Card Network: The POWERHOUSE of the payment ecosystem- Part 2
Our last blog explored all about card networks, their origins, and why we call them the powerhouse of the payment ecosystem. To the uninitiated, here’s a gist:
Gist from Part 1:
The first part spoke all about how credit cards fueled the need for a network for smoother distribution of credit cards which eventually opened the door to know about
- Origin and evolution of major card networks like Visa, Mastercard, Discover, Amex, and Rupay
- What card networks do?
- Types of Network- Open and Closed
- Major Industry Identifier (MII) number of the card networks
In Part 2 of the card network blog series, we are on a mission to uncover the behind-the-scenes workings of the card network when processing Point of sale (POS) transactions, ATM transactions, and cross-border payments, how they generate revenue, etc.
How card networks process payments?
A basic transaction approval process takes only a few seconds, but to facilitate this, the card network acts as the backbone of the ecosystem. At the end of the day, all transactions are forwarded over the card network for clearing and settlement.
Let us know in detail how card networks process Point of Sale (PoS), ATM, Online, and Cross Border Payments.
Point of Sale (PoS) transaction:
Step 1: Cardholder Initiates Transaction
The process begins when a cardholder (customer) decides to make a purchase using their credit card. They present their card at the Point of Sale (POS) terminal in a merchant’s shop to pay for a product or service.
Step 2: Transaction Initiation
The POS terminal, provided by the acquiring bank (also known as the merchant’s bank), reads the card’s information and prompts the cardholder to input the necessary transaction details along with an authentication PIN to process the transaction.
Step 3: Transaction Routing
The acquiring bank’s POS terminal sends the transaction details to its servers, as they act as an intermediary between the merchant and the card network.
Step 4: Authorization Process
The acquiring bank then forwards the transaction to the relevant card network (e.g., Visa, Mastercard, American Express). The card network plays a crucial role in facilitating communication between the acquiring bank and the issuing bank (the cardholder’s bank).
4.1. The card network routes the transaction to the cardholder’s issuing bank for authorization. The issuing bank checks the cardholder’s account details, credit limit, and other factors to determine whether the transaction can be approved.
4.2. If the issuing bank approves the transaction, it sets aside the necessary funds for payment and sends an authorization response back to the card network.
4.3. The card network relays the approval response to the acquiring bank, which then communicates it to the POS terminal. The cardholder receives confirmation that the transaction has been approved.
Step 5: Transaction Completion
With the authorization response in hand, the PoS will generate a customer and merchant copy to indicate the successful completion of the sale. The issuing bank places a hold on the approved funds, ensuring they are available for settlement later.
Step 6: Settlement Process
6.1. At the end of the day, the merchant initiates the “settlement” process using their POS terminal. This signals their intent to settle the authorized transactions in batches.
6.2. The acquiring bank collects the authorized transactions from various merchants and compiles them into a batch file.
6.3. The acquiring bank sends the batch file to the card network for clearing and settlement.
Step 7: Clearing and Settlement
7.1. The card network performs clearing, a process where it processes and reconciles the batch transactions received from multiple acquiring banks. This involves netting out mutual offset transactions to reduce the number of individual transactions.
7.2. The card network then sends the cleared transactions to the respective issuing banks for confirmation and settlement.
Step 8: Issuing Bank Confirmation and Settlement
8.1. The issuing banks verify the accuracy of the clearing files and confirm the transactions.
8.2. The issuing banks transfer the appropriate funds to the card network, which will eventually be routed to the acquiring banks.
Step 9: Funds Transfer to Acquiring Banks and Merchants
9.1. The card network transfers the funds from the issuing banks to the acquiring banks, settling the transactions.
9.2. The acquiring bank then transfers the funds to the merchant’s bank account, finalizing the payment for the goods or services.
Step 10: Transaction Completion and Settlement
10. The entire process is completed, with the merchant receiving the funds, the issuing bank releasing the held funds, and the cardholder’s account being charged for the purchase.
Throughout this process, the card network serves as the intermediary that facilitates communication between the various entities involved, ensuring smooth and secure transaction processing. The network takes on the responsibility of managing communication, authorization, clearing, and settlement, and it earns service fees for its role in enabling electronic payments.
ATM transaction:
Step 1: Card Authentication
The cardholder inserts their debit or ATM card into the ATM’s card slot. The ATM reads the card’s magnetic stripe or chip, extracting essential information, including the card number and account details.
Step 2: Transaction Request
The cardholder selects the desired transaction request on the ATM interface (e.g., cash withdrawal, balance inquiry). The ATM prompts the cardholder to enter any necessary information, such as the withdrawal amount.
Step 3: Transaction Routing
The ATM sends the transaction request, along with the cardholder’s information and transaction details, to the card network. This network acts as the intermediary that facilitates communication between the ATM, the cardholder’s bank (issuing bank), and the ATM’s owning bank (acquiring bank).
Step 4: Authorization Process
4.1. The card network routes the transaction request to the cardholder’s issuing bank for authorization. The issuing bank checks the cardholder’s account balance, transaction limits, and other factors to determine whether the requested transaction can be approved.
4.2. If the issuing bank approves the transaction, it sends an authorization response back to the card network.
Step 5: Authorization Response
5.1. The card network relays the authorization response to the ATM.
5.2. The ATM displays a confirmation message to the cardholder, indicating that the transaction has been approved.
Step 6: Transaction Completion
6.1. With the authorization response, the ATM dispenses the requested cash amount to the cardholder, if it’s a cash withdrawal.
