How Do Credit Card Transactions Work?

The Parties Involved In the Transaction

Consumers often choose to pay for purchases by credit card, usually because it's easy and convenient. The issuer of the credit card actually is lending money to the cardholder to be paid to a businessperson or merchant. In most cases, a credit card is swiped through a machine known as reader. If the card issuer approves the transaction, an acquiring bank, which receives credit card transactions from the merchant, then credits the merchant's account. The merchant pays the acquiring bank a fee for processing the transaction. Once approved, the card issuer posts the transaction to the customer's account. At the end of the billing period, the cardholder receives a monthly statement from the issuer, at which time payment must be made.

What Happens At the Point of Sale

Swiping the credit card through a machine at the point of sale allows the information from the magnetic stripe on the back of the card to be read. The machine transmits the credit card data to the bank that issued the card in order to verify that the account exists. If there is enough credit in the account to cover the sales transaction, the issuing bank generates an authorization code, and then places a hold on the cardholder's account for the amount of the sale.

Organizations Involved In the Transaction

In addition to a credit card company (e.g. Visa, Mastercard, Discover) there are two banks involved in most credit card transactions--the acquiring bank that handles the merchant's credit card account and the bank that issued the credit card. Information must be passed among these three organizations quickly in order for a credit card transaction to be processed successfully. Since there are thousands of banks which issue credit cards, the credit card company's computers and the card issuer's computers work together so that the merchant is able to communicate only within that particular network.

The Batching Process

All authorized credit card transactions are stored in batches and submitted to the acquiring bank at the end of each day. The acquiring bank then sends the transactions through the credit card association, which debits the card issuer for payment and credits the acquiring bank. In essence, the issuer is paying the acquirer for the transaction. Once the card issuer pays the acquirer, the acquirer pays the merchant. The acquiring bank deposits the amount of any sales drafts submitted by the merchant, less the discount fee, into the merchant's bank account.