Surprising as it may sound participants and flow somewhat changes depending on credit card association. While Visa and MasterCard use open-loop networks to connect between issuing banks and acquiring banks, American Express and Discover use closed-loop systems, as issuing bank, merchant bank and association are in fact one in the same.
The associations develop, maintain, monitor and regulate the networks that enable: authorization, capture, refund and chargeback data and money transactions. Issuing banks and acquiring banks are members of the associations, to which they pay fees for the smooth operation of the network.
Issuing banks issue individuals credit cards and take full responsibility on a person’s ability to fulfill a financial obligation. When a transaction is “Authorized” by an issuing bank, same bank will have to fund the transaction regardless if it is able to collect authorized funds from cardholder or not. This fundamental obligation is the basis on which the credit card processing flow is based. It is the reason merchants are willing to accept credit cards and also explains why majority of fees end up being paid to the issuing banks.
Acquiring banks take the commercial risk of merchants going out of business which means they have to fund all chargeback transactions they can’t collect from a merchant. This is why acquiring banks are picky accepting a merchant, split the market and relate to merchants according to pre-set risk categories and set mechanisms, such as “rolling reserve”, to ensure at least a partial recovery of a potential loss.
Payment processors grew into the ‘operating arm’ of the acquiring banks, providing merchants with both technological and financial infrastructure needed to operate the merchant’s site.
Gidi Argov, Founder and CEO
www.CreditCardProcessing-r-us.com
Good reading and thanks for posting!
Though you clearly stated the different participants in the credit card processing flow, I am somewhat stuck on the beginning and still wondering regarding the open-loop Vs. closed-loop systems.
In what way is the Visa/MasterCard credit card processing flow different than the Amex/Discover flow?
Thanks! Martin.
Hi Martin – Thanks for asking!
I think the best way to explain it is to look into credit card processin history. The first credit card (issued by Flatbush National Bank of Brooklyn, NY), could have been used only by customers of same (issuing) bank at merchants who also maintained an account with the very same bank.
This is the essence of a “closed-loop” system – it all starts and ends at the very same place and in this specific case – the first issuing/acquiring bank. American Express, Diners Club & Discover keep working in the very same way – these banks provide both issuing and acquiring services, and cardholders holding these card brands can perform purchases with merchants who maintain a merchant account with these banks.
Visa and MasterCard provide networks through which different (non-related) issuing banks and/or acquiring banks can work. This open-loop system enables any member bank to issue and or acquire Visa and MasterCard cards all around the globe through the Visa and MasterCard networks.
It sure sounds like the closed-loop systems are simpler and have less participants.
That said – processing fees on such closed-loop systems should be lower.
Should merchants prefer accepting Amex on Visa/MC?
Hi Kris,
I like your line of thinking yet reality is somewhat different.
Surprisingly enough Visa and MasterCard, running on open-loop systems, sharing fees between member banks and the associations, are usually cheaper.
As a rule of thumb, most merchants end up paying higher processing fees when accepting closed-loop card brands. If you are indifferent and running on a fixed processing fee for accepting all card brands, try shopping around and check if that fixed rate is the best deal you can get.
Start your market survey at our domestic merchant account category. If you do your business on the road, an iPhone credit card app might be the solution for you.
Decided to let you know – You have one dedicated reader here!
Must ask, you got us familiar with “the participants”. What about the actual flow?
Hi Roselyn – Stay tuned. It’s coming!