HOW DOES CREDIT CARD PROCESSING WORK?
When you make a purchase with your credit card and complete a transaction, you are normally on your way in seconds. Today is all about supper persuasion. But what happens behind the scenes? When a cardholder makes a purchase by swiping their card or entering their information online, credit card processing happens quickly before the transaction is accepted. The processing involves the cardholder, the merchant, the acquiring bank, the issuing bank, and the card network.
When swiping, inserting, or tapping the card to start the procedure, the cardholder plays the initial part in credit card processing. The cardholder additionally pays the card issuer for the purchase when the monthly statement arrives. However, because the merchant must set up a point-of-sale system offered by the acquiring bank or a merchant service firm, the merchant is more involved in card processing. Because the acquiring bank generally charges fees for each transaction, some merchants set minimum purchase quantities when customers pay with a credit card.
What Is Credit Card Processing?
When a customer swipes a credit card, various behind-the-scenes processes take place in a matter of seconds. A transaction process begins when a cardholder enters, swipes, inserts, or taps a credit card. When the transaction says “authorized” or “declined,” the processing is finished.
Credit card processing involves a number of parties:
- Cardholder: Swipes, inserts a chip card, taps a tap-to-pay card, or types a card number into an online payment portal.
- Merchant: Any retailer or seller that sells goods and services is referred to as a merchant. Customers swipe their cards and pay processing fees to the bank or card company using a card machine provided by the merchant.
- Acquiring Bank: The card and transaction information are sent to the card network by the acquiring bank (or merchant bank). The acquiring bank may also offer the merchant with credit card processing equipment as well as a merchant account through which to receive cash.
- Card Network: A card network (such as Visa or Mastercard) serves as a link between acquiring and issuing banks. It exchanges data and establishes any fees or standards between the acquiring bank, issuing bank, and merchant.
- Issuing Bank: The issuing bank is the one that gave the cardholder the credit card. It authorizes card information, pays the acquiring bank, and bills the cardholder on a monthly basis for each transaction.
How Does Credit Card Processing Work?
Several tiny steps are conducted via an internet or phone line connection in the few seconds it takes for a credit card transaction to be approved or rejected. Credit card processing is divided into two stages: authorization and settlement.
The issuing bank must first verify and validate the card details and purchase amount. This occurs in the few seconds it takes for a credit card to be authorized or rejected for a customer. After a cardholder swipes or enters a card, the message frequently appears on the card machine.
- Step 1: To make a transaction, the cardholder swipes, taps, or inserts their card into a merchant’s card machine. (Or, if ordering online, enters a credit card number.)
- Step 2: The acquiring bank (or merchant bank) receives the card information and transaction details from the merchant’s credit card terminal through the internet or phone line.
- Step 3: The information is received by the acquiring bank, which then sends it to the relevant card network (Visa, Mastercard, Discover or American Express).
- Step 4: The information is routed to the cardholder’s issuing bank by the card network.
- Step 5: Once the information is received, the issuing bank verifies the card details (such as the card number and CVV code) to ensure the transaction is not fraudulent. The bank also confirms that the cardholder is in good standing and has sufficient credit available to cover the purchase (or has sufficient funds to cover the transaction if using a debit card).
- Step 6: The issuer sends the acquiring bank a response via the card network.
- Step 7: The merchant’s credit card machine or terminal receives the response. The transaction will be accepted if all of the credentials in Step 5 are correct. Otherwise, the system will display a warning such as “denied.” The cardholder sees this information right away and completes the transaction, while the merchant’s system saves the response code for stage two processing.
Depending on whether the transaction takes place in-store or online, the process may differ slightly. Traditionally, merchants open a merchant account with an acquiring bank and link the account to the point-of-sale system. Merchant service firms such as Square allow merchants to open accounts. As a result, merchants are no longer required to have a direct partnership with an acquiring bank.
Settlement is the second stage of credit card processing, and it takes place between the merchant, the acquiring bank, the card network, and the issuing bank. This procedure necessitates a lot of back-and-forth to debit and credit money from one party to another (including processing fees charged to the merchant).
Each credit card authorization is saved in the point-of-sale system of the merchant. A merchant typically sends a batch of authorizations to the acquiring bank at the conclusion of the business day. The acquiring bank will then confirm each authorization and transfer the batch to the relevant issuing bank via the card network. The payments owing to the merchant will also be deposited into the merchant account by the acquiring bank (minus any processing fees).
The card network is used to pay the issuing bank to the acquiring bank. The card network debits the issuing bank and credits the acquiring bank for each transaction, basically functioning as a middleman between the two.
If a cardholder monitors his or her spending activities online on a regular basis, he or she may see that a recent transaction has moved from “pending” to “posted” status on the account. As the merchant settles sales with the other parties, this normally takes one to three business days. According to the card agreement, the cardholder pays the issuing bank what he or she owes for each purchase, plus any fees or interest accrued.
Why Do You Need to Know About Credit Card Processing?
While cardholders do not need to know every detail of credit card processing, it is beneficial to grasp what happens behind the scenes in order to better comprehend what could go wrong.
For each credit card transaction, acquiring banks and card networks impose a modest fee to the merchant. As a result, if a consumer desires to pay with a credit card, the retailer may impose a minimum charge. To compensate for credit card processing fees, merchants may increase the price of goods or services (or give a discount if the customer pays in cash).
Some states prevent retailers from passing credit card processing fees directly to customers, and many merchants don’t see the use in going to the trouble of adding charges for using a credit card. When vendors don’t want to deal with credit card transaction costs, “cash only” signs have become frequent at the register of some (typically small) restaurants, businesses, or other services. When a customer sees a “cash only” sign, it means the business is avoiding credit card processing fees in order to keep prices low.
Credit card processing fees benefit credit card firms, issuers, and even cardholders through rewards programs, but this comes at a cost to businesses. Merchants frequently increase their rates to cover the higher credit card processing expenses they incur. Some states prohibit discrimination in pricing based on payment method, so individuals who pay with cash or a check pay higher charges even if they don’t get cash back or benefits.
Credit cards are convenient for cardholders, but the back-end communication between the merchant and other parties is impressive. A wealth of data is exchanged between the merchant, acquiring bank, card network, and issuing bank in the few seconds it takes a cardholder to swipe a card and sign a receipt in order to approve the card details and secure the purchase. Although cardholders are not required to grasp how it all works, understanding why merchants may impose purchasing limits on customers in their stores or online is beneficial.