How Does Payment Processing Work?

October 8th, 2020 by Loyalty Sense Inc.

Accepting credit cards has become an essential part of business operations because it enables business to get paid. In the payment processing world, there are different entities that work in synchronization to make the payment processing work seamlessly and enable payments within microsecond. To understand how this entire cycle works it is essential that we understand the roles of the payment system participants involved.

So, WHO exactly is involved?

1. Merchant

A Merchant is any person or company that sells goods or services. Parties who sell goods or services through the Internet are known as eCommerce Merchants.

Acquiring Banks Canada

2. Acquiring Bank (Merchant’s Bank)

An Acquiring Bank, also known as Merchant’s Bank, is a bank or financial institution that accepts credit or debit card transactions by cardholders. These banks are registered members of a card network (MasterCard, VISA, etc.) and accept transactions on behalf of the networks for a merchant. The card network connects acquiring bank to issuing banks to ensure that a customer transaction is verified. The fees from an acquiring bank are charged behalf of themselves, card network, and issuing bank, considering for credit card interchange costs as well and other activities such as transactions, refunds, and chargebacks.

3. Issuing Bank (Credit Card Issuer)

An Issuing Bank is any bank or financial institution that grants (or issues) credit or debit cards, through card networks (MasterCard, VISA, etc.). They approve or decline cardholder transactions based on the shopper’s financial situation. They take full risk and responsibility with the transactions it processes. Because of this, they charge fees for its services, which varies by acquirer.

4. Payment Processor

A Payment Processor is a company authorized to process credit card transactions between buyers and sellers. It has various functions that include validating the source of the transaction, implement rules regarding to frauds, identity thefts and chargebacks. Payment processors enable merchants to receive debit or credit card payments online by providing a connection to an acquiring bank. Payment processing companies typically provide related equipment to merchants, such as the credit/debit payment terminals, also known as debit/credit card machine or in some cases, virtual terminals.

5. Card Network

The Card Network is network of banks that process a particular brand of payment cards. These brands (MasterCard, VISA, etc.) are known as association members. Within these association members, some of them may approve or decline transactions directly (i.e. AMEX), or contact the card’s issuing bank for authorization (i.e. MasterCard & VISA).

6. Cardholder (Shopper):

The cardholder is the customer who purchases goods or services from a merchant.

In addition to all the payment system participants involved, there are a few more additional procedures that takes place in this process which are:

1. Payment Gateway:
The Payment Gateway consists of software and servers that facilitate communication of transaction’s information and transmits them to the acquiring banks. They encrypt the data to keep it private and sends the transaction information to the payment processor.

2. Credit Card Interchange:
The Credit Card Interchange is the process in which an acquirer or acquiring bank submits approved card transactions on behalf of its merchants. It is the clearing and settlement of records between payment system participants.

3. Transaction Settlement:
The Transaction Settlement is the process which a merchant receives funds for a transaction with a customer. It is when all the funds for the transaction have been approved and deposited by an acquiring bank to the merchant’s account.

4. Pre-Authorization:
The Pre-Authorization process is necessary to check if a card holder’s debit or credit card holds sufficient funds for the purchase. It is sent by the acquiring bank to the card holder’s issuing bank to ensure that the transaction will be approved. If it is approved, then a hold (preauthorization) will be placed on the necessary funds in the shopper’s account and the result (approval) will be sent to the payment processor and appear on the merchant’s payment terminal.

The Full Process:

Flow Chart of the Process of Payment Processing

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