9/28/2020 How Credit Card Transaction Processing Works: Steps, Fees & Participants

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How Credit Card

Transaction Processing
Works: Steps, Fees &
Participants

   

Odysseas Papadimitriou, WalletHub CEO

Apr 2, 2009

On the surface, the credit card transaction process seems simple: Customers swipe their cards, and
before they know it, the transaction is complete. Behind every swipe, however, is a profoundly more
complex procedure than what meets the eye. In fact, sliding the card and signing the receipt are
only the first and final steps of a complicated procedure. And the whole process — though it
happens in merely a few seconds — involves multiple stages and several actors working behind the
scenes.

Although being familiar with the credit card transaction process may not seem useful to the average
consumer, it provides valuable insight into the inner-workings of modern commerce as well as the
prices we ultimately pay at the register.  What’s more, knowledge of the credit card transaction
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process is extremely important for small business owners since payment processing represents one
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of the biggest costs that merchants must confront.  Below, we provide a cross-sectional perspective
of the process that takes place with every swipe — from the participants to getting approved or
declined.

1. CREDIT CARD TRANSAC TION PART IC IPANTS

2. CREDIT CARD TRANSAC TION PROC ES S

3. CREDIT CARD PROCESSING FEES & C OS TS

4. WHEN A CREDIT CARD GETS D EC LINED

Credit Card Transaction Participants

Before you can understand the process of a credit card transaction, it’s best first to familiarize
yourself with the key players involved:

Cardholder: While this is pretty self-explanatory, there are two types of cardholders: a
“transactor” who repays the credit card balance in full and a “revolver” who repays only a
portion of the balance while the rest accrues interest.

Merchant: This is the store or vendor who sells goods or services to the cardholder. The
merchant accepts credit card payments. It also sends card information to and requests
payment authorization from the cardholder’s issuing bank.

Acquiring Bank/Merchant’s Bank: The acquiring bank is responsible for receiving payment
authorization requests from the merchant and sending them to the issuing bank through the
appropriate channels. It then relays the issuing bank’s response to the merchant.

Acquiring Processor/Service Provider: This third-party entity is sometimes an arm of the

acquiring bank. A processor provides a service or device that allows merchants to accept
credit cards as well as send credit card payment details to the credit card network. It then
forwards the payment authorization back to the acquiring bank.

Credit Card Network/Association Member: These entities operate the networks that process
credit card payments worldwide and govern interchange fees. Examples of credit card
networks are Visa, MasterCard,
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credit card network receives the credit card payment details from the acquiring processor. It
forwards the payment authorization request to the issuing bank and sends the issuing bank’s
response to the acquiring processor.

Issuing Bank/Credit Card Issuer: This is the financial institution that issued the credit card
involved in the transaction. It receives the payment authorization request from the credit card
network and either approves or declines the transaction.

Credit Card Transaction Process

Credit card transactions are processed through a variety of platforms, including brick-and-mortar
stores, e-commerce stores, wireless terminals, and phone or mobile devices. The entire cycle —
from the time you slide your card through the card reader until a receipt is produced — takes place
within two to three seconds. Using a brick-and-mortar store purchase as a model, we’ve broken
down the transaction process into three stages (the “clearing” and “settlement” stages take place
simultaneously):

Stage 1: Authorization

In the authorization stage, the merchant must obtain approval for payment from the issuing bank.

1. The cardholder presents their credit card for payment to the merchant at the point of sale.

2. After swiping their credit card on a point of sale (POS) terminal, the customer’s credit card
details are sent to the acquiring bank (or its acquiring processor) via an Internet connection or
a phone line.

3. The acquiring bank or processor forwards the credit card details to the credit card network.

4. The credit card network clears the payment and requests payment authorization from the
issuing bank. The authorization request includes the following:
Credit card number

Card expiration date

Billing address — for Address Verification System (AVS) validation

Card security code — CVV, for instance

Payment amount

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Stage 2: Authentication

In the authentication stage, the issuing bank verifies the validity of the customer’s credit card using
fraud protection tools such as the Address Verification Service (AVS) and card security codes such
as CVV, CVV2, CVC2 and CID.

