Card processing, how does it work ?

I am always amazed at how seamlessly card processing works when you consider the chain of inter-linked IT networks that authorise and settle each transaction.  Its not the complexity of these networks or their sheer size, reach and cost which is amazing, but the fact that they are all owned by different parties who all work together to present merchants and cardholders with a seamless transaction.

Card processing consists mainly of 2 processes – authorisation and settlement.  The authorisation and settlement process below is known as the “4 party model” (the merchant, the acquirer, the card scheme/network and the issuer) and applies to all Visa and Mastercard credit and debit transactions.  The card processing for other card Schemes, such as American Express and Discovery are simpler in that the card scheme and the issuing Bank are one and the same.  This process is known as “closed loop” or imaginatively the “3 party model.

For e-Commerce transactions a fifth party is involved in card processing – the payment gateway supplier.  They are positioned in between the merchant and acquirer and will capture transactions from the merchant and onsend them to the acquirer and will make settlement from the acquirer to the merchant.

 Authorisation

When a cardholder buys goods from a merchant using a card, the acquirer captures the card and transaction details via a chip and pin machine, virtual terminal or an internet gateway.  These details are processed by the acquirer’s platform and onsent to the card scheme which passes them to the issuer of the card to authorise the transaction.  This authorisation is then transmitted back to the merchant via the card scheme and the acquirer.

What does authorisation mean ? It means that the card has not been reported stolen and there are sufficient funds to cover the transaction.  It is not a contractual guarantee of payment to the merchant but the reality is, unless the cardholder processes a chargeback or fraud is discovered, then the merchant will receive payment in the short-term.

If the transaction is considered abnormal by the issuer (either by size or nature) then the issuer may ask for other forms of verification as to the cardholder’s identity.  This usually involves a phone call between the merchant/cardholder and the issuer/acquirer.

Settlement

At the end of its trading day the merchant transmits all of its transactions for the day to the acquirer.  The acquirer batches all of the transactions from all of its merchants for that day and transmits these to the card schemes for settlement.  The card schemes transmit the transaction details to the various issuing banks who forward the settlement funds to the card scheme who in turn forward these to the acquirer.

The acquirer typically receives settlement funds from the card schemes the day after the transaction occurs then typically remits the funds to its merchants 2 days later (known as “transaction +3” or “T + 3”).  The acquirer benefits from the interest generated on these funds during these 2 days and given the billions of pounds spent daily on cards, this interest income can be substantial.

Larger merchants will insist on getting their settlement funds on the same day that the acquirer receives these from the card schemes, ie T+1, so many SME merchants are at a 2 day cashflow disadvantage to their larger competitors.  In the case of online businesses, settlement can often be delayed by up to 10 days depending on the risk profile of the merchant (delayed settlement acts as collateral against chargebacks).  Settlement of purchases made on cards issued by non-UK Issuers takes c.2 days longer than UK cards.

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