What is an issuing bank?
When you process a customer's credit card payment, the transaction moves through multiple financial institutions and systems before the payment ends up in a merchant's bank account. Understanding the transaction process is paramount to understanding credit card transactions, as they are integral in the intricate system behind all payments. These players facilitate everything from online sales to in-person purchases and contribute to aspects like cost, approval and declines, and more.
An issuing bank is a bank that "issues" or provides people with debit and credit cards. You might not have thought about it too deeply, but if you have, you might have assumed a payment card can only be issued by a major credit card network such as Visa or Mastercard, but in fact, these big card brands use a financial institution (think Royal Bank, Chase, Wells Fargo, Scotiabank, etc.) as an intermediary through which to distribute cards. Card brands do not directly issue credit cards to customers because of the risk that a customer could default on their credit balance.
What is an acquiring bank?
Contrary to acquiring banks, which service merchants, issuing banks service cardholders.
An acquiring bank is used by businesses to process credit card payments from customers. This type of bank provides merchants with the ability to accept credit cards and charge customers for the goods and services that they purchase. Merchant acquirer banks also act as mediators between merchants and credit card companies by negotiating transaction fees, terms, conditions, and other important details related to credit card processing. Businesses can either work directly with acquiring banks or through a payment provider who can mediate between the two, and provide other features and services such as payment tools, hardware and software, and increased flexibility on pricing models.
The role of issuing banks in credit card transactions
Issuing banks are given the job of underwriting a potential cardholder's risk and issuing the card to the customer when approved. They take the job of determining appropriate credit limits based on income, credit history, risk, and more. If a cardholder is not able to pay their credit card balance, it is written off by the issuing bank, and it is they, not the card brands, who are responsible for working with the customer to recoup the costs.
Now, why would the issuing bank do this? Is this all for the privilege of giving their customers access to credit card networks? Partially. When it comes to credit card processing, we need to remember that there is a lot of money changing hands, and a single purchase goes far beyond the simple exchange between merchant and customer. Issuing banks, like the card networks and payment processors, get their slice of the payments pie too. In their case, by way of charging credit card interest to customers who don't pay their card balance.
Worldwide, there are more than 100,000 issuing banks providing payment cards to consumers. Their relationship with the card brands is a strategic one, whereby both entities work together to their mutual benefit.
How issuing banks work with card brands
If a card issuing bank issues credit cards to its customers, they will work closely with the credit card networks (Visa, Mastercard) to create a co-branded card as well as the structured reward program that customers can benefit from by using it. The issuing banks and card brands work together closely to ensure their customers are able to use their cards wherever credit cards are accepted and to provide customer service as needed.
Issuing Bank Role & Responsibilities
The issuing bank plays an important role in any given transaction. When a credit or debit card transaction is processed, an approval request gets sent from the merchant's terminal, through the processor and card networks, back to the issuing bank. The issuing bank then checks to see if the cardholder has enough credit on their account for the requested transaction and whether or not any holds are in place on the card. If everything checks out, the issuing bank then sends an approval code back through the card network and processor to the terminal, completing the transaction.
When the merchant later settles the batch, the card network will transfer the funds from the issuing bank to the processor, who will then transfer the funds to the merchant account. Confused yet? It's okay, this process is complicated, but it's all part of one chain reaction to how your customers' money becomes your money.
How do issuing banks make a profit?
Issuer banks make a portion of their bottom line by charging a fee to payment processors and businesses. This fee, known as the interchange fee, compensates the issuing bank for handling credit card purchases, chargeback management, approval of purchased goods, and any credit risk associated with credit card accounts.
This fee is passed on to you as a business accepting credit or debit card payments; however, it is only a part of the cost. Your payment processor will charge you a credit card processing fee which will vary depending on their margins and pricing models. Interchange plus pricing, for example, pass on the direct interchange fee plus a small margin, so you don't pay large markups on lower transaction costs as you might with flat rate pricing.
While issuer banks earn revenue from interchange fees, they predominantly get it from other areas such as annual, late payment, and over-the-limit fees. Additionally, they may receive income from balance transfers between credit cards as well as cash advances and interest on outstanding balances after the grace period has expired. Ultimately, credit card processing fees are a great source of profits for issuer banks in the ever-evolving payments industry.
Issuing banks are an important component of the credit card processing chain. They do a lot of the heavy lifting when it comes to credit card fulfillment, and taking on risk so that people like you and I can have access to a personal credit card. If you want more information on how credit card processing works, check out this article. If you want to learn more about what an acquiring bank is and how they compare to an issuing bank, click here.