At first glance, credit card processing appears simple. A customer swipes or taps their card, or enter their information into a form in an online shopping cart, and, almost instantaneously, the transaction is complete. Behind every transaction, however, is a far more complex process, which, while it appears to take only seconds, involves multiple steps and many actors working behind the scenes.

Understanding the credit card transaction process is important for business owners since payment processing represents one of the biggest costs that merchants incur in running their business. The following provides an overview of the process that takes place with every transaction — from start to finish.

The Key Players

The key players involved in the authorization and settlement of a credit card transaction are the cardholder, the merchant (business), the acquiring bank (the merchant’s bank), the issuing bank (the cardholder’s bank), and the card associations (Visa and MasterCard.)

The Cardholder

If you have a credit or debit card, you’re already familiar with the role of the cardholder. The cardholder is someone who obtains a credit or debit card from a card issuing bank. The cardholder presents that card to merchants as payment for goods or services.

The Merchant

A merchant is any business that sells goods or services and accepts debit and credit cards as payment for those goods and services. In order to accept debit and credit cards, the merchant must have a merchant account that enables them to accept credit or debit cards as payment from customers (cardholders) for goods or services provided.

The Acquiring Bank (Merchant’s Bank)

The acquiring bank (also referred to as the merchant bank) contracts with merchants to create and maintain merchant accounts that allow a business to accept credit and debit cards.

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. The acquiring bank also deposits funds from debit and credit card sales into the merchant’s business bank account.

Many merchants don’t recognize their acquiring bank as the primary provider of their merchant account. This is because acquiring banks often enlist the help of third-party independent sales organizations (ISO) and membership service providers (MSP) – like Fortune Payments to conduct and monitor the day-to-day activities of their merchant accounts.

The Acquiring Processor/Service Provider:

This third-party entity is sometimes an arm of the acquiring bank. A processor provides a service or device (such as credit card machines, point of sale systems, software and online gateways) that allow 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.

The Issuing Bank or Cardholder Bank

The issuing bank issues credit cards to consumers. The issuing bank is also a member of the card associations (Visa and MasterCard).

Issuing banks pay acquiring banks for purchases that their cardholders make. It is then the cardholder’s responsibility to repay their issuing bank under the terms of their credit card agreement.

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, Discover and American Express. In the transaction process, a 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.

The association members also function as the governing body of a community of financial institutions, ISOs and MSPs that work together to support the credit card processing and electronic payments system.

The primary responsibility of the Card Association is to govern the members of their association, including interchange fees and qualification guidelines, act as the arbiter between issuing and acquiring banks, maintain and improve the card network and their brand.

The 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.

How Credit Card Processing Works: Step By Step

Credit card transactions are processed through a variety of platforms, including brick-and-mortar stores, e-commerce stores, wireless terminals, and 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, as the “clearing” and “settlement” stages take place simultaneously.

Step 1: Authorization

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

1. The first step in credit card processing happens when a cardholder swipes or dips their card, or otherwise provides their card information (eg. when shopping online) to the merchant.

2. Next, the merchant collects the payment information. This can be done in a number of ways. The payment can be accepted physically with a credit card machine or point of sale system. In the case of online shopping, merchants use an online gateway to collect the payment from their customer.

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. Your customer’s card will engage with one of the major credit card networks — the most common ones are Visa and Mastercard. Once the networks receive the payment information from the processor, they pass it to your customer’s 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

Stage 2: Authentication

n 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.

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

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.

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.

The message that the payment has been requested or denied flows back through the same channels it did to get to the cardholder’s bank. When the transaction is handled in-person, this usually corresponds with a message on the card reader like “Approved” or “Declined”. Assuming a transaction is cleared, the merchant is expected to provide the customer with whatever goods or services were promised in return for the payment.

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

It’s important to note that at this point no funds are released yet, meaning the transaction is not completely settled. Settlement is a separate process that can take up to several days to complete, depending on the card networks involved.

Generally speaking, Visa and MasterCard transactions tend to settle faster than American Express. The process of settling a transaction and releasing the funds from the cardholder bank to the merchant bank involves the same players described above, with the flow of communication being very similar.

Part 3: Clearing and Settlement

You’ve made the sale. Depending on your business, your customer has either left your store, logged off your web site or hung up the phone and considers the sale complete. For you, however, the transaction is still in process, since it must now be cleared and settled.

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.

Settlement is the process of managing electronic payment transactions so they can clear and be funded. To make this happen, you, as the merchant, must present approved card transactions to your merchant services provider. Your provider then submits those approved transactions to the payment brands for clearing through interchange. These transactions are typically referred to as “deposit” transactions.

How Settlement Works:

At the end of each business day, the merchant sends the approved authorizations in a batch to the acquiring bank or processor. For example, the merchant would use their point-of-sale device to trigger, or “batch”, a settlement.

The acquiring processor routes the batched information to the credit card network (eg. Visa, MasterCard, American Express) for settlement.

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

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.
The credit card network pays the acquiring bank and the acquiring processor their respective percentages from the remaining funds.

The acquiring bank credits the merchant’s account for cardholder purchases, less a “merchant discount rate.”
The issuing bank posts the transaction information to the cardholder’s account. The cardholder receives the statement and pays the bill.