Curious how the credit card processing industry works? Here is a crash-course:
Credit Cards are an extremely popular form of payment. They are used everyday to pay bills, purchase items online and in stores, and to pay for all types of services. However, many people do not fully understand how the payments are coordinated between the customers credit cards, banks, and payment processors to allow for the quick and easy payment experience that consumers are accustomed to today.
The Card Brands
So what do Visa and MasterCard do? Visa and MasterCard are credit card networks (often referred to as "Card Brands"). These credit card networks facilitate a system of real-time authorization and fund transfers between merchants (businesses), customers, and their respective banks. The most popular networks in US and Canada are Visa, MasterCard, Discover and American Express.
The Cardholders And Issuiers
The customer who uses a credit card to make purchases is called the "cardholder".
In order to get a credit card, a customer will usually call their local bank and apply for one. It is the customer's bank that is responsible for issuing the credit card. The banks that provide credit cards are called ‘issuing banks’ or ‘issuers’. Some examples of issuing banks including RBC, Bank of America, and TD. There are over 100,000 issuing banks world-wide. These issuers work in partnership with card brands such as Visa, Mastercard and Discover to offer structured rewards and insure that cards follow network rules and will work wherever credit cards are accepted.
There is risk involved for issuing banks when extending credit to cardholders - e.i. if a cardholder is unable to pay their credit card balance, the loan must be written off. This is why issuing banks provide credit cards, and not the card networks themselves.
The Merchants And Processors
Just like cardholders, businesses looking to accept credit cards (called "merchants") do not contact Visa or Mastercard directly. Instead, businesses will signup for a merchant account through a credit card processor. There are many processors available, including Helcim, Moneris, Chase Paymentech, First Data, Global Payments, PayPal and others.
The processor will provide a number of functions to the merchant. First, they will register their business with the various card-networks so that they can accept all the payment types required. The processor will also arrange for the processed funds to be deposited back to the merchant, typically within a few business days. The processor will provide the merchant with the equipment, software or platform needed for them to accept credit cards. Finally, the processor will charge processing fees for their service, and provider customer service to help merchants in need.
American Express (also known as Amex) is another popular credit card brand and network. American Express is unique when compared to Visa and MasterCard, as not only are they a card-brand and card-network, but they are also the card issuing bank and card acquirer. American Express is actually a bank, and therefore can take on cardholders directly and approve their credit risk. Many cardholders, especially businesses, will chose American Express credit cards as they often offer greater rewards and perks. However, this usually means higher processing fees for merchants accepting those cards.
American Express also does not provider equipment or services to merchants looking to accept their cards. Merchants must signup with a credit card processor, just like other card-types.
How Credit Card Transactions Flow Through The Network
The diagram and notes below walk you through a credit card transaction as it flows through the network.
1. A cardholder visits a merchant location and issues their credit card through a payment terminal.
2. The payment terminal communicates with the credit card processor and send information about the transaction. Information includes the credit card details and the amount to be processed.
3. The processor will detects what type of credit card it is, and communicates with the appropriate network (such as Visa).
4. Visa determines the issuing bank (such as Citi Bank) and communicates the transaction to them.
5. The issuing bank ensures that the card is valid, as not been flagged for fraud and that the funds are available. If so, it provides a response back to the network with an APPROVAL CODE.
6. The network responds back to the processor with the approval information.
7. The processor responds back to the merchant's equipment, which then displays the approval message.
8. At the end of the night, the network will transfer the funds from the issuing bank to the processor, which will then transfer the funds to the merchant.
What's amazing about the above is that most transactions go through these steps in less than a second, providing real-time authorizations to merchants accross the world. Visa alone processes thousands of tansactions per second accross its network, serving over 150 millions transactions between cardholders and merchants worldwide every day.