What I want to do is give a reasonable understanding of the different players involved with that issue and process your credit cards.
Processors
So let’s start with the processors, Sometimes you could say that the network or the processors or the people that maintain the credit card networks and examples of those are Visa, MasterCard, American Express, and Discover, and what they do is they essentially maintain networks of IP and policies that connect a bunch of banks. But for just the sake of this article, let’s do it very simple math.
Example Networks
So let’s say that this is network 1 and maybe that’s Visa. Maybe this right here is a network to this right here could be MasterCard. MasterCard and right now, the networks are just circles, but you’ll see their networks as I build out this explanation diagram, let’s say that I’m some bank out there.
Bank A and the Network
I’m let me call myself Bank A and I decided, you know what, it would be good for my business, for me to issue a credit card, I can extend credit to my customers, and they’ll pay me interest. Maybe I’ll make some fees off of that and I’ll it’ll be a good business for my bank. So I go up to, let’s say, Visa and I say, hey, can I be a member of your network? Visa has some policies and if you’re, I guess, a legitimate bank and you agree to all those policies, you’ll become a member of that network.
Other Banks on the Network
So I’ve joined that network and I’m, of course, not the only person on that network. There are tons of other banks on that network. So that could be Bank B, this could be Bank C, this could be Bank D, and of course, each of these are network. So they all have their member banks on them. That’s MasterCard‘s network right there and so in this situation, they’ll come up to, let’s say I’m a customer of a bank.
Credit Card Issuance
They say you want a credit card, and I say, sure, that’ll be convenient. I don’t like carrying cash in my pocket. So give me a credit card and they’ll issue a credit card that looks something like this, the credit card. I think we’ve all seen credit cards will say bank a big up at the top. Bank A, I’ll have a credit card number. That’s unique to me, my credit card number and my name will be there if I’m of maybe an expiration date, and then here in the bottom right corner, they’re going to say what network I’m a part of.
Credit Card Details
In this case, it would be Visa. A credit card issuer over here would say MasterCard or if it is American Express, but American Express here and maybe there’s some type of a hologram. So great.
I have a credit card here. I think we all have a general sense. I could use it and then I’ll build a balance. And then in the future, I could pay off that balance to the bank or I could carry a balance and they’ll charge me interest, which is usually reasonably high interest. So I want to pay it off fairly quickly. But how does this work in the context of a network?
Transaction at a Grocery Store
So let’s say I go to some grocery store over here. I’ll say, gee, for groceries and I buy a hundred dollars worth of groceries and I want to pay with my newly issued credit card. The grocery store, if they accept credit cards, needs to have some relationship with another bank someplace on this Visa network for them to accept a Visa card. So let’s say that they have a relationship with Bank B. This would be the merchant bank where we can say the retailer’s bank or it’s often in credit card lingo called the acquiring bank or the acquirer and you might wonder why is it called the acquirer.
Role of the Acquiring Bank
It’s called the acquirer because this is the player that goes out and goes to each of the merchants and says hey, right now you only accept cash or you only accept American Express. Wouldn’t it be great if you also accepted Visa or MasterCard? That way you’ll have more appeal to more customers and, you know. Every time it will be more convenient for your customers + every time a transaction happens, we’ll just take a little bit of a cut of that transaction and so they go out and acquire different retailers.
Acquiring More Retailers
This was the example of a grocer. Maybe Bank B goes off and acquires the shoemaker or Maybe he goes and he gets the I don’t know, gets to the tailor on the network. These are all different. Retailers will now all of a sudden accept Visa because they’re their bank. Their merchant bank is a member of the visa network. Likewise, it could have been a member of the MasterCard network. It doesn’t matter. This is the processor and this is their network. Now, this guy, Axwell, we use in this context, he would accept Visa. So I would give him my Visa card in the first process called authorization, and that’s literally to check whether I’m good for the money, whether this card is valid to buy a hundred dollars worth of, let’s say groceries. So when I swipe the card or when the grocer swipes the card, it’s going to send a message from that little point of sale unit to the acquiring bank that’s going to be forwarded to Visa. Then Visa API will say, oh, that’s bank a card, and it’ll give the number to the bank on its proprietary network. Then the Bank will look into their database, and say, oh yes, I’ve got a thousand dollars of credit. He hasn’t used any of it. He is good and authorizes the transaction. That message goes back through the network to Bank B, and so then we get authorized, and then the transaction goes forward and eventually, you know, as you can imagine, you can’t just authorize the transaction and then just walk away with the groceries.
