Credit cards and loans
Institutional Roles in Issuing and Processing Credit Cards The institutions involved in processing your credit credit and how they relate to each other
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- [MUSIC]
- What I want to do in this video is try to give a
- reasonable understanding of the different players involved
- that issue and process your credit cards.
- So let's start off with the processors.
- Sometimes you could say that the network or the processors
- are the people that maintain the credit card networks and
- the examples of those are Visa, MasterCard, American
- Express, Discover.
- And what they do is they essentially maintain networks
- of IT and policies that connect a
- bunch of banks together.
- But for just the sake of this video, we'll do a very
- simple-- so let's say that this is network one, maybe
- that's Visa.
- Maybe this right here is network two, this right here
- could be MasterCard.
- And right now the networks are just circles, but you'll see
- that they're networks as I build out this explanation.
- Now let's say that I'm some bank out there.
- Let me call myself Bank A.
- And I decided, you know what?
- It would be good for my business for me to issue a
- credit card.
- I could extend credit to my customers, they'll pay me
- interest, maybe I'll make some fees off of that and it'll be
- a good business for my bank.
- So I go up to, let's say, Visa and I say, hey, can I be a
- member of your network?
- Visa has some policies and if you're, I guess, a legitimate
- bank and you agree to all those policies, you'll become
- a member of that network.
- So I've joined that network, and I'm of course not the only
- person on that network, there's tons of other banks on
- that network.
- So that could be Bank B, this could be Bank C, this could be
- Bank D and, of course, each of these are networks, so they
- all have their own member banks on them.
- That's MasterCard's network right there.
- And so in this situation, let's say I'm a customer of
- Bank A, and they say, do you want a credit card and I say
- sure, that'll be convenient.
- I don't like carrying cash in my pocket.
- So give me a credit card.
- And they'll issue a credit card that looks
- something like this.
- I think we've all seen credit cards, it will say Bank A
- really big up at the top.
- I'll have a credit card number that's unique to me.
- My name will be there, some type of maybe expiration date,
- and then here in the bottom right corner, they're going to
- say what network I'm a part of.
- In this case, it would be Visa.
- A credit card issuer over here would say MasterCard or if it
- was American Express, they'd put American Express here and
- maybe there's some type of a hologram.
- So great, I have a credit card here.
- I think we all have a general sense, I could use it and then
- I'll build a balance.
- And then in the future I could pay off that balance to this
- bank or I could carry a balance and they'll charge me
- interest, which is usually reasonably high interest, so I
- want to pay it off fairly quickly.
- But how does this actually work in the
- context of a network?
- So let's say I go to the local grocery store, let me draw
- that in orange.
- So let's say I go to some grocery store over here, I'll
- say G for grocery.
- And I buy a $100 worth of groceries and I want to pay
- with my newly-issued credit card.
- Let me write this down, this is the issuing bank.
- I go to the grocery store and I say, hey, I'd like to pay
- with a credit card.
- The grocery store, if they accept credit cards, they need
- to have some relationship with another bank some place on
- this Visa network in order for them to accept a Visa card.
- So let's say that they have a relationship with Bank B over
- here, this would be the merchant bank or we could say
- the retailer's bank or, it's often in credit card lingo
- called the acquiring bank or the acquirer.
- You might wonder why they called it the acquirer.
- It's called the acquirer because this is the player
- that goes out and goes to each of the merchants and says hey,
- right now you only accept cash or you'll only accept American
- Express, wouldn't be great if you also accepted Visa or
- MasterCard?
- That way you'll have more appeal to more customers and,
- you know, it'll be more convenient for customers, and
- every time a transaction happens we'll just take a
- little bit of a cut of that transaction.
- And so they go out and acquire different retailers.
- This was the grocer, maybe Bank B goes off and acquires
- the shoemaker.
- Maybe he goes and he gets the tailor on the network.
- These are all different retailers who will now all of
- a sudden accept Visa because their bank, their merchant
- bank, is a member of the Visa network.
- Likewise, it could have been a member of the MasterCard
- network, it doesn't matter.
- This is the processor and this is their network.
- Now, this guy would, in this context, he would accept Visa.
- So I would give them my Visa card and the first process is
- called authorization.
- And that's literally to check whether I'm good for the
- money, whether this card is valid to buy $100 worth of
- say, groceries.
- So when I swipe the card or when the grocer swipes the
- card, it's going to send a message from that little unit,
- from that point of sale unit, to the acquiring bank.
- That's going to be forwarded to Visa, then visa will say,
- oh, that's Bank A's card, and it'll give the number to Bank
- A on their own proprietary network.
