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Confession: I'm a nerd. Spent the whole morning learning about how a credit card works. Surprisingly, it's incredibly complicated. Here's what I've learned.
1/ There are five main parties involved.
- Consumer
- Issuing bank
- Card network (Visa/Mastercard)
- Acquiring Bank aka merchant banks
- Merchants
- Consumer
- Issuing bank
- Card network (Visa/Mastercard)
- Acquiring Bank aka merchant banks
- Merchants
2/ Consumers
- People who buy stuff
- People who buy stuff
3/ Issuing bank
- The bank that gives consumers credit cards. The risk is placed on these banks' shoulders (will be helpful to remember this).
- The bank that gives consumers credit cards. The risk is placed on these banks' shoulders (will be helpful to remember this).
4/ Card networks
- Acts as a toll-booth, connecting issuing banks and acquiring banks.
- Sets the interchange fees (which we'll cover in a sec)
- Acts as a toll-booth, connecting issuing banks and acquiring banks.
- Sets the interchange fees (which we'll cover in a sec)
5/ Acquiring banks
- The bank responsible for holding merchants' money.
- Sometimes these banks also act as acquiring processors. Ex. Chase has merchant accounts and it can do the processing with Chase Paymentech.
- The bank responsible for holding merchants' money.
- Sometimes these banks also act as acquiring processors. Ex. Chase has merchant accounts and it can do the processing with Chase Paymentech.
6/ Merchants
- Stores, retailers, etc.
- They sell stuff.
- Stores, retailers, etc.
- They sell stuff.
Ok back to the interchange fees.
- When you swipe your credit card at Starbucks, the transaction data is sent through the chain of command, first to the acquiring bank, then the card network, then to the issuing bank, which bills your credit card statement.
- When you swipe your credit card at Starbucks, the transaction data is sent through the chain of command, first to the acquiring bank, then the card network, then to the issuing bank, which bills your credit card statement.
But now that the transaction data has flowed through the system, the money data has to flow back through, but each party will take a little bit in fees.
Let's say your purchase from Starbucks was $4.
- The issuing bank, since the risk falls on its shoulders as mentioned, takes the biggest interchange fee (somewhere in the ball park of 2%.)
- Then the card network will take a cut, about .13%
- Then the acquiring bank will also.
- The issuing bank, since the risk falls on its shoulders as mentioned, takes the biggest interchange fee (somewhere in the ball park of 2%.)
- Then the card network will take a cut, about .13%
- Then the acquiring bank will also.
Here's an incredibly helpful diagram. Source: fin.plaid.com/articles/major… 
It gets trickier when talking about smaller merchants or online payments though.
- For instance, Square acts as a payment service provider, aggregating a bunch of merchants and then passing off the processing (to Chase I believe)
- The benefit is quick set-up and standardization
- For instance, Square acts as a payment service provider, aggregating a bunch of merchants and then passing off the processing (to Chase I believe)
- The benefit is quick set-up and standardization
It's similar in online payments. PayPal or Stripe acts as a gateway to hook merchants into this chain. Check the graphic below for it to make more sense or maybe less sense...I'm not sure.
Who knew online ordering could be such an ordeal...?😅
Square and Stripe and these disruptors in the fintech space are called aggregators because they essentially act as one big merchant account so set-up is very easy for small-medium sized businesses. The simplicity is why they have done so well vs. traditional merchant accounts.
/Fin
So that's how buying stuff on credit works. Card networks like Visa sit in the middle, taking mini-cuts of each transaction. Banks issue cards and take the risk. Merchants work with upstarts or traditional acquiring banks. And everyone takes a little cut.
So that's how buying stuff on credit works. Card networks like Visa sit in the middle, taking mini-cuts of each transaction. Banks issue cards and take the risk. Merchants work with upstarts or traditional acquiring banks. And everyone takes a little cut.
