What happens in the background when I pay with a card

It has been a while since I have used cash for transactions. Ever since I have moved to London, I use Apple Pay for most of my transactions. And when I am not using Apple Pay, I use my cards. I have always been amazed at how easy and seamless paying for something has become. With the goal of understanding how this works, I am writing this to help explain this business to myself in an easy way.

The Players

There are 5 main players in this ecosystem. There are a few differences between online and offline, but broadly this remains the same. The online also includes websites, browsers and apps as players, but the process largely does remain the same.

1. Cardholder / Customer:

This is easy. It is people like you and me, who have an account with a bank, and hold one of their credit or debit cards. We would use this card to buy things.

2. Merchant / Seller of goods and services:

This is easy too. It is the shop or person who is selling stuff. A little more specific here though, as all sellers do not accept cards. So here, Merchant / Seller are the ones which accept card payments.

3. Issuer bank

This is the bank which has issued Cardholder / Customer with the card. Once a transaction is made, it is the Issuer Bank which pays the Acquiring Bank the money for the good / services purchased. Ex: The banks we have accounts with: HSBC, Natwest, HDFC etc.

4. Acquiring bank

This is the bank with which the Merchant / Seller has an account with. This bank will provide the merchant all the tools (Point of Sale machines etc.) to be able to accept cards as a payment method. Sometimes, acquiring banks hire third-party companies to provide the tools to the merchants. But I am going to ignore this for the sake of simplicity. Ex: Adyen, Stripe, etc these are examples of Acquirers.

5. Payments network / Card Associations

This is the most interesting one. These are the companies which provide the infrastructure for all the above to communicate with each other. They are the “pipelines” or the “network” on which the payments ecosystem relies on. The main players are VISA and MasterCard. Other companies are AMEX, Discover etc. Their main responsibility is to set “Interchange rates” and act as intermediaries between all the parties so that billions of transactions can be done within seconds.

The Transaction

1. The cardholder swipes their card (or uses apple pay) with the merchant
2. The merchant uses their point-of-sale machine, software, or gateway (if online) to transmit the card information and details of the transaction to their acquirer bank. (Or a third party which will then transmit the information to the acquirer bank)
3. The Acquirer bank (or the third party processor) will use the Visa or MasterCard network to transmit the information to the Issuer bank of the card holder for approval. This would involve a check of whether there are sufficient funds or credit limit to complete the transaction
4. The Issuer bank will receive the information through the Visa or MasterCard network, and will complete the check which includes validity of transaction information, security checks, sufficient funds, etc. and send back an approval or decline message through the Visa or MasterCard network
5. Merchant will receive the response from its acquirer bank, and the transaction is complete

How is money being made?

Let’s assume a transaction amount of £100.

• The merchant receives £98
• The Issuer Bank receives £1.5 (Called the Interchange fees, because the Issuer bank bears the risk of the final payment)
• The Card Association (Visa / Mastercard) receives £0.3 to facilitate the transaction. It is also called Network Access and Band Usage (NABU).
• The Acquirer Bank keeps £0.2 to process the transaction

Even though it might appear that the merchant is losing out on £2, this system is actually win-win for everyone. Here is how:

• The cardholder can pay easily. She doesn’t need to worry about carrying cash (or even cards, in case of Apple Pay / Google Pay)
• The Merchant wins because she can accept different payment methods, which in turn drive sales
• All the other players - Issuer, Acquirer and the Network win through commissions, and scale of operations

I am over-simplifying this for my understanding. But this is a fairly complex system. And ever evolving.

Payment Service Providers and Apple Pay / Google Pay

Payment Service Providers (PSP) help ease the merchants, and enable them to take various methods of payments. They become an additional layer between the Merchant and the Acquirer Bank, and helping simplify the system for everyone. Some of the big names are: Stripe, Adyen, Razorpay, Worldpay, Ingenico, Square, AliPay etc.

Apple Pay and Google Pay make it easier for card holders to pay the merchants. So they add another layer of security and ease for the customer, and form an additional relationship between the card holder and the issuer bank.

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