1. The issuing bank receives the payment authorization request from the credit card network.

2. The issuing bank validates the credit card number, checks the amount of available funds,
matches the billing address to the one on file and validates the CVV number.

3. The issuing bank approves, or declines, the transaction and sends back the appropriate
response to the merchant through the same channels: credit card network and acquiring bank
or processor.

4. Once the merchant receives the authorization, the issuing bank will place a hold in the amount
of the purchase on the cardholder’s account. The merchant’s POS terminal will collect all
approved authorizations to be processed in a “batch” at the end of the business day.

5. The merchant provides the customer a receipt to complete the sale.

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Stage 3: Clearing  & Settlement

In the clearing stage, the transaction is posted to both the cardholder’s monthly credit card billing
statement and the merchant’s statement. It occurs simultaneously with the settlement stage.

1. At the end of each business day, the merchant sends the approved authorizations in a batch
to the acquiring bank or processor.

2. The acquiring processor routes the batched information to the credit card network for
settlement.

3. The credit card network forwards each approved transaction to the appropriate issuing bank.

4. Usually within 24 to 48 hours of the transaction, the issuing bank will transfer the funds less an
“interchange fee,” which it shares with the credit card network.

5. The credit card network pays the acquiring bank and the acquiring processor their respective
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6. The acquiring bank credits the merchant’s account for cardholder purchases, less a “merchant
discount rate.”

7. The issuing bank posts the transaction information to the cardholder’s account. The
cardholder receives the statement and pays the bill.

Credit Card Processing Fees & Costs

For the convenience of their customers, many merchants accept credit cards as payment. But you
may have wondered why some merchants will accept only cash or require a minimum purchase
amount before allowing the use of a credit card. Here’s why: Merchants must pay a price to accept
credit card payments. Hence, most will seek the cheapest credit card processing rates or mark up
the prices of their products so customers’ payments can absorb the card-processing cost.
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Depending on the type of merchant and through which platform a good or service0 is delivered (e.g.,
at the retail store, through e-commerce or by phone), credit card processing rates will vary. They
usually are charged as flat fees, per-transaction fees or volume-based fees. For the purpose of this
guide, only major costs will be explained below:

Merchant Discount Rate: Merchants pay this fee for accepting credit card payments and receiving
service from acquiring processors. It’s usually between 2% and 3% (online merchants pay the higher
end) — to as much as 5% — of the total purchase price after sales tax is added. Also known as a
discount fee, this rate comprises several components:

Interchange Fee: The acquiring bank and acquiring processor pay this fee to the issuing bank.
It is market-based and set by each credit card network (except American Express). Visa and
MasterCard, for instance, update their interchange rates twice per year. Most interchange fees
are assessed in two parts: a percentage to the issuing bank and a fixed transaction fee to the
credit card network. For instance, the per-swipe fee might be 2.35% plus $0.15.

Interchange fees vary and are categorized through a process called “interchange
qualification,” which determines the rate based on several criteria:

Physical presence or absence of the card during the transaction

Processing method used (e.g., swiped, manually entered or e-commerce)

Credit card company

Card type (e.g., regular, premium, commercial, rewards or government-issued)

Merchant’s business type (as determined by merchant category code)

Assessments: Credit card networks (except American Express) charge this fee for transactions
that are made with their branded cards. It usually is based on a percentage of the total
transaction volume for the month. The fee usually is fixed, and the merchant’s acquiring bank
may not charge a lower rate or negotiate a better deal with the merchant. Assessments
generally are charged per transaction but can vary depending on the pricing model the
merchant follows. For instance, Visa might charge a 0.11% assessment plus $0.0195
processing or usage fee for each card swipe. Assessment amounts may change
periodically. Combined with the interchange fee, assessments constitute between 75% and
80% of total card-processing costs.

Markups: Acquiring banks and acquiring processors usually will include a markup over
interchange fees and assessments partly as profit and partly to cover the cost of facilitating
credit card transactions. It constitutes between 20% and 25% of total card-processing costs.
Merchants generally can negotiate the markup with the entities that charge them. Markups
vary by processor and pricing model. They may also include other types of fees.

