How credit card works

Credit cards have made life so easy for us and it will not be wrong to tag credit cards as one of the greatest innovations of financial world. Since they have arrived, cash has lost its significance. Earlier whenever somebody wanted to do some costly purchasing he had to undergo a lengthy and risky process. You need to go to the bank, carry a lot of cash with you, reach the shop, make payment and then take the delivery. The process was both time consuming and painful. As credit card has added wings to our spending power, it’s worth knowing how the whole system operates.

 


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How all the transactions complete without a single rupee getting transacted in cash? Through this article let’s try to understand the functional overview of whole system.

 

What all entities are involved in the credit card transaction?

There are basically five entities involved:

1.     The end user – This is the person who owns the credit card issued by an issuer bank. He gets an interest free credit for approximately 50 days and a spending limit that varies from 10000 to more than 1 lakh at times. After the free credit period he has to pay an agreed interest rate on outstanding amount to the issuer bank.

2.     Merchant - Merchants are basically who accept the payment through credit card and provide goods and services in return. These are the physical shops or online stores where either you swipe your card or provide the credit card details.

3.     The Merchant Bank – This is the bank with which the merchant has the direct relationship. This is the bank which actually deposits the amount you paid for purchase in merchants account.

4.     The Issuer Bank – This is the bank which actually issues the credit card to the end user. Issuer bank takes care of the credit limit, interest rate and other terms and conditions of the issued credit card. The payment which the end user makes after the free credit period goes to the issuer bank. The debt collection from the end user is the concern of issuer bank and merchants have nothing to do with it.

5.     The Network Service Providers – This whole business runs on the network of various financial institutions. This networking service is taken care by the service providers like MasterCard and Visa. They are the one responsible for making the whole process smooth. For their service they charge fees from the financial institutions on the network.

 

Credit Card Transaction – From Start to End

You go for shopping and purchase a nice jacket for you. The merchant asks if you will pay by cash or card. You say card and he swipes it in his machine and keys in the amount of purchase there. Your credit card data and the transaction amount are transmitted to the merchant’s bank for authorization. Merchants bank in turn transmits the data to credit card issuer bank for authorization. If your credit card details are valid and credit limit equivalent to purchase amount is available, the card issuer bank returns a green signal to the merchant’s bank. Merchant bank passes on the authorization received to the merchant and a sales receipt is generated on the swipe machine. You sign the receipt, take the jacket and happily leave the store. At the bill generation date the card issuer sends you the credit card bill and you have to make the payment to the issuer bank by the means which you both have agreed upon. What happened to the merchant? He has yet not received a single penny from anywhere. Don’t worry he is safe and has not sold for free. In the evening he sends all the sales and credit card data for the whole day once again to merchant bank for payment. The merchant bank transmits the data to the card issuer bank and the card issuer bank makes the payment against the sales receipt to the merchant bank. After receiving the total amount from the issuer bank the merchant bank transfers the amount to the merchant account. This whole transmission of data inside the network happens with the help of the setup of service providers like MasterCard and VISA. The cycle completes here and end user pays the issuer bank at the end of the free credit period.

 

 

How the Merchant Bank, Network Service Providers and the Issuer Bank earn money?

When issuer bank transfers the money to the merchant bank against the sales receipt it deducts some service charges of which some part is paid to the network service providers like MasterCard and Visa. Similarly Merchant Bank deducts some service charges when it transfers money to the merchant’s account. At the end of day it’s the merchant who pays for the whole show. He pays them because he is relieved from the pain of handling cash and running to bank every now and then. This is the reason some times they insist on extra payment of 2% from the card holders as the total cost of this service is round 2 % of the transaction amount. There is one another way the card issuer bank earns a lot of money. To find out that other means you need to be a bit lazy. Just do not pay your next credit card bill on time and you will automatically come to know what I mean to say. The whole credit of this show goes to the excellent network of financial institutions which is running seamlessly to sustain the ever growing credit card business. Let’s thank them from core of our heart for their great job.

For a good infographics on “How credir card works” please visit  http://www.truemerchant.com/infographic-credit-card-payment-processing-how-it-works/

 

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