Basics of Banking: 101
How do payments work?
Basics of Banking:101 is a series of short articles on understanding the Banking domain for anyone starting their journey in the Fin-tech world of startups.
7 essential concepts to know about payments for anyone in a fin-tech startup!
This article is a compilation of various terms and concepts that one would use in a fin-tech startup on a daily basis. Therefore, I thought of curating a single source of reference for myself and others like me to reflect on these continually.
1. What is a Card ?
It is a type of payment instrument(physical or digital) to make online payments as an alternative to cash transactions. A card could be of various types like credit, debit, prepaid, etc.
BIN: Bank Identification Number
It is the initial 4 to 6 digits that appear on the card. (credit, debit, prepaid, etc.)
- The first digit identifies the card issuer’s industry also known as the Major Industry Identifier(MII)
- BIN is also interchangeably referred to as Issuer Identification Number (IIN)
- The remainder of the 16 (or 15, in some cases) digits make up the cardholder’s account number
- The last digit is called the checksum digit calculated using Luhn algorithm
After entering the first four to six digits of the card while doing any online / POS transaction, the retailer can detect:
- which institution issued the customer’s card,
- the card brand (such as Visa or MasterCard),
- the card type (such as a debit card or a credit card),
- the card level (such as corporate or platinum),
- the issuing bank country
Most importantly, the BIN allows any merchants to accept multiple forms of payment and speed up the overall processing.
2. Who is a Cardholder?
They are entities (real or legal) who own any of the card types (credit, debit, prepaid, rewards, etc.) These are the users who initiate the payment by allowing the card details to be shared with the merchants, which could be through either card-present and card-not-present transactions.
3. What is an Issuer / Issuing Bank?
These are the entities (financial/non-financial) that issue various cards (credit, debit, prepaid, etc) to their customers i.e. card holders, enabling them to make digital payments at retailers (online/offline).
These issuing banks work with card brands like VISA, Mastercard, Discover, etc. to issue co-branded cards to their cardholders.
4. Who is a Merchant?
Merchants are the online/offline retailers who accept the various types of cards as an instrument for making a digital payment.
The merchants collect the card details either by POS swipe(card-present transaction) or by taking it from the users online (card-not-present transaction).
5. Who is an Acquirer or an Acquiring bank?
It is an institution that sets up merchants with merchant accounts. They are responsible to complete the card processing for the merchants.
Once the transaction is approved by an issuing bank, the funds are then cleared by the acquiring bank and then the funds are deposited into the Merchant’s account (which could be with the Acquiring bank or some other bank).
6. Who is a Card Network Operator?
Network operators are the entities that process the transaction request by collecting the card details from the acquirers to send an authorization request to the respective issuing bank and forward the response from the issuer to the acquirers, to take the transaction further or not.
These are players like VISA, Mastercard, Discover, American Express, etc.
7. What happens during a card transaction?
- When a cardholder swipes a card at a merchant,
- merchant shares the card information to the card network via an acquirer or a payment processor,
- the card networks send an approval request,
- to the respective card issuing bank,
- the issuing bank then checks to see, if the cardholder has enough credit or not on their account for the requested transaction,
- based on the available funds with the issuing bank, the issuing bank then sends an approval or decline code, back through the card network and processor, back to the merchant terminal.
- the merchant terminal collects all the approved transactions as a batch, which is settled later (EOD mostly) and actual money is then transferred from the issuing bank to the merchant account via acquirer bank.
- the merchant provides a sales receipt generated by the POS machine to the cardholder.
For a better understanding please refer to this diagram below:
P.S. A lot of detailed information is not included in the article to keep it simple, and understandable. There are many other concepts involved during a card transaction, like clearing & settlements, interchange rates, chargebacks, etc. which I will cover in more details in another article or may update this one itself :)
If you would like to have more such articles or have questions, please comment below. I’d be happy to continue to add more to this compilation.