Chargebacks: Customers reserve the right to dispute a charge on their credit card billing statement
within 60 days of the statement
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it charges the merchant between $10 and $50 as a penalty and for issuing a “retrieval request.” If
the merchant doesn’t respond to the retrieval request within a certain timeframe, it could incur
additional fees. The merchant may appeal, but the process is long and likely to favor the customer. If
the merchant loses, the issuing bank will recover, or charge back, the customer’s payment.

When a Credit Card Transaction Gets Declined

Getting your credit card transaction declined is never enjoyable. It’s embarrassing. But the rejection
of a credit card can be caused by other reasons besides maxing out the card.

When a credit card is declined, the point of sale (POS) terminal will return a response code that
explains why. Sometimes those codes don’t tell the full story. In those instances, only your credit
card issuer can identify the particular reason for the rejection, so you may need to call customer
service to resolve the problem.

Below are some of the most common issues you might encounter if your card gets declined:

Incorrect credit card number or expiration date

Insufficient funds

Some credit card companies reject international charges

The issuing bank or credit card company experienced technical issues while your transaction
was being processed

If the customer made a large number of online purchases within a short period of time, some
banks will reject several of the charges as a fraud-prevention measure

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DISCUSSION

Your thoughts?

Submit

@pastorev8
June 29, 2020

Should credit card usage fees be calculated pre-tax or post tax?

Reply (1)

Doug Mack @thedougmack

September 17, 2020

I think you're asking in reference to surcharging your customers. If your terminal is doing it
automatically as it should---technically a requirement to produce a proper receipt--it is
based on the total transaction amount.

Doug Mack
25-year payment veteran and CEO of Brightr Payments
Donating 50% of top-line profits to charity.
www.brightrpayments.com
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9/28/2020 How Credit Card Transaction Processing Works: Steps, Fees & Participants

Reply 0

Richard Garrison @rgarrison

May 20, 2020

This article is pretty cool... It would be awesome if the language that currently describes how
transactions are routed could be expanded to include what the consumer of the transactions is
actually doing. For example, "the merchant sends the approved authorizations in a batch to the
acquiring bank or processor", doesn't explain what the 'acquiring bank or processor is doing with the
'approved authorizations. Whereas, "acquiring processor routes the batched information to the credit
card network for settlement" actually defines the process the 'credit card network' is going to
execute ('settlement').

Reply

@sliktopper
November 1, 2019

How does the debit card flow differ from this?

Reply (1)

Doug Mack @thedougmack

September 17, 2020

@sliktopper -- The process itself is essentially the same. The pricing is different and
instead of being set by the credit card network (eg. Visa) it's set by the debit card network
(eg. Star). Hope that helps.

Doug Mack
25-year payment veteran and CEO of Brightr Payments
Donating 50% of top-line profits to charity.
www.brightrpayments.com

Reply

@gate420
August 24, 2019

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9/28/2020 How Credit Card Transaction Processing Works: Steps, Fees & Participants
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What information does a retailer get when you swipe your card? My friend was asking becasue he
got a charge to his credit card without putting in his pin or giving the 3 digit code at the back. The
charge isn't unauthorized but we don't understand how the retailer was able to put the charge
through without him using his card and pin.

Reply

@naman_sang
June 18, 2019

Just the article I was looking for. Referred a lot many online but every article had a piece of
information missing. This is the one I felt joy after having gone through and cleared the fog in my
mind.

Thanks!

Reply

@tkrukoff
February 25, 2019

How can a bank approve $8,000 of charges which exceeded the approved credit limit?

Reply (1)

Doug Mack @thedougmack

September 17, 2020

Approvals are given by the card-issuing bank. So it is 100% at their discretion on whether
to approve or decline.

Doug Mack
25-year payment veteran and CEO of Brightr Payments
Donating 50% of top-line profits to charity.
www.brightrpayments.com

Reply

Anonymous
April 11, 2019
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9/28/2020 How Credit Card Transaction Processing Works: Steps, Fees & Participants
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There is a percentage(%) buffer set above the approved credit limit till which you can
spend
For eg. If your card limit is $10000, then there is an overload limit set lets say 10% so you
can spend $1000 above your limit

Reply

Miss Wendy @wandalbyrd

February 6, 2019

I accidentally overcharged a credit card. What steps do I take to correct the transaction?

