Credit Card Transaction Overview 101

Originally Posted on Technical  Notes



Glossary of Terms

• Customer: A customer is the one who purchases goods or services.


• Cardholder: A person who is the owner of the card issued by the bank.


• POS: Point of sale or point of service (POS or PoS) can mean a retail shop, a checkout counter in a shop, or the location where a transaction occurs.


• Merchant: Merchant is the one who sells commodities to consumers (including businesses). A shop owner is a retail merchant.


• Acquiring bank: An Acquiring bank (or acquirer) is the bank or financial institution that accepts payments for the products or services on behalf of a merchant.


• Card Issuer: An issuing bank is a bank that offers card association branded payment cards directly to consumers.


• Card Association: A card association is a network of issuing banks and acquiring banks that process payment cards of a specific brand. Familiar payment card association brands include Visa, MasterCard, American Express, Discover Diner’s Club, and JCB

1 Credit Cards

A credit card s part of a system of payments named after the small plastic card issued to users of the system. The issuer of the card grants  a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant.

Credit cards allow the consumers to ‘revolve’ their balance, at the cost of having interest charged.



1.1 Monthly Billing Cycle

The issuer generates a credit card bill on a predetermined day of month. The customer should pay it before grace period expires; else, a late payment fee has to be paid.



1.2 Grace period

A credit card’s grace period is the time within which the customer has to pay the balance before interest is charged to the balance. Grace periods vary, but usually range from 20 to 40 days depending on the type of credit card and the issuing bank.



1.3 Late Payment

If you carry a balance, credit cards function like very expensive loans. The credit card company allows you to pay off what you owe little by little each month, as long as you pay a minimum amount each time. In exchange, you pay interest on the balance you owe (as high as 29% each year) at the end of each period.

2 How credit card companies make money?

Credit card companies earn high profits in several ways.

• High rates of interest — interest on credit cards accounts for the bulk of the profits earned by banks that issue credit cards.


• Annual fees.


• Late fees, over-the-limit fees, and other miscellaneous charges.


• Charging merchants and service provide a fee each time a customer uses the company’s credit card in the merchant’s establishment.

3 Overview of Credit Card Processing

Signature-based (non-PIN-based) credit card transactions are a two-step process, consisting of an authorization and a settlement.



3.1 Authorization

Authorization is a verification process that happens at the time of purchase that allows merchants to verify that the customer’s account is valid and that sufficient funds are available to cover the transaction’s cost.



The verification takes place using a credit card payment terminal or Point of Sale (POS) system with a communications link to the merchant’s acquiring bank. Data from the card is obtained from a magnetic stripe or chip on the card.

At this step, the funds are "held" and deducted from the customer’s credit limit (or bank balance, in the case of a debit card) but are not yet transferred to the merchant. Upon placing a hold, this amount will become unavailable either until the merchant clears the transaction (also called settlement), or the hold "falls off." In the case of credit cards, holds may last as long as 30 days, depending on the issuing bank.



3.2 Canceling an authorization hold

The merchant can cancel an authorization hold if the merchant uses an acquirer that supports a process known as authorization reversal. Different acquirers place different restrictions on the conditions that must be met for the merchant to make an authorization reversal, but it is typical that the reversal must be made very shortly (generally within a minute) after the original authorization. In cases where the merchant cannot perform a reversal, but wishes to cancel the authorization it is typical that the merchant would contact the acquirer by telephone. Alternatively, the cardholder may contact the issuing bank to request cancellation.



3.3 Batching

Authorized transactions are stored in "batches", which are sent to the acquirer. Batches are typically submitted once per day at the end of the business day. If a transaction is not submitted in the batch, the authorization will stay valid for a period determined by the issuer, after which the held amount will be returned back to the cardholder’s available credit. Some transactions may be submitted in the batch without prior authorizations; these are either transactions falling under the merchant’s floor limit or ones where the authorization was unsuccessful but the merchant still attempts to force the transaction through.



3.4 Clearing and Settlement

The acquirer sends the batch transactions through the credit card association, which debits the issuers for payment and credits the acquirer. Essentially, the issuer pays the acquirer for the transaction.



3.5 Funding

Once the acquirer has been paid, the acquirer pays the merchant. The merchant receives the amount totaling the funds in the batch minus the "discount rate," which is the fee the merchant pays the acquirer for processing the transactions.







3.6 Process Flow Diagram

Below we have depicted Authorization, Batching, Clearing and Settlement and Funding in a process flow diagram.





4 Chargebacks

A chargeback is an event in which money in a merchant account is held due to a dispute relating to the transaction. The cardholder typically initiates charge backs. In the event of a chargeback, the issuer returns the transaction to the acquirer for resolution. The acquirer then forwards the chargeback to the merchant, who must either accept the chargeback or contest it.

The card-issuing bank will investigate disputes, and will "charge back" the value of the original transaction directly from the merchant’s acquiring bank, which is obligated under card network rules to pay the card issuer. The merchant’s acquirer will then attempt to recover an equal value of the chargeback plus a processing fee from the merchant’s bank account. Chargebacks, are typically passed on to the merchant as a matter of acquirer policy unless the merchant can prove the transaction was legitimate, or goods and services have been rendered to a customer claiming otherwise.

Sometimes the consumer dispute is untrue, and their refund claim gets denied. In these situations, merchant might have to pay a processing fee.

In cases of credit card fraud, the merchant loses

• The goods or services sold.


• The fees for processing the payment


• Any currency conversion commissions


• The processing fee for chargeback

For obvious reasons, many merchants take steps to avoid chargebacks—such as not accepting suspicious transactions. This may spawn collateral damage, where the merchant additionally loses legitimate sales by incorrectly blocking legitimate transactions.





4.1 Process Flow Diagram Files







4.2 Some of the reasons for a chargeback

• Card holder requests a copy of the transaction receipt.


• Card holder did not authorize the transaction.


• Non-matching account number.


• Transaction was processed more than once.


• Refund not processed.


• No authorization.


• Customer never received services.


• Card not used within valid expiration date.


• Error in transaction amount.


• Transaction receipt is incorrect, incomplete, or illegible.


• Transaction processed for incorrect amount.


• Product different from what was described or promised.


• Transaction not processed within Visa or MasterCard time frames.


• Signature on receipt different from card.


• Card-holder claims merchant changed transaction amount without permission.


• Merchant knowingly participated in a fraudulent transaction.


• Incorrect Transaction Date.


• Card-holder claims invalid mail or telephone order transaction.


• Card-holder was denied ability to return item.


• Transaction was not cancelled successfully.


• Card-holder not satisfied with quality of product or services.

Buyer initiating a false chargeback after receiving goods or services; this is considered fraud.



Glossary of Terms

• Customer: A customer is the one who purchases goods or services.


• Cardholder: A person who is the owner of the card issued by the bank.


• POS: Point of sale or point of service (POS or PoS) can mean a retail shop, a checkout counter in a shop, or the location where a transaction occurs.


• Merchant: Merchant is the one who sells commodities to consumers (including businesses). A shop owner is a retail merchant.


• Acquiring bank: An Acquiring bank (or acquirer) is the bank or financial institution that accepts payments for the products or services on behalf of a merchant.


• Card Issuer: An issuing bank is a bank that offers card association branded payment cards directly to consumers.


• Card Association: A card association is a network of issuing banks and acquiring banks that process payment cards of a specific brand. Familiar payment card association brands include Visa, MasterCard, American Express, Discover Diner’s Club, and JCB