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Current time:0:00Total duration:11:41

Institutional roles in issuing and processing credit cards

Video transcript

what I want to do in this video is try to give a reasonable understanding of the different players involved what that issue and process your credit cards so let's start off with the processors the processors sometimes you could you could say that the network or the processors are the people that maintain the credit card networks and examples of those are Visa MasterCard master card American Express Discover and what they do is they essentially maintain networks of IT and policies that connect a bunch of banks together but from just the sake of this video will do very simple so let's say that this is network 1 maybe that's visa maybe this right here is network 2 this right here could be MasterCard MasterCard and right now the network's 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 I'm let me call myself Bank a bank a and I decide that 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 I'll 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 network so they all have their own member banks on them that's mastercards network right there and so in this situation they'll come up to let's say I'm a customer of Bank a they say 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 the credit card I think we've all seen credit cards you'll say Bank a really big up at the top bank a I'll have a credit card number that's unique to me my credit card number my name will be there as I'm a type of maybe an 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 the 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 g4 grocery and I buy $100 worth of groceries and I want to pay with my newly issued credit card let me write this down this is the issuing issuer this is the issuing bank I go to the grocery store 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 someplace 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 where we could say the retailer's Bank or it's often in credit-card lingo called the acquiring Bank or the acquirer and you might wonder why is it called the acquire it's called the acquire 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 only expect accept American Express wouldn't it be great if you also accepted Visa or MasterCard that way you'll have a more appeal to more customers and you know every time it'll be more convenient for your 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 May he goes and he gets the I don't know gets the tailor on the network these are all different retailers will now all of a sudden accept visa because their 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 X will would in this context he would accept Visa so I would give them my Visa card in the first process is called authorization authorization 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 is going to send a message to 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 we'll give the number to bank a on their own proprietary Network then Bank a will look into their database and says oh yeah Sal's got a thousand dollars of credit he hasn't used any of it he is good for it I authorized the 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 the transaction then I walk away with the groceries at some point this guy here expects to get his money back for of giving me the groceries he expects to get $100 back and that $100 is going to come from Bank a but they're not he's 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 so he's offering credit he's offering credit the network operator or the processor is offering their network and there's other fee there's other I guess services they might provide different security mechanisms if they say hey Sal lives in Chicago but all of a sudden he's buying $100 worth of groceries in in in Saltzburg or someplace you know that you would that would seems unlikely then it might send some type of a warning trigger so 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 hundred dollars so I got a hundred dollars worth of groceries hundred dollars worth of groceries there will be a two percent and it's not always two percent I'm just kind of 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 hundred dollars of that hundred dollars that this guy I guess could have gotten for his groceries he has to pay a two percent he's got to pay well yeah let's write it that way he's got to pay a two percent or in this case two dollars that's two percent of a hundred dollars he's got to pay a two dollar discount discount rate discount rate to his acquiring bank to acquirer and you might say gee the aquire that's great they got two dollars that before they get two percent of all of these guys transactions but of course they're gonna have to share it with these other people up here and actually the bulk of it the bulk of it ends up with Bank a so of this two dollars and I'm doing it in roundabout numbers Bank a so now we're going to split up the two dollars Bank a is going to get let's just say a dollar seventy 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 network's might change their rates one dollar seventy goes to Bank a so the issuing bank besides not you know now that I have a credit balance it'll be able to charge interest on it it also got a dollar seventy for that transaction that dollar seventy of the two dollars this is called an interchange fee this right here is an interchange fee interchange fee and it generally gets set by the individual networks although the networks don't share in that interchange fee they just say our standard in Jersey HP is X percent of transactions plus I don't know 10 cents and then 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 two dollars this guy is charging that guy and then the network and 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 one thousandth of the transaction or 0.1% so in this example ten cents of this discount rate that this guy charged would go to would go to the processor 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 30 well let's see a dollar seventy $0.10 dollar eighty we're coming from two dollars this guy's going to be left with 20 cents 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 settlement Bank $100 - the dollar seventy that it gets to keep as part of its interchange fee so it's going to send visa what is that that's ninety eight dollars ninety eight dollars and thirty cents to visa visa will keep ten cents of it send it to the acquire so the acquire is going to get ninety eight dollars and 20 cents and then the acquire is going to keep twenty cents for itself and give the retailer and give the retailer ninety eight dollars so my numbers aren't exact but I want to give you the general idea of how all this works so for the in order for this retailer to be able to use all of this infrastructure out there he essentially had to pay two percent of the actual transaction that's always not going to be two percent 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 transit action so that's where they make their money and they're obviously you 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 rate and then of course they they extended credit to me so that hundred dollars might not be paid immediately they might be able to charge me fifteen twenty percent annualised an annualized percentage rate interest on that money until I pay it off and of course I have some type of minimum balances to pay so hopefully that explains things a little bit I'll see you in the next video