association’s network (VisaNet or Banknet).
The acquiring bank also deposits funds from sales into the merchant’s account via the automated clearinghouse (ACH) and debits its merchant’s account for processing fees either monthly, daily or both depending on the merchant’s processing agreement.
Card Network
The card association debits the issuing bank’s account and credits the acquiring bank’s account for the net amount of the authorizations which is gross receipts less interchange and network fees.
Issuer
The card issuing bank essentially pays the acquiring bank for its cardholder’s purchases.
Cardholder
The cardholder is responsible for repaying his or her issuing bank for the purchase and any accrued interest and fees associate with the card agreement.