A Quick Guide to Credit Card Payment Processing
The Payments industry is constantly reimagining the ways we pay, but for most in the U.S., paying with a card feels like second nature: a quick tap, dip, or swipe, and you’re done. Beneath the surface-level simplicity lies a sophisticated, two-sided story.
Tales of Two Sides
Every transaction involves two parties: a buyer and a seller. And between them? A sprawling digital infrastructure powered by millions of lines of code, thousands of professionals, and countless miles of data cables. This article takes you behind the scenes, introducing the key players and processes that make a card payment happen.
A two-sided industry (or is it two industries?)
The card processing industry has two distinct, but interconnected sets of players – acquiring players and issuing players. Acquiring players focus on serving businesses that sell things, enabling the acceptance of electronic payments. Issuing players focus on serving buyers or cardholders. A variety of company types interact between these two sides, and the lines blur at times.
Acquiring Participants
- Merchant: A merchant is any person, business, or organization that sells goods or services to consumers under a merchant agreement with an acquirer or processor.
- Point of Sale (POS) Provider: A company that supplies integrated point-of-sale (POS) systems, including hardware, software, or both, to facilitate customer checkout and capture transaction data.
- Payment Gateway: A web-based service that enables electronic payment transactions by securely transmitting payment data from a merchant’s website, point-of-sale system, or other commerce platform to an acquirer or processor.
- Acquirer: An acquirer is a financial institution or non-bank entity that receives transactions from a merchant and submits them to the payment networks. The acquirer settles with the merchant for those transactions. If the acquirer is not a bank, it must partner with one to access the payment networks (in the U.S.).
- Processor: A technology provider that handles transaction processing on behalf of acquirers, issuers, or both. Processors connect to the payment networks to facilitate authorization, clearing, and settlement. Some processors are also acquirers, while others support both the acquiring and issuing sides of the transaction flow.
Intermediaries
- Payment Network: Payment Networks are organizations like Visa and Mastercard that route transaction data between card issuers and acquirers. American Express and Discover operate as closed-loop networks, acting as both issuer and acquirer, and also permit third-party acquiring.
- Sponsor Bank: A financial institution that enables non-bank entities (e.g., payment processors or fintech companies) to connect to the banking system. The sponsor bank is liable for the activities of the entities it sponsors, including compliance with regulations and network rules. For acquiring, it receives settlement funds on behalf of the sponsored entity and holds the accounts from which merchant funding is initiated. In issuing arrangements, the sponsor bank provides BIN sponsorship, enabling the entity to issue cards and access the card networks.
Issuing Participants
- Issuer: A financial institution, or other sponsored commercial entity, that provides credit or debit cards to cardholders and is responsible for managing the associated accounts.
- Cardholder: Any person or organization that holds a credit or debit card issued in their name.
A two-sided transaction
A transaction is also two-sided, involving authorization and settlement.
- Authorization: The process of submitting a transaction for approval, or decline, from the issuer. The issuer responds with a code indicating the outcome, which may include additional instructions. Authorized transactions must be settled for the merchant to receive funds.
- Settlement: the process of moving funds between the issuer and the acquirer to complete a transaction. For purchases, the issuer transfers funds to the acquirer, who then pays the merchant. For refunds, the flow is reversed.
- Clearing: a separate but related process, in which the transaction details (e.g., amount, card type, MCC, etc.) are confirmed between the issuer and acquirer before funds move during settlement.
Two transaction environments
There are two general types of transactions – card present and card not present.
Card-present transactions involve a cardholder physically presenting a card to complete a transaction. This typically involves inserting, swiping, or ‘tapping’ a card, or card-linked digital wallet, on a mobile device with a point-of-sale device offered by a merchant. (Click to expand illustration below)
Card-not-present transactions do not involve a physical card reading device. For example, card details (e.g., card number, expiration date) may be keyed in. These transactions typically occur via phone (voice), website (eCommerce), or mobile (mCommerce). There are also instances when a card number may be keyed in on a physical point of sale device. (Click to expand illustration below)
Did you know? Despite a card not being physically “present”, transactions using digital wallets (e.g., Apple Pay) are still classified as card-present transactions as long as they occur in-person at the point-of-sale.
The diagram below is a simplified example of how revenue from a transaction is split across participants. Many of these companies play multiple roles. You’ll see that the issuer has the largest revenue allocation. This is because they assume responsibility for cardholder credit losses and managing, maintaining, and growing cardholder accounts. (Click to expand illustration below)
This is for example purposes. The amounts paid to each part of the ecosystem can vary depending on variables like merchant size, industry, location, pricing model, and onboarding date.
The largest driver of a card transaction fee is called interchange. This is the base fee that an acquirer/acquiring bank pays to the issuing bank. Card networks like Visa set interchange rates that serve as compensation to the issuer for enabling the transaction and assuming financial risk. On average, interchange drives 70% of the total fees merchants pay to accept card transactions.
Interchange fees vary based on the card type used in a transaction (like its associated rewards), the transaction environment (CP vs. CNP), the merchant’s industry (MCC), and other factors that often relate to a transaction’s risk level. They are designed to balance the economics of the payment system by compensating issuers for risk, funding rewards programs, and covering processing costs.
This overview highlights the foundational structure of the payments industry and transaction flow. While various payment methods and emerging technologies follow distinct processes and economic models, they frequently involve many of the same key players.
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