Payments

There are various players in the payments space.

Customer, merchant, payment processor, visa/Mastercard network/issuing bank/ acquirer ban etc., let's look at their roles.

The Payment Processor.

Once transaction is done by customer, it comes to payment processor.  The payment processor acts as the first line of defense against fraudulent transactions before sending information to Visa or Mastercard. Here are the key verification steps a payment processor typically performs:

1. Basic Information Validation: This is the most basic check. The processor verifies the following:

   • Card Number: Ensures the card number is a valid format (e.g., 16 digits for Visa) and hasn't been flagged as blacklisted.

   • Expiration Date: Checks if the card is expired and unusable.

   • CVV Code: Compares the 3-digit code on the back of the card with the one entered by the customer. This helps ensure the physical card is present during the transaction.

VISA  / Mastercard Network.

Once the payment processor finishes its verification steps and sends the transaction details securely to Visa or Mastercard, the network takes over to facilitate the authorization and settlement process:

1. Authorization:

• Visa/Mastercard receives the transaction information from the payment processor.

• They act as a secure intermediary, communicating with the customer's issuing bank (the bank that issued the card).

• The issuing bank verifies the customer's account information:

  • Checks available balance to ensure sufficient funds for the purchase.

  • Verifies the card hasn't been reported lost or stolen.

• Based on the verification and pre-set spending limits, the issuing bank sends an authorization response back to Visa/Mastercard. This response is either an approval or a decline for the transaction.

While the authorization hold reserves the funds in the customer's account, the actual funds aren't transferred at this point, i.e settlement happens as later stage.

2. Settlement (Transfer of Funds):

• If the transaction is approved by the issuing bank:

  • Visa/Mastercard facilitates the transfer of funds between the issuing bank and the merchant's acquiring bank (the bank that holds the merchant's account).

  • This is where the interchange fee comes into play. It's a fee paid by the merchant's acquiring bank to the issuing bank for processing the transaction. Visa/Mastercard establishes the interchange fee structure, but the issuing bank receives the majority of this fee.

• The acquiring bank then deposits the transaction amount (minus interchange fees and any other processing fees) into the merchant's account.

Additional Services by Visa/Mastercard:

• Fraud Prevention: Visa/Mastercard have their own fraud detection systems that analyze transaction patterns and identify potential fraudulent activities. They can alert issuing banks about suspicious transactions and help prevent losses.

• Dispute Resolution: In case of purchase disputes between merchants and customers (e.g., not receiving the product), Visa/Mastercard can provide a process for resolving the issue and potentially reversing the transaction.

• Data and Analytics: Visa/Mastercard offer data and analytics tools to merchants and issuing banks. This data can help businesses understand customer spending habits, identify trends, and make informed decisions.

In essence, Visa and Mastercard act as the secure and efficient communication channels between banks, ensuring smooth authorization and settlement of transactions while managing the interchange fee structure and providing additional security and dispute resolution services.

Merchant:

• Provides goods or services: The merchant is the business that sells products or offers services to customers.

• Accepts payments: The merchant sets up a system to accept various payment methods, such as debit cards, credit cards, or mobile wallets. This often involves partnering with a payment processor to handle the technical aspects of transaction processing.

• Sets prices: The merchant determines the prices of their goods or services.

• Provides customer service: The merchant is responsible for handling customer inquiries and resolving any issues related to purchases.

• Pays fees: Merchants pay processing fees to the acquiring bank and potentially additional fees to the payment processor for handling transactions.

Acquiring Bank (Merchant Acquirer):

• Processes payments: The acquiring bank establishes a merchant account for the business, enabling them to accept electronic payments. They handle the authorization, settlement, and clearing of transactions.

• Provides merchant services: Acquiring banks offer various services to merchants, such as:

  • Merchant account setup and management

  • Fraud prevention tools

  • Chargeback management (handling disputes with customers)

  • Reporting and analytics on transaction data

• Assumes financial risk: The acquiring bank takes on the initial financial risk for fraudulent transactions. (They may recover these costs from the merchant in case of fraud).

• Charges fees: Acquiring banks charge merchants various fees for their services. These can include:

  • Per-transaction fees

  • Monthly account fees

  • Chargeback fees

How they make money

Merchant:

• Sales: The primary way merchants earn revenue is by selling their goods or services. While not directly related to the payment process itself, efficient payment processing can encourage customers to complete purchases by offering convenient options.

Acquiring Bank (Merchant Acquirer):

• Merchant Fees: Acquiring banks generate revenue by charging merchants various fees associated with processing their transactions. These can include:

  • Per-transaction fees: A fixed fee charged for each successful transaction.

  • Monthly account fees: A recurring monthly fee for maintaining the merchant account.

  • Chargeback fees: A fee charged to the merchant if a customer disputes a transaction and wins the chargeback.

  • Statement fees: Fees for receiving monthly statements or other reports.

Payment Processor:

• Processing Fees: Payment processors charge merchants a fee for handling the technical aspects of transactions. This fee can be a flat rate, a percentage of the transaction amount, or a combination of both.

• Additional Services: Some payment processors offer additional services like fraud prevention tools, data analytics, or subscription management, which they charge extra fees for.

Issuing Bank:

• Interchange Fees: When a customer uses their debit or credit card, the merchant's acquiring bank pays a fee (interchange fee) to the customer's issuing bank (the bank that issued the card). This fee is a major source of revenue for issuing banks. (Note: Fintech companies issuing prepaid cards typically don't directly receive interchange fees).

• Interest on Credit Card Balances: For credit cards, issuing banks earn interest on the unpaid balance carried by customers. This is a significant revenue source, especially for cards with high-interest rates.

Network Fees (Visa, Mastercard etc.):

• Network Assessments: Card networks like Visa and Mastercard charge both issuing and acquiring banks annual assessments to participate in their network. These fees help cover the costs of maintaining the network infrastructure and security.

Fintech Companies

Fintech companies involved in prepaid cards can still benefit indirectly from interchange fees through a few different models:

1. Network Participation: If a fintech issues prepaid cards directly on a network like Visa or Mastercard, they might negotiate a portion of the interchange fee with the issuing bank they partner with. In this scenario, the issuing bank would still receive the majority of the fee, but the fintech company might get a share for facilitating the transaction through their card program