How Does the Credit Card Processing Work: A Simple Guide

Credit card transaction is not a new concept. Everyone claims to know the process: swipe the card, hit the button and the transaction is complete in a blink. But do you really know the process? Do you think that it is as simple as it seems? It actually is a much more complex procedure than what you witness. The fact is swiping the card and signing the recipe is the first and the last step of the procedure. In between lays multiple steps that include more than one person working invisibly for the customer to complete that particular transaction.

Most of the customers do not care about the complete process. It may seem unnecessary, it provides important information about the inner workings of the modern commerce. Not only for customers but knowledge about credit card transaction process is tremendously important for small business owners as well, as it is a merchant who has to confront the cost of the payment processor. Let us discuss the working of credit card processing in detail.

Key Players

CARDHOLDER

There are two types of cardholders

1. Who repays full credit card balance?

2. Who pays only a portion of balance and rest accrues interest?

MERCHANT

It is a vendor who sells product or services. The job of a merchant is to accept payment through a card, send the card information to the issuing bank and request payment authorization.

MERCHANT’S BANK

It is also known as acquiring the bank and is responsible for sending an authorization request to the issuing bank through a proper channel followed by communicating the response of the issuing bank to the merchant.

SERVICE PROVIDER

Also known as acquiring processor is a third party entity that works as an arm of the merchant’s bank. It provides service or device that allows the merchant to accept credit card for payment and also sends the credit card details to the credit card network and further sends back payment authorization to the acquiring bank.

CREDIT CARD NETWORK

Also referred as Association member, operates the network to facilitate the credit card payment process, worldwide and administrate interchange fees. Credit card network receives details of credit card payment from the service provider and forwards the request for authorization to the issuing bank. In return, it sends a response of the issuing bank to the service provider. Some of the examples of the credit card network are Visa, MasterCard, and American Express.

ISSUING BANK

Also called the credit card issuer is a financial institution that provides the customer with a credit card, which is involved in the transaction. After receiving the authentication request from credit card network, the issuing bank either approves it or declines it.

Credit Card Transaction Process

Let us understand transaction process in just three steps

STEP 1: AUTHENTICITY

• At the point of sale, a cardholder gives the card to the merchant to swipe the card on POS terminal to make a payment.
• Credit card details are sent to the acquiring bank, which forwards the same to the credit card network
• Credit card network clears the payment and a request is sent to the issuing bank for an authorization.
• Authorization request includes credit card number used for the payment, expiration date, billing address, card security code and the payment amount.

STEP 2: AUTHENTICATION

• When the issuing bank receives the authorization request, it validates the credit card number, checks the availability of the funds in the cardholder’s account, verifies the billing address and validates Card security code (CVV number).
• It is up to the issuing bank whether to approve or deny the request. When they make a decision, it sends back the suitable response through a proper channel (credit card network and acquiring bank).
• Once the merchant receives the authorization, the customer is provided with the receipt at the completion of the sale.

STEP 3: CLEARING AND SETTLEMENT

• In clearing stage, the transactions get the post to the cardholder’s monthly billing statement and in the merchant’s statement.
• The merchant sends all the approved authorizations in a batch to the acquiring bank by EOD.
• For settlement, service provider routes the batched information to the association member, which in turn forwards all the approved transactions to the corresponding issuing bank.
• Then the issuing bank transfers the funds (minus interchange fee, which is shared with the credit card network) within 1-2 days. Then the credit card network pays from the remaining funds to acquiring bank as well as the acquiring processor.
• The merchant account gets credited for the cardholder’s purchases by the acquiring bank (minus merchant discount rate). At this time, the issuing bank posts the transaction information to the cardholder’s account. The cardholder receives the statement and bill is paid off.