How Credit Card Processing Works

visualizing credit card processing with a pipeline

Though it all happens in a flash, the tap of your credit card on the screen of a card terminal is more than a simple beep. In reality, credit card processing is one of the most complex networks of interdependence on the planet. There are a lot of stakeholders in the credit card transaction process, all of which have a reason to benefit from the use of the card network.

Key Players in Credit Card Processing:

Cardholder – the customer or owner of the credit card using the network to make purchases.
Merchant – the business owner with a card terminal or ability to accept credit card payments online.
Acquiring Bank – the “merchant bank” which settles & distributes credit card payments to business owners.
Issuing Bank – these are the banks with which we are all familiar, who supply us with credit cards to use.
Payment Processor – often the go-between for merchants and the acquiring bank, payment processors facilitate credit card transactions.
The Card Brands – Visa, Mastercard, Amex are all examples of card brands that allow payments to be processed via their card network.

The Credit Card Processing Cycle (from Cardholder to Settlement)

Authorization

1. A cardholder visits a merchant location and uses their credit card to make a purchase by tapping, inserting, or swiping it through a payment terminal.

2. The payment terminal communicates with the credit card processor (or acquirer in the instance where the acquiring institution fulfills both roles) and sends information about the transaction. Information includes the credit card details, cardholder information, and the amount being processed.

3. The processor will detect what type of credit card it is and communicates with the appropriate network (i.e. Visa).

Authentication

4. Visa determines the issuing bank (e.g. Citi Bank) and communicates the transaction to them.

5. The issuing bank ensures that the card is valid, has 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 sends a message back to the merchant’s equipment, which then displays the approval message.

Settlement

8. At the end of the night, the network will transfer the funds from the cardholder’s issuing bank to the processor or acquirer, which will then transfer the funds to the merchant.

Credit Card Processing Costs

As mentioned above, all of the players in the credit card processing chain have a reason to benefit from the passing of funds via credit card from customer to merchant. Customers want credit or they want rewards (and of course to shop online and have a convenient way to pay in person), merchants want to make it as easy as possible for people to pay (even when they haven’t got ‘cash in hand’). Issuing banks want to loan money at interest because that’s how they make money, and acquiring banks and processors take their cut of the transaction cost in exchange for giving merchants access to the card networks. Finally, the card brands themselves benefit most from this arrangement, as the more people that use credit cards, the more they can earn too.

So, when it comes to calculating the costs of accepting credit cards, we need to think of everyone that’s involved in a transaction and the fees associated with an electronic purchase. The most important of these is the interchange fee, which comprises the bulk of credit card processing costs for merchants. This is the fee set by the card brands to offset the risk of customers defaulting on their credit, or the risk of a fraudulent transaction. (This fee is also part of what helps pay for rewards programs for cardholders).Other fees include the card brand fee, and the processing fee, both of which are usually a percentage of the total transaction cost.

Final Thoughts

Credit card processing is more than just tapping some plastic to pay. It’s an intricate patchwork of organizations and stakeholders who all work together to make money move. The credit card network is really a wonder of the modern world, bringing buying power to everyone and giving businesses the ability to get paid instantly, from anywhere in the world.

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