Basic card operation cycle

The first article of the payment technology series will focus on a basic card operation cycle as it would happen in any retail store online or offline. Throughout this article and all others in this series, I will provide some inside information (non-proprietary) on payment service providers and banks I have worked with to make the reading more tangible.

Within this use case, I will use an offline supermarket as the main example for a merchant. This supermarket uses any kind of a payment terminal which is able to read cards. The terminal was either provided by a bank or a payment service provider such as Ingenico, WorldPay or Adyen. If this example would depict an online merchant then instead of the physical payment terminal the merchant would be using a “checkout page” which uses a payment service provider’s proprietary technology to initiate the payment.

Sidenote: Ingenico’s business mainly consists of providing physical payment terminals while as Adyen, for instance, is primarily an online payment service provider.

For the sake of simplicity let’s assume that the terminal was provided by a bank. In this case, the bank will be referred to as the Acquirer bank (or bank A) because its sole purpose is to acquire the outstanding amount the customer is about to pay with their card. The supermarket or in general any seller will be referred to as the merchant. The acquirer bank, its terminal and the merchant all together form the what is depicted as NETWORK 1 (the acquiring network).

The customer, on the other hand, uses a payment card (credit card or debit card) which was issued to them by “another” bank. This “other” bank will be referred to as issuing bank ( or bank B) because in this example it is a different financial institution than the acquiring bank A. The issuing bank and its card together form what is depicted here as NETWORK 2 (the issuing network)

Sidenote: In another article I will go more into detail how a payment process looks like if the acquiring bank and issuing bank are in fact one and the same institution.

In order to pay for the goods purchased in the supermarket, a middleware is needed to establish a connection between NETWORK 1 (acquiring network) and NETWORK 2 (issuing network) because the banks are not able to communicate directly to each other. The middleware is also known as the payment scheme. This scheme can have very prominent labels such as Visa, Mastercard, Amex, etc.

In detail, the process looks as follow. When the customer pays with their card at the terminal the card will transmit very basic information bundled as a package (card number, pin code and expiry date). Based on the 16 digit card number the terminal will be able to read the payment scheme and route the payment request to Visa for instance. Based on the card number Visa will be able to identify the customer’s bank and re-route the request to the issuing bank (bank B).

Sidenote: It is important to know that the terminal the merchant uses for accepting card payments has to officially support specific payment schemes. If a terminal only supports Visa and the customer is trying to pay with a Mastercard then the transaction will not work. In many cases, the merchant decides before the terminal is installed in their store which payment scheme they want to support. The reason for this is that payment schemes charge the merchant a certain percentage of the purchase value as a fee. This is one of many revenue streams for credit card companies. Usually, AMEX has the highest fees and therefore very rarely is supported by merchants. In Europe, those charges are relatively small ranging somewhere between under 1% to max 2.5%. In the US these charges are much higher reaching an average of 4% per transaction value.

Once the transaction request reaches the issuing bank all the necessary validations will happen. The issuing bank will check the customer’s credit or balance and match it with the amount they want to pay to see if necessary funds are available. Furthermore, the bank will check the PIN-code and expiry date. In some cases, banks can perform additional security checks based on currency and location to identify fraudulent behaviour.

If the validation was successful an approval code will be sent back to the payment scheme which again sends it to the acquiring bank and the terminal will print a receipt. This entire process takes less than two seconds.

In the following articles, I will deep dive more into the different parts of this process.

As always, if you have questions, general feedback or would like to share your experience in the payment space please leave a comment. If you would like to contribute to this publication with interesting content on your own please reach out to me.