Expectation of Payment
At some point, this guy here expects to get his money back for giving me the groceries. He expects to get one hundred dollars back and that one hundred dollars is going to come from Bank A, but they’re not he’s not going to get a complete one hundred dollars because each of these players, they’re providing a service. This guy, he’s plugged into the network and he’s offering credit. So he’s offering credit. He’s offering credit, the network operator of the processor is offering their network and there are other services, they might provide different security mechanisms if they say, hey, Sal lives in Chicago, but all of a sudden he’s buying one hundred dollars worth of groceries in a Saltzberg or someplace, you know, that would seem unlikely that it might send some type of a warning trigger so these players might have their security mechanisms, but they’re all providing it as a service.
Services Provided
This guy is going out there. He might be providing the actual point-of-sale terminals, the actual network. So they’re all going to get a little bit of a cut of things and so out of the hundred dollars, I got one hundred dollars worth of groceries, 100 dollars worth of groceries. There will be a two percent and it’s not always two percent, I’m just kind of saying that as a round number, but it also is a ballpark not completely outlandish relative to what tends to be the case. So of that hundred dollars that this guy received for groceries, he has to pay two percent fees. He’s got to pay well, regardless, right that way he’s got to pay two percent, or in this case, it would be 2 dollars. That’s two percent of one hundred dollars.
Discount and Fees
He’s got to pay a two-dollar discount. To his acquiring bank to acquire and you might say gee, from the acquirer, that’s great, they got two dollars, they get two percent of all of these guys transactions. But of course, they’re going to have to share it with these other people up here, and the bulk of it ends up with Bank A, so of this two dollars and I’m doing it in a round-about Numbers Bank. So now we’re going to split up the two dollars Bank A is going to get, let’s say, a dollar seventy and these aren’t that far off from what the real numbers might be and they change and they depend on the banks, and the network and all of that + the networks might change their rates.
Interchange Fee
One dollar seventy goes to Bank A. So the issuing bank besides now, You know now that I have a credit balance, will be able to charge interest on it. It also got a dollar seventy for that transaction, that dollar seventy of the two dollars. This is called an interchange fee. The interchange fee generally gets set by the individual networks, although the networks don’t share that interchange fee, they just say our standard fee is X percent of transactions plus, I don’t know, 10 cents, and that that’s what Bank B is going to pay to Bank A. So it’s essentially bank A cut of the discount rate of the two dollars. This guy is charging that guy and then the network and they make their money in several ways, but in general, they make money off of every transaction as well. So this situation, they make roughly about 1000 of the transaction or zero point one percent. So in this example, 10 cents of this discount rate that this guy charged would go to the processor or the network, so every time you transact with the processor, get a small fraction of your actual purchase and then this guy will be left with 30.
Splitting the Fees
We’re coming from two dollars. This guy is going to be left with 20 cents. So when the whole transaction gets settled, which essentially means everyone gets the money they need to get it, this bank is going to send Visa’s settlement bank a hundred dollars minus the dollar 70 that it gets to keep as part of its interchange fee. So he’s going to send to Visa. What is that? That’s ninety-eight dollars. Ninety-eight dollars and 30 cents to Visa. The visa will keep 10 cents of it, and send it to the acquirer. So the acquirer is going to get ninety-eight dollars and 20 cents and then the acquirer is going to keep 20 cents for itself and give the retailer and give the retailer ninety-eight dollars.
I know my numbers aren’t exact. But I want to give you a general idea of how all this works. So for this retailer to be able to use all of this infrastructure out there, he essentially had to pay two percent of the actual transaction. That’s always not going to be two percent, but it gives you a nice round figure. So this guy benefits because he gets access to a network. It’s convenient for the customers. This guy is getting some type of fee. The more retailers he signs on or the more retailers he acquires, the more cuts of transactions he’s going to make. Visa makes a small cut on many transactions and that’s where they make their money and they have to use some of that money to support all of this infrastructure.
Because then Bank A is going to make that interchange fee, which was the bulk of really that discount rate, that retailer discount rate not related at all to the federal funds discount rate, and then, of course, they extended credit to me so that one hundred dollars might not be paid immediately. They might be able to charge me 15, 20 percent annualized percentage rate interest on that money until I pay it off and of course, I have some type of minimum balance to pay.
