Institutional Roles in Issuing and Processing Credit Cards The institutions involved in processing your credit credit and how they relate to each other
Institutional Roles in Issuing and Processing Credit Cards
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- 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
- 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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