- Then Bank A will look into their database, and say, oh
- yeah, Sal has got $1,000 of credit.
- He hasn't used any of it, he is good for it.
- I authorize that transaction.
- That message goes back through the network to Bank B and so
- then we get authorized.
- And then the transaction goes forward and eventually, you
- know, as you could imagine, you can't just authorize a
- transaction and then I walk away with the groceries.
- At some point this guy here expects to get his money back
- for giving me the groceries.
- He expects to get $100 back.
- And that $100 is going to come from Bank A.
- But they're not going to get a complete $100, because
- obviously each of these players,
- they're providing a service.
- This guy, he's plugged into the network and
- he's offering credit.
- The network operator or the processor is offering their
- network, and there's other services they might provide
- for security mechanisms. If they say, hey, Sal lives in
- Chicago, but all of a sudden he's buying $100 worth of
- groceries in Salzburg or some place that would seem
- unlikely, then it might send some type of warning trigger.
- Some people might have their own security mechanisms.
- But they're all providing a service.
- This guy is going out there, he might be providing the
- actual point of sale terminals, the actual network.
- So they're all going to get a little bit of a cut of things.
- And so out of the $100 worth of groceries, there will be a
- 2%-- and it's not always 2%, that's a round number, but it
- also is a ballpark not completely outlandish relative
- to what tends to be the case.
- So of that $100 that this guy, I guess, could have gotten for
- his groceries, he has to pay a 2%, or in this case, $2--
- that's 2% of $100-- he's got to pay a $2 discount rate to
- his acquiring bank.
- And you might say, gee, the acquirer, that's great.
- They got $2, they got 2% of all of these guys'
- transactions, but of course they're going to have to share
- it with these other people up here.
- And actually the bulk of it ends up with Bank A.
- So of this $2-- and I'm doing it in roundabout numbers-- so
- now we're going to split up the $2, Bank A is going to
- get, let's just say, $1.70.
- And these aren't that far off from what the real numbers
- might be, and they change and they depend on the banks and
- the network and all of that and the networks might change
- their rates.
- $1.70 goes to Bank A.
- So the issuing bank, besides now that I have a credit
- balance, it'll be able to charge interest on it, it also
- got $1.70 for that transaction.
- That $1.70 of the $2, this is called an interchange fee.
- And it generally gets set by the individual networks,
- although the networks don't share in that interchange fee.
- The just say our standard interchange fee is x percent
- of transactions plus, I don't know, $0.10 and that's what
- Bank B is going to pay to Bank A.
- So it's essentially Bank A's cut of the discount rate, of
- the $2 this guy is charging.
- That guy.
- And then the network, they make their money in several
- ways but, in general, they make money off of every
- transaction as well.
- So in this situation, they make roughly about 1/1000 of
- the transaction or 0.1%.
- So in this example, $0.10 of this discount rate that this
- guy charged would go to the processor or the network.
- So every time you transact, the processor gets a small
- fraction of your actual purchase and then this guy
- will be left with-- well, let's see: $1.70, $0.10,
- $1.80, we're coming from $2, this guy is going to be left
- with $0.20.
- So when the whole transaction gets settled, which
- essentially means everyone gets the money
- they need to get.
- This bank is going to send Visa's settlement bank $100
- minus the $1.70 that it gets to keep as part of its
- interchange fee.
- So it's going to send Visa, what is that, $98.30 to Visa.
- Visa will keep $0.10 of it, send it to the acquirer.
- So the acquirer is going to get $98.20.
- And then the acquirer is going to keep $0.20 for himself and
- give the retailer $98.
- So my numbers aren't exact, but I want to give you the
- general idea of how all this works.
- So in order for this retailer to be able to use all of this
- infrastructure out there, he essentially had to pay 2% of
- the actual transaction.
- That's always not going to be 2%, but it gives you a nice
- round figure.
- So this guy benefits because he gets access to a network,
- it's convenient for the customers, this guy obviously
- is getting some type of fee.
- The more retailers he signs on or the more retailers he
- acquires, the more cuts of transactions
- he's going to make.
- Visa makes a small cut on many, many, many, many, many
- transactions, so that's where they make their money and they
- obviously have to use some of that money to support all of
- this infrastructure.
- And then Bank A is going to make that interchange fee,
- which was the bulk of really that discount rate, that
- retailer discount rate, not related at all to the federal
- funds discount rates.
- And then, of course, they extended credit to me, so that
- $100 might not be paid immediately.
- They might be able charge me 15% to 20%, an annualized
- percentage rate interest, on that money until I pay it off.
- And of course I have some type of minimum balance to pay.
- So hopefully that explains things a little bit.
- I'll see you in the next video [MUSIC]
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