What Goes On When A Cardholder Slides Their Plastic?
ARLINGTON, Va. - Whether they access a share draft account or a line of credit, members using debit or credit cards promise to become a steadily larger part of credit unions' bottom lines. But for all their growing importance, what goes on behind the scenes when a cardholder swipes their...
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ARLINGTON, Va. – Whether they access a share draft account or a line of credit, members using debit or credit cards promise to become a steadily larger part of credit unions’ bottom lines. But for all their growing importance, what goes on behind the scenes when a cardholder swipes their plastic and signs their name remains a mystery to many who don’t work day to day with the cards. In the spirit of clearing up possible misunderstanding, Credit Union Times offers this brief overview of both a card and a card transaction. According to several encyclopedias, the first cards were issued in 1920′s by individual retail companies, hotels and oil companies whose customers would use them at just their establishments. Diners Club issued the first bona-fide charge card in 1950, where the company charged the cardholder a yearly fee for the card and then billed them for their accumulated balances. The American Express company followed suit in 1958 with its card. Banks got into the picture in the late 1950′s as well. The first bank issued card was the Bank Americard which was issued by Bank of America in 1959 in California. It spread through other states during the 1960′s and became the VISA card association in 1976. Master Charge, which later became MasterCard, followed a similar path. The essential dynamics of the card relationship were the same then as they are today. The bank credits a merchant’s account as the sales are made. This gives the merchant easier access to reliable payments and expands their market as the bank lends money through its card accounts to consumers who would otherwise be unable to become customers. The card issuer benefits because the loans it makes carry an interest rate on the balances that remain unpaid each month, as well as on part of the fees the merchant pays for the service of being able to accept payments using the card system. By The Numbers Contrary to a popular misconception, the numbers on the front of a credit or debit card actually do have meaning beyond just the card account of the card issuing bank or credit union. The meaning for the numbers follows a regulation established by the American National Standards Institute. The first digit of the card number actually identifies the sort of card it is. Cards which begin with three are cards like Diners’ Club or American Express. Numbers four, five and six indicate whether the cards is a VISA card, MasterCard or Discover Card, respectively. The next numbers are the Bank Identification Number, which credit union card issuers must also use. They can be between two and six numbers. The remaining numbers are the card account numbers and sometimes, as in American Express, can indicate things like the currency in which the card account is denominated. By The Stripes Despite the seeming emphasis of the numbers on the front of the card, for face to face transactions the really important information hides on the back, in three magnetic stripes of which most financial institution card issuers often use just two. The information contained on each of the two stripes most often used is also regulated, just as the numbers are. The first character on track one of the stripe alerts a magnetic reader that numbers are following. Those numbers include the primary account number, which can be up to 19 characters, as well as a country code, name, expiration date and a character to alert the reader that the numbers have come to an end. Much of the information on track two is the same and must match in certain key ways to help ensure security. So What Happens? When a cardholder presents a card the clerk or cardholder usually swipes the card through a machine that reads information from the magnetic stripe on the back of the card, and then types the amount of the purchase on the machine’s keypad. The electronic data capture software in the point of sale terminal captures the data and then the machine sends the card and transaction data to an acquirer. An acquirer is an organization that collects merchant’s authentication requests and guarantees payment to the merchant for transactions that are authenticated. Let’s look at the transaction in a number of steps, supposing the merchant pays a 3% credit card discount rate, which includes an interchange fee of 1.5%. The discount fee is used to reimburse the merchant’s financial institution for transaction processing costs, and a portion of the fee is sent to the card issuer. The portion received by the card issuer is called the interchange fee. Step One: Jane Member, who belongs to the Typical Credit Union of Springfield and holds the credit union’s Typical Gold MasterCard, puts a $200 charge on her card at her favorite Springfield Mall shop, the The High End Outdoors Store. She walks out with that new pair of hiking boots she has been waiting to go on sale. Step Two: The High End Outdoors Store in effect “sells” the transaction to its merchant bank, the First Bank of Merchantsville, by depositing the transaction in the store’s daily bank deposits. The First Bank will credit the store’s account with $194 (for the original $200 charge minus 3 percent, or $6). Step Three: First Bank of Merchantsville submits the sales ticket via the MasterCard interchange system. Step Four: The MasterCard interchange system routes the transaction overnight to the Typical Credit Union, the Card Issuer. MasterCard sends the Typical Credit Union (or a processor designated by the credit union) the $200 sale, which is netted with the 1.5% interchange fee for a total debit of $197. MasterCard credits First National Bank of Merchantsville for the netted amount of $197. Step Five: Typical Credit Union (or its processor) adds the $200 transaction to Jane Member’s account balance. This raises the credit union’s total outstanding loans by $200 that day. Step Six: Jane Member will receive a statement showing this purchase and will have the option to pay the amount in full or she may choose to pay the amount off in several monthly payments. Until payment in full is made, Typical Credit Union will carry this amount as an outstanding loan. Step Seven: Each time a payment is received from Jane Member, her credit card loan balance is lowered by the amount of the payment until she has paid the charge in full plus any associated interest charged by Typical Credit Union for the loan. Since there are so many merchants and card issuers, all these transactions can only happen with the help of the card association’s or companies networks. Although the settlement process has sped up with the advent of electronic processing and VISA has spoken about moving to real time processing, the actual transfer of money between the banks and the actual debiting of the purchaser’s account still often happens only a couple of days after the actual transaction date. So Who Makes Money? The Visa and MasterCard organizations are funded by membership dues and fees paid by the banks that make up the organizations. The amounts of those fees have been in the news lately as MasterCard has restructured its fees somewhat and asked that all card issuers generate enough transactions to generate a minimum amount of revenue or more to another form or membership. As indicated in our example, banks and credit unions have two main sources of revenue from credit-card transactions. First, the acquiring bank charges a fee to the merchant in the form of a discount on credit-card transactions. The acquiring bank keeps some of transaction amount as its discount fee and shares some with the issuing bank or credit union through a interchange. The amounts of these fees have long been a matter of some controversy since VISA and MasterCard have traditionally simply set them and have now agreed with a court settlement to negotiate them with the merchants who accept the cards. In general, the more transactions a card accepting merchant can generate, the lower the per transaction fee it will pay, so a smaller merchant might pay that $2 or more fee, while large merchants might pay only a small fraction of this amount. Card issuing banks and credit unions also earn income from the finance charges on the outstanding balances each month on their cards, as well as in fees on card accounts. The role of fees on card accounts has also become more controversial as some (primarily bank) card issuers have hiked their fees in order to compensate for lower income from finance charges. -
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