Demystifying the payments ecosystem

Back in 2017, when I first entered the world of Fintech, I, being a new entrant, was quite vivacious and curious about this emerging space. I wanted to understand the nuts and bolts of this fascinating and ever-evolving world. Sounds easy, right?

It hasn’t been such. There are several players involved to execute a process that takes even less than one-fifth of a minute (in the range of 3–12 secs). To make matters more baffling, the names of different components are often used interchangeably. Many a time, the components have overlapping functionalities (This is usually because financial institutions often provide multiple services together, hence making it difficult to classify). Different payment glossaries held slightly different definitions. Some components even seemed redundant.

After a rollercoaster ride in this effort laden path of fintech space, I think I have been able to figure out some of it. So, here’s an attempt to distinctly explain the role of each of the players:

Different components and flow involved in a transaction (Source: First Data annual report)

Capture and Authorization

In the capture and authorization process, the transaction is approved by the issuing bank

1. Once the consumer makes a purchase, he or she presents their card details (let’s assume it is a HDFC VISA credit card)
2. For an offline transaction — The card is swiped in the Point-of-Sale (POS) device, which captures the account information contained on the card’s magnetic stripe of the card. For an online transaction, payment gateways performs the same functionality of capturing the card details
3. A payment gateway then encrypts this data for security and transmits it to an acquirer’s processor
4. The acquirer’s processor identifies the card network based on the first digit of the card (the first digit is known as the industry identifier). It then forwards the card details to the identified network (in this case VISA)
5. The payment network on receiving the authorization request identifies the card-issuing bank (HDFC here) and forwards the transaction to the issuer processor. Usually, the first 6 digit of the card (including industry identifier) represents the card issuer.
6. The issuer processor than evaluates the request on the basis of different parameters — availability of funds, fraud, and any other qualifiers
7. The issuer processor then approves or declines the transaction and relays this message to the payment network (VISA in this example)
8. The authorization approval is then forwarded by the payment network to the acquirer’s processor
9. The approval confirmation is passed on to the payment gateway/PoS which then completes the authorization leg of the transaction

Clearing and Settlement

In this process, funds are transferred and the transaction is completed.

10. This is usually a batch process, where the merchant submits a bunch of authorized transactions to the acquirer’s processor via. the payment gateway or the PoS device

11. The acquirer processor then classifies it based on the payment network and forwards it to each of the applicable networks

12. This data is then forwarded by the networks to the respective issuer processor (HDFC and also other banks depended on all the transactions that have occurred on merchant’s platform)

13. The payment network calculates net settlement amount for the merchant acquirer bank (this is the merchant’s bank and can be different from HDFC for this particular example) and the issuer bank (HDFC for this example) and then forwards the order to both the banks

14. Issuing bank transfers the funds to the acquiring bank and the money is credited into the merchant’s account

Some more clarifications:

• The terms acquiring bank and acquirer’s processor are often used interchangeably as large institutions usually provide both functionalities together. An acquiring bank is like a gatekeeper responsible for settlement of funds and dispute resolution. A processor is like a conduit to transmit data through the value chain. Similarly, issuing bank and issuer processor are often clubbed together
• Payment service provider: This is probably the most confusing term. Is it a payment gateway, a payment processor, or something completely different. In some explanations, it is referred to as the back-end where a gateway is the front end of a transaction. Again, super confusing. The most satisfactory explanation that I have found is — It is a broader term used to refer to players that offer services of a payment gateway, payment processor, and also ancillary services like risk management, etc.

Inspiration: First Data annual report

Let me know in comments if there are any technical aspects of the payment industry that you would like me to cover and I shall include them in this article.

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