February 25, 2010

How does payment processing work?

On average, it takes three seconds to process a credit card payment. In this time, several organizations must relay data and funds to each other to authorize and settle a transaction. There are six parties involved in payment processing: the customer, the merchant, the payment processor, the credit card association, the card issuing bank, and the underwriting bank. These parties work together in the payment process.

The parties: who’s involved

• The customer — In order for any transaction to occur, there must be a customer who wants to pay for a product or service with a credit card.
• The merchant — The merchant is the business or individual accepting the credit card payment. The merchant must have a system capable of processing credit card transactions.
• The credit card association — Credit card associations like Visa and MasterCard provide authorization, clearance, and settlement services. Credit card associations partner with the card issuing bank, who provides credit.
• The card issuing bank — The card issuing bank provides credit and the physical credit card to the customer. The card issuing bank also authorizes or declines the transaction depending on a number of factors, most importantly how much credit is available to that customer.
• The underwriting bank — The underwriting bank works with the payment processor to provide a merchant account. The underwriting bank takes on some of the chargeback risk of a business, and provides deposits into the merchant’s bank account. The underwriting bank is sometimes referred to as the acquiring bank or acquirer.
• The payment processor — The primary role of the payment processor is to collaborate with an underwriting bank to offer merchant accounts. The payment processor also manages the flow of information and funds during payment processing. Additionally, the payment processor may provide ancillary products and services such as payment gateways, point of sales terminals, and fully integrated payment systems.

Payment processing: how it works

There are two parts to payment processing: authorization and settlement.

Authorization

1. The customer makes a purchase and provides credit card information to a POS terminal.
2. The POS terminal encrypts and relays the information to the payment processor. The payment processor uses a payment gateway to relay the credit card data to the Visa/MasterCard network.
3. The payment gateway verifies credit card information by asking the appropriate credit card association for charge approval.
4. Upon receiving the request for charge approval, the credit card association asks the card issuing bank to approve the charge.
5. The issuing bank accepts or declines the charge and relays the message back to the credit card association. The credit card association transmits the message to the payment gateway. If the card is approved, the customer is notified that the transaction is complete.

The entire authorization process takes approximately two to three seconds.

Settlement

1. The card issuing bank sends payment to the credit card association. The credit card association transfers the payment to the payment processor. The payment processor deposits the full amount into the merchant account.
2. The underwriting bank transfers the deposited funds from the merchant account to the merchant’s business account. The merchant can then access the funds from his or her business account.

The entire settlement process takes approximately three days.