6.2. If the transaction request is a balance inquiry or another non-cash transaction, the ATM displays the requested information on the screen.
Step 7: Transaction Settlement
7.1. The ATM transactions along with other transactions are collected by the acquiring bank (the bank that owns the ATM) and compiled into a batch.
7.2. The acquiring bank sends the batch of transactions to the card network for clearing and settlement.
Step 8: Clearing and Settlement
8.1. The card network processes the batch transactions received from multiple ATMs and acquiring banks.
8.2. The network performs clearing, reconciling the transactions, and netting out mutual offset transactions to reduce the number of individual transactions.
8.3. The cleared transactions are sent to the issuing banks for confirmation and settlement.
Step 9: Issuing Bank Confirmation and Settlement
9.1. The issuing banks verify the accuracy of the clearing files and confirm the transactions.
9.2. The issuing banks transfer the necessary funds to the card network, which will eventually be routed to the acquiring banks.
Step 10: Funds Transfer to Acquiring Banks
The card network transfers the funds from the issuing banks to the acquiring banks, settling the transactions.
Step 11: Transaction Completion and Settlement
The entire process is completed, with the cardholder receiving their cash or transaction details, and the relevant banks settling their financial transactions.
Cross Border Payments:
Step 1: Transaction Initiation
A cardholder initiates a cross-border payment by using their credit or debit card for a purchase in a foreign country. The transaction details, including the card number, transaction amount, and currency, are transmitted to the merchant’s payment terminal.
Step 2: Merchant Acquiring Bank
The merchant’s acquiring bank processes the transaction request and sends it to the card network for authorization. The acquiring bank is responsible for facilitating the merchant’s relationship with the card network.
Step 3: Authorization Request
The card network receives the authorization request and routes it to the cardholder’s issuing bank. The issuing bank is the bank that issued the card to the cardholder.
Step 4: Currency Conversion (if applicable)
If the transaction involves a different currency than the cardholder’s native currency, the card network may perform currency conversion. The network uses exchange rates to convert the transaction amount into the cardholder’s currency for approval.
Step 5: Issuing Bank Authorization
The issuing bank receives the authorization request, checks the cardholder’s account balance, credit limit, and transaction history, and then sends an authorization response back to the card network. This response indicates whether the transaction is approved or declined.
Step 6: Authorization Response
The card network receives the authorization response from the issuing bank and relays it to the merchant’s acquiring bank. If approved, this response includes an authorization code.
Step 7: Transaction Completion
With the authorization code, the merchant’s acquiring bank notifies the merchant’s payment terminal that the transaction is approved. The merchant can proceed with completing the sale and providing the goods or services to the cardholder.
Step 8: Settlement Process
After the transaction is approved and completed, the settlement process begins. The card network handles the settlement process by coordinating the movement of funds between the issuing bank and the acquiring bank.
Step 9: Currency Conversion (if applicable)
If the transaction involved currency conversion, the card network calculates the final amount based on the conversion rate used during authorization. This ensures that the issuing bank transfers the correct amount to the acquiring bank in the currency of the merchant’s country.
Step 10: Funds Transfer and Reconciliation
The card network facilitates the transfer of funds from the issuing bank to the acquiring bank, ensuring that the merchant is compensated for the transaction. This involves reconciling the transactions and settling accounts between banks.
Step 11: Reporting and Record Keeping
The card network maintains records of cross-border transactions for reporting, auditing, and compliance purposes. This includes details about the transaction, currency conversion rates, fees, and the parties involved.
In all these payments, the card network acts as the intermediary that ensures seamless communication, authorization, currency conversion, and settlement between various banks and financial institutions involved in the payment process.
And the highlight of all these processes is that all these steps happen within a fraction of seconds. Well, Imagine that!
And now, coming to the most important question of all: The Revenue?
From where do card networks earn money?
In simple terms, it is by processing the data, facilitating the international transaction, and providing services card networks generate revenue.
Assessment fee: The merchant pays an assessment fee to the card network on every purchase made through the particular card network branded card. The card network charges the merchant this fee in exchange for enabling the merchant to accept payments from cards that are part of their network.
Interchange fee: It is paid to the card issuer by the merchant. If the card network itself is the issuer (closed network), the merchant needs to pay an interchange fee directly to the network. This fee is calculated using a flat rate plus a small percentage of the total sales. This interchange fee is the primary source of income for the card networks.
Usage fee: The issuer is assigned a usage fee for transferring data through the card network.
Service fee: It is charged to the issuer for using the card network services like fraud protection services, etc.
Annual license fee: Card networks collect annual license fees from the issuer for using their logo, name, and brand.
Cross-border payment fee: This type of fee includes both network fee and issuing banking fee, and it is applicable only for cross-border payments.
Conclusion:
In a nutshell, card networks are quintessential in the payment ecosystem. Delving into the intricate realm of card networks reveals the vital role they play in our modern financial landscape. It facilitates a seamless flow of transactions and embraces financial inclusion, empowering individuals and businesses to engage in secure and efficient commerce across the globe. In the cobweb of issuers, acquirers, merchants, and cardholders, card networks process the transaction with remarkable speed and reliability.
However, the journey of card networks doesn’t end here. The landscape will continue to evolve with the emergence of new innovations in the payment ecosystem.
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