Credit cards have made life easy for merchants as well as consumers. The convenience and flexibility of payment have been the main advantages of using these cards. When a customer swipes their credit card or enters the card details online, in a couple of seconds, the transaction is completed. When you look at it, credit card processing seems quite simple. Behind the scenes, however, there is a complex and intricate process going on.
What is credit card processing?
Credit card processing is done through a number of platforms like e-commerce stores, brick-and-mortar stores, mobile devices, and wireless terminals. Multiple key players involved in the process include the cardholder, merchant, acquiring bank/merchant bank, acquiring processor/service provider, credit card network/association member, and issuing bank/credit card issuer.
Participants in a credit card transaction process
- Cardholder: There are two types—transactor and revolver. Transactors repay their credit card balance in full. Revolvers repay only a part of the balance as the rest of the amount accrues interest.
- Merchant: Vendors and stores that sell services and goods to the cardholder are called as merchants. These accept credit card payments. Additionally, the card information is sent to the cardholder’s issuing bank by the merchant. They also make payment authorization requests to the cardholder’s bank.
- Acquiring bank/merchant bank: Payment authorization requests from merchants are received by the acquiring bank that sends the request to the issuing bank via appropriate channels. The acquiring bank then sends the issuing bank’s response to the merchant.
- Acquiring processor/service provider: This is a third-party participant in the card transaction process. In some cases, it can be an arm of the acquiring bank. Processors provide merchants with a device or service that allows them to accept credit card payments. These processors or providers also help the merchants to send details of credit card payments to the credit card network. The payment authorization is forwarded back to the acquiring bank by the processor.
- Credit card network/association member: Visa, MasterCard, American Express, and Discover are some of the well-known credit card networks. These operate the networks that globally conduct credit card processing. These also govern and regulate interchange fees. During a transaction process, a credit card network or association member receives the details of credit card payment from the acquiring processor. The payment authorization request is then forwarded to the issuing bank. After this, the network sends the response of the issuing bank to the acquiring processor.
- Issuing bank/credit card issuer: This financial institution issues the credit card involved in the transaction. The payment authorization request is received by this bank from the credit card network. Also, the issuing bank will approve or decline the transaction based on certain factors.
Various costs and fees involved in credit card processing
Credit card processing involves multiple fees and costs. These are charged for the convenience that credit cards bring. The credit card processing rates are not uniform; they vary based on the type of merchant and the platform through which a service or good is delivered. These charges are usually in the form of flat fees, volume-based fees, and per-transaction fees. The following are some of the major fees involved in credit card processing.
- Merchant discount rate: This fee is paid by merchants for receiving service from acquiring processors and accepting credit card payments. It is a combination of multiple components—interchange fee, assessments, and markups. These fees can range between 2% and 5% of the total purchase amount, after the addition of sales tax. Online merchants pay more than brick-and-mortar ones. Merchant discount rate is also known as a discount fee.
- Chargebacks: Customers can dispute a charge on their billing statement. But this should be within 60 days of the statement date. The complaint goes to the issuing bank; after receiving the complaint, the bank will charge the merchant a penalty of $10 to $50 and also issue a retrieval request. Additional fees are imposed if the merchant does not respond to the request within a certain period. The merchant can appeal against the complaint. In case the merchant loses the appeal, the bank will charge back (recover) the payment made by the customer.
Various stages of credit card transaction
Processing involves an entire cycle from swiping the card in the card reader to getting a receipt. One cycle takes barely two to three seconds. Here, taking the model of a brick-and-mortar store, credit card processing has been explained. The process has three stages—authorization, authentication, and clearing and settlement, which happen simultaneously.
- Authorization: In this first stage of credit card processing, the merchant obtains payment approval from the issuing bank. First, the cardholder gives their credit card for payment at the point of sale (POS) terminal to the merchant. Once the card is swiped at the terminal, the credit card details of the customer are sent to the merchant or acquiring bank. The details can be sent to the acquiring processor as well. This is done through a phone line or an Internet connection.
The details are forwarded to the credit card network by the bank or processor. The network will clear the payment and send a request for payment authorization to the issuing bank. The authorization request will ask for the credit card number, card expiration date, billing address, card security code, and the payment amount. After this, the next step in the process is authentication. - Authentication: In this stage, the issuing bank will verify the validity of the cardholder’s credit card. This is done with the help of numerous fraud protection tools like Address Verification Service and card security codes such as CID, CVV2, CVC2, and CVV2. The issuing bank will receive a payment authorization request from the credit card network. The bank will validate the credit card number and then check the available fund. The billing address is matched to the one in the database and thereafter, the CVV number is validated. The issuing bank will then approve or decline the transaction based on the results of the verification process. The appropriate response is sent back to the merchant through the credit card network and the acquiring bank processor or bank.
After the merchant gets the authorization, the issuing bank will place on hold on the amount requested in the cardholder’s account. The cardholder will get a receipt of the sale from the merchant. At the end of each business day, the POS terminal of the merchant will accumulate all the approved authorizations. These will be processed together in a batch at the end of the day.
- Clearing and settlement: In this final stage, the transaction will be posted to the monthly billing statements of the cardholder as well as the merchant. This stage happens along with the settlement stage. All the approved authorizations will be sent in a batch by the merchant to the acquiring processor or bank that will further send the batch for settlement to the credit card network. The network will forward each approved transaction to the respective issuing bank. The bank transfers the funds within 24-48 hours after the transaction. An interchange fee is deducted in this stage. This fee is shared by the bank with the credit card network.
From the remaining funds, the network will pay the acquiring processor and bank their due percentages. The bank will send the balance to the merchant’s account. A merchant discount rate is deducted from the balance before the transfer. After this is done, the issuing bank will post the information about the transaction to the cardholder’s account. The cardholder will pay the bill after receiving the statement.
What happens when a transaction is declined?
A decline of credit card can be an unpleasant experience. However, a credit card rejection may happen due to various reasons apart from the card maxing out. Here are some of the common reasons for credit card decline during credit card processing.
- The expiration date of the credit card number is incorrect.
- There are insufficient funds in the account of the cardholder.
- The credit card company may reject international charges. So, if the credit card has been used to make a purchase abroad or through a website located in another country, the transaction will be declined.
- There were technical issues faced by the credit card company or the issuing bank while the transaction was processed.
- In some cases, a cardholder may make multiple online purchases in a short period. In such cases, the bank rejects the transaction as a part of the fraud-prevention measure.
After a credit card is declined, the POS terminal returns a response code, which gives the reason for the decline. However, most of these codes are not self-explanatory. In such a case, contacting the card issuer through their customer service can be helpful.
With automated credit card processing, transactions between merchants and customers have become structured and transparent. Although the process barely takes any time, it goes through multiple intricate stages. Understanding the process is quite essential, especially when a customer has to dispute a charge. After all, it is better to be informed always!
