Overview#If you're using a so-called "universal" card like Visa or MasterCard, there are typically four parties involved:
- the Merchant is the person offering goods or services that you (the customer) want to buy.
- the Card Processor then sends the transaction information to the correct Issuer Bank so the funds can be taken from the customer's account and delivered to the Merchant.
- the Acquirer signs up Merchants to accept cards and routes each transaction to the Payment Network.
- the Card Issuer distributes cards to customers, extends lines of credit to them in the case of credit cards, and bills them.
What happens when you buy something#When a transaction takes place, two major processes occur:
- the card gets authorized
- the transaction is then cleared.
The Issuer Bank conducts a series of checks for fraud and verifies that the cardholder’s available credit line is sufficient to cover the purchase before returning a response, either granting or denying authorization.
Usually, this process takes no more than a few seconds.
Once the card has been authorized, the second part of the transaction is clearing it, or getting the goods to the customer and the money to the Merchant's bank. The Merchant sends transactions to the Card Processor, and the Card Processor sends that information along to the merchant accounting system, or MAS, that supports an individual merchant's account. The distinction between the Card Processor and the MAS can be muddy. "In some cases, the MAS is a part of the Card Processor; in others, it is a different entity."
The MAS distributes the transactions to the appropriate network—Visa transactions to the Visa network, MasterCard transactions to the MasterCard network, and so forth. Next, the MAS deducts the appropriate merchant discount fee (to cover the costs of the merchant acquirer’s activities) from the transaction amount and generates instructions to remit the difference to the merchant’s bank for deposit into the Merchant's account. The MAS sends these instructions to the automated clearinghouse (ACH) network, which is a computer-based system used to process electronic transactions between participating depository institutions.
Merchants typically pay what is called a Discount Rate and a Transaction Fee, which are tied to what is called an Interchange Fee, which is determined by the payment card network (again, Visa or MasterCard). According to a Quora post by CEO of 1st American Card Service Brian Roemmele, republished on Forbes, 85 percent of this Interchange Fee is paid to the card's Issuer Bank (like Chase, or Bank of America, for example). These fees usually amount to about two percent of the purchase price on credit card purchases and are a profit driver for the Issuer Bank. They also help cover fraud costs and fund reward programs.
This system is complicated, and it is growing increasingly fraud-prone, especially when card information is stored on a Merchant's terminal or is sent insecurely. To keep this article (relatively) short, we won't discuss Card Not Present CNP transactions, which usually occur online or over the phone and require a customer to input her or his card's security code (those digits on the back of the card).
In a quick note, however, because CNP transactions are much less secure than transactions where the card is present, CNP transactions usually demand higher Interchange Fees from Merchants. But although NFC transactions on an Apple Pay or Google Wallet enabled phone don't physically require a card to be present, they transmit information as if the card was present, so fees aren't higher for merchants that choose to enable NFC on their terminals.