Explaining the Tech Behind Credit Card Processing

The technology behind credit card processing is really incredible, and has made our lives so much more convenient in the digital age. No cash on hand for a taxi? Add your credit card to a ride-sharing app like Grab or Uber. You don't even need to carry your physical card anymore, with MST (magnetic secure transmission) strips in modern smartphones utilized by apps like Samsung Pay, Google Pay, PayPal, and other mPOS systems (mobile point of sales).

With all of this digital convenience, it's easy to overlook the complexity behind credit card processing. In this article, we're going to give a brief overview of how credit card processing works. For more information on the process, you can learn about credit card processing services like Merchant One.

The web of connections

A bankcard network will conduct billions of transactions between customers, merchants, processors and banks, in mere seconds. The merchant's terminal software (payment gateway) passes the transaction information to the processor, and the processor asks for authorization from the issuing bank. The bank grants the approval through the card network, back to the processor, which passes the approval through the merchant's terminal. This is fairly similar to the process used for approving or denying an online credit card application.

This sounds like a fairly straightforward pathway, but it's a little more complex than that. First, there is a difference between acquiring banks (merchant's banks) and issuing banks (cardholder banks). The merchant's bank is a registered member of the card associations (Mastercard and Visa), and provides merchants with the equipment and software for accepting card transactions. This applies to e-commerce websites as well as physical retail stores.

The cardholder bank is an issuing bank that grants credit cards to consumers, and is also a member of the card associations. Issuing banks pay the merchant banks for purchases that the issuing bank's clients make, and the cardholder is then responsible for paying their issuing bank.

The card associations Visa and Mastercard aren't banks, acquiring or issuing. Visa operates the VisaNet network, whereas Mastercard uses Banknet. The card associations basically function as governing bodies of financial institution communities, like ISOs (independent sales organizations) and MSPs (member service providers). The card association governs the members, such as by setting interchange fees, qualification guidelines, improving the card network, and acting as an arbiter between issuing and merchant banks.

Clearing and settlement

So now that you know how the transactions take place between the various pathways, let's examine the second part of credit card processing – this is clearing and settlement.

Settlement is when the merchant sends a bunch of authorizations to the processor, usually once daily. The processor will forward these authorizations over to the card association networks, while depositing the funds from those sales into merchant's bank account (while deducting any processing fees). The merchant is no longer involved in the process after this step.

Now the credit card network will pay the merchant bank and debit the cardholder's account, and the cardholder will pay it (i.e. monthly bill).

Processing fees and funding

As mentioned above, processors will deposit funds from card sales into the merchant's bank account, but it depends on the processing company how fees are deducted and when funds are deposited.

In most cases, processors will provide next day funding, but typically with the requirement that the merchant batch all of their transactions before a cutoff time (business days). A processor can also hold funds if there is an investigation pending into a transaction, such as suspected fraud activity.

As for fee deductions, there are two main methods. The first is daily discounting, which means the processor will deduct their fees each day before funds are deposited. The merchant receives the net sale amount, after fees. The second method is monthly discounting, where the processor will deduct fees for an entire month of transactions once per month, but still deposit funds daily.