Payment processing terminology isn’t always easy to understand. Here, we’ll cover some of the most important payment processing terms so you can better understand how payment processing works.
Acquiring Bank (or Merchant Bank)
To facilitate payment processing payments, businesses work with a specific kind of bank, that might be different from their regular operational bank. This institution, known as the “acquiring bank”, handles a merchant’s credit and debit card transactions. Among its other responsibilities, the acquiring bank secures funds from the customer’s bank (known as the issuing bank) and credits them to the merchant’s account.
Automated Clearing House (ACH)
When a payment is made using bank information, it’s known as an ACH transaction. ACH, which stands for Automated Clearing House, is an electronic network used for financial transactions and is a type of payment processing that allows money to be transferred electronically between bank accounts. The ACH Network is governed by NACHA (formerly the National Automated Clearing House Association).
Accepting credit and debit cards offers the advantage of pre-verification through a process called authorization. In this stage, the issuing bank checks the card’s validity and confirms whether the cardholder has adequate credit or sufficient funds for the transaction.
Once this verification is complete, the issuing bank communicates and an authorization response back through the credit card processing network. This informs the merchant about the status of the transaction: whether the card is approved, declined, or if further action is required.
Batch processing occurs when payments are grouped together and processed. Usually, a merchant accumulates transactions throughout the day or until another cut-off time. Then, the merchant closes the batch and submits it to their payment processor. Each batch of transactions includes details about each transaction including the card number, its expiration date, the amount of each transaction, and the merchant identification number.
Batch processing is particularly efficient for handling large volumes of transactions. It streamlines processing and reduces overhead. This, in turn, leads to lower processing fees compared to real-time payment processing.
Organizations that create and maintain the networks that process payment cards are known as card networks. These networks form a crucial link between merchants, banks, and cardholders to facilitate credit and debit card transactions. In the U.S., the major card networks are Visa, Mastercard, American Express, and Discover.
Card networks also:
- establish and maintain the rules that govern payment processing
- routes information between banks
- clear transactions
- provide a framework for handling disputes and chargebacks
A chargeback occurs when a bank reverses a credit or debit card charged that’s fraudulent or disputed by the customer. This process can pose a significant challenge for merchants because it results in the loss of sales revenue and incurs additional fees. Not to mention, merchants also lose the goods or services initially provided. A high number of chargebacks can lead to higher processing fees and even the suspension of a merchant’s ability to accept card payments.
Interchange fees represent the charges paid by the merchant’s bank to the credit card issuer when a customer makes a purchase using a credit or debit card. These fees compensate the issuing bank for its role in the payment process. This includes the risk taken in approving the transaction, managing billing, extending credit, and providing funds for the transaction.
Typically, the interchange fee is composed of a small percentage of the transaction amount plus a flat fee. For instance the fee might be set at 1.25% of the transaction plus $0.08. Specific interchange rates are set by the payment networks, i.e. Visa, Mastercard, Discover, and American Express, and apply to the majority of card-based transactions.
Banks that issue credit and debit cards to consumers are referred to as issuing banks. These banks pay a crucial role in the payment process by advancing funds to merchants on behalf of the customer, even before the customer has paid the bank. In exchange for taking on this risk, issuing banks charge an interchange fee to merchants. It’s common for some banks to serve both consumers as issuing banks and merchants as acquiring banks.
To process electronic payments, businesses need a specific kind of account called a merchant account. This account serves as a temporary repository for funds from credit and debit card transactions. These funds are first credited to the merchant account before they’re transferred to the business’s regular bank account.
Businesses can set up a merchant account through bank that offers merchant services or through a payment processor.
A payment gateway is the technology that authenticates and transmits payment data in electronic transactions. It operates by encrypting the transaction details, ensuring the data is securely transmitted to the business’s payment processor. The payment gateway then receives an authorization response and communicates the transaction’s status back to the originating web browser or app.
Payment processors are responsible for processing transactions. This includes verifying transaction details, authorizing payment, and settling funds between the customer and business. Payment processors provide businesses with a merchant account.
All companies that accept, process, store, or transmit credit card information are required to maintain a secure environment. The standards are developed by the PCI Council and are known as PCI DSS. When a company meets they standards, they’re said to be PCI Compliant.
The stage in the payment process when the funds from a transaction are transferred from the issuing bank to the acquiring bank. It may take a few days from the initial process for settlement to occur. During settlement, various fees are deducted from the transaction amount before the funds are deposited into the merchant’s account. These fees can include interchange fees, assessment fees, and the acquiring bank’s markup or service fees.
There you have it. An introduction to a few of the most common payment processing terms. With an understanding of these basics, you’ll have a much easier time navigating the world of payments.