How Does A Credit Card Processing System Work?
Posted May 30th, 2010 and last modified December 28th, 2011Who does what in the credit card business? The average shopper would say there are three parties: you, the store, and your bank. Others would add the store’s bank to the list. But what goes on behind every online transaction is something much more complex. In fact, according to David Schwartz of Authorize.net, a payment gateway provider, it’s one of the most complex systems he’s ever come across—to think that every transaction takes no more than three seconds. For one thing, there aren’t just three or four people involved—there are seven. These are:
- The customer (you)
- The merchant (the store)
- The payment gateway
- The acquiring bank’s processor
- The credit card interchange (Visa, MasterCard, etc.)
- The customer’s credit card issuer (your bank)
- The merchant’s acquiring bank (the store’s bank)
Money is transferred at most of these stages, as each player charges for its service. So stores don’t usually get the entire purchase price—what you pay is split between a number of companies. In other words, it costs your bank money to let you use your credit card. That’s why many stores offer discounts to those who pay with cash (as transaction fees also apply to debit cards).
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Who Else Are Involved?
To better understand how those extra parties come into the picture, and how your money makes its way from point A to point B, let’s follow the footsteps of a typical online transaction.
You buy a new keyboard for $100 with your credit card. The second you click on “Buy Now,” information about your purchase is sent through cyberspace to the payment gateway. Payment gateways are companies that authorize payments for most online businesses. They are the equivalent of point-of-sale or checkout counters in brick-and-mortar stores. Gateways also protect the sensitive information you’re sending over, such as your bank details, by encrypting them on the way from Keyboard Paradise to the payment processor. In exchange for their service, they take a small percentage of your payment, around .10¢, although it varies from one merchant to the other.
The next stop is the payment processor, which is typically a third party hired by the merchant to handle transactions on behalf of their banks. There are two types: front-end and back-end.
- The front-end processor is where most of the security measures kick in—it checks your bank details, your payment history, and even your country of origin before letting the transaction through.
- The information is then transferred to the back-end processor, which actually moves the funds from your bank to the store’s, usually through a controlling authority such as the Reserve Bank. This shaves another few cents off your $100, around .08¢.
Next, the money goes to the credit card interchange, or the association that handles your card. Amex act as the issuing bank, so they will directly approve or deny the transaction. If you’re using Visa or MasterCard, which act through local banks (and which is why they’re more popular), the transaction will instead be forwarded to the bank that issued your card. Your bank will then verify that you can afford your new keyboard, either with your available funds or your credit limit. The interchange and issuing bank charge a little over 2¢ collectively from your $100.
And If It Approved…
If the transaction is approved, it traces the same steps back to the website, except that it goes through the acquiring bank, where Keyboard Paradise holds a merchant account. If the transaction is denied, it is redirected to the merchant along with the authorization details. After the acquiring bank collects its processing fee of about .65¢, the remaining $97 or so is deposited into their account, and the equivalent charge appears on your credit card bill a day or two. It doesn’t immediately register on your account because banks usually process the information at the end of the working day.
It’s hard to imagine all that taking place in the time it takes you whip out your card. No wonder we love our plastic—it makes things so easy, from buying a new keyboard to renovating your home. But that’s also what makes credit cards tricky. It’s not just the added spending power, which makes you prone to excessive debt. It’s also the exposure to so many parties with every swipe. Although the large majority of online transactions are safe, in such a complex system, there’s always bound to be a weakness or two. When you know what happens every time you use your card, you’ll be better equipped to protect yourself.
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