Reply (2)

Doug Mack @thedougmack

September 17, 2020

If the transaction is the same day, you want to "void" the transaction. If it's any day
thereafter, you will need to run a "refund/credit". Most all credit card processors charge
based on GROSS sales -- not net. So if you processed a card for $1000 and only meant to
run it for $100, you do NOT want to run a refund for $900 as you'll be billed on the
original $1000. However, if you VOID the $1000, it's as if the transaction didn't exist in the
first place and you are only charged the transaction fees -- not interchange/percentage
rates.

Doug Mack
25-year payment veteran and CEO of Brightr Payments
Donating 50% of top-line profits to charity.
www.brightrpayments.com

Reply

Anonymous
February 12, 2019

Contact to your card provider.

Reply

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Anuj Gaonkar @anujgaon
January 9, 2019

How does a merchant send a batch of approved transactions to the acquirer at the end of the
business day ? Is it a manual process ?

Reply (3) · View All

Anonymous
November 13, 2019

No it's an automated process.The data is normally stored in a file or table(data base). The
account is updated at around midnight.

Reply

@rajeshjnu06
January 13, 2019

Yes it is manual like doing a txn .

Every terminal has an option and merchant process settlement at the end of the business
day.
It is very simple as all txn stored in a single Batch with different invoice number.

Reply

@sheluvscntry
September 20, 2018

I am a small business who accepts cc and charges a convenience fee I then post those payments to
my customers account once they have been approved. Do I add the fee on the customers account
so the fee reflects on their billing statement since it is included in the amount I actually charge?

Reply

@sujit_shaw
August 22, 2018

When a credit card is declined , Does the network (Visa,MC,AMEX,Discover) charge any party
(Merchant/Gateway/Processor/Issuing Bank)?
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Reply 0

@ashokdeiva
October 2, 2017

What does an offline transaction mean?

Reply (4) · View All

Anonymous
March 26, 2018

@ashokdeiva: I am in Dubai.. I received my new card on 15 March 2018 and was advised
that my first bill will be generated on 6th April 2018. But suddenly on 25 \\March 2018 my
main account balance got deducted with an amount of money in the name of credit card
recovery without any notice or prior info. I lodged a complaint same time and waiting for
resolution. Is it a human error ? Happened by mistake ?

Reply

Saurabha Sahu @saurabhasahu

March 26, 2018

Hi Ashok, Please find the details:

Offline debit card networks
The second component of the ATM and debit card infrastructure is offline debit card
networks. Offline debit card networks are a telecommunications/payments infrastructure
linking consumers, merchants, and banks. There are two offline debit card networks, one
run by Visa and the other by MasterCard, which essentially piggyback off the card
associations’ credit card networks. Visa has named its offline debit product Visa Check
Card and MasterCard refers to its product as MasterMoney. The physical components of
the offline debit network consist of POS terminals, telecommunication connections,
apparatus that route transaction information to appropriate parties, and computers that
store deposit and transaction information. Information necessary for the authorization of
an offline debit transaction as well as information for processing the payment follow the
same infrastructure routes as for credit card transactions.
Two characteristics distinguish offline debit transactions.

First, transactions are signaturebased.

Second, consumer accounts are debited one or two days after the transaction (that is,
there is a lag before funds are deducted from demand deposit accounts).

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To complete this section, it may be useful to emphasize the similarities and
between online and offline debit transactions. Both transactions are conducted at a POS
terminal. Both represent payments in exchange for goods or services. But online debit
requires the use of a PIN and funds are debited immediately, while offline debit does not
require a PIN and funds are not debited immediately. Online debit transactions are
processed over an EFT network. By contrast, offline debit transactions are processed over
credit card networks. Online debit allows the consumer to obtain cash back at the point of
sale, while offline debit does not. Finally, consumers and merchants face differing fees for
online and offline debit.

Saurabha Sahu

Reply

Sebrina Taylor @sebrinat

April 30, 2016

Really need a credit card.

Reply

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