The Basics: How Payment Cards Work – Part 1

Cash and checks are getting used less and less while debit and credit cards are becoming donors’ preferred method of payment; a result of more online and mobile interaction with consumers, especially younger generations who may not even own a checkbook or carry cash. Online giving offers convenience to these donors and often increases donation flow and consistency. Since they were introduced in the early 1900s, payment cards revolutionized transactions and consumer behavior. While these early credit/charge cards were limited to valued clients of private department stores and oil companies, payment cards have quickly grown into an integral part of our financial structure. The more options you offer your donors, the easier and more convenient it is for them to support your organization financially.

This blog series of The Basics explores the industry, the players and the process to educate and answer questions on electronic payments to equip you with a better understanding of what happens behind the scenes in the world of online giving.

In this first installment of “How Payment Cards Work” we will answer the following question:

What is a payment card and who are the players involved with card transactions?

As the name suggests, a payment card is a card that can by used by a consumer and accepted by a merchant to make a payment for goods, services, donations, etc. These cards typically fall into one of two basic varieties: the credit card and the debit (or prepaid) card. A credit card is issued by a bank that “lends” funds to the consumer to complete transactions, and then bills the cardholder at a later date (typically on a monthly basis). A debit card uses the funds from the consumer’s account to automatically cover transactions.

The fundamental purpose of the payment card industry is facilitating transactions between cardholders and merchants. To this end, the players can be grouped into one of two process categories: issuing and acquiring. The issuing side relates to and provides payment services to the cardholder, while acquiring (looking at it in the broadest sense) relates to the functions and services provided to card-accepting merchants. So let’s begin with the four main parties:

  • The cardholder is any individual or business who uses a card to make purchases or payments. An organization purchasing resource material and books, a parent registering their child for summer camp, or a donor making a gift of support are all cardholders when using a card to make payment.
  • The issuer is a financial institution that markets to consumers, manages the application and issuance of cards, authorizes and clears card transactions and provides customer service to the cardholder. The issuer is the fund “lender” in the case of credit cards. In the case of a debit card, the account holder’s bank is the issuer.
  • The merchant is any seller that accepts card payments. Many of these entities do not think of themselves as merchants; instead they are “retailers”, “restaurants”, “hotels”, “airlines”, “nonprofits”, “ministries”, or “churches”. However, in the card industry these are collectively known as merchants and this is where an organization, like yours, fits in the process.
  • The acquirer is a member bank of the card network that provides merchants with a merchant account so they can accept card payments. They are responsible for handling the acceptance, authorization, settlement and payment of card transactions as well as customer service to the merchant.In addition to these four main parties, there are others that play one or more roles to support the issuing or acquiring functions.
  • The card brands are probably the most obvious; organizations such as Visa, MasterCard and Discover. These card brands own the card networks and make the rules of card acceptance and use in conjunction with various local, state and federal government agencies. These rules cover security regulations, data requirements and interchange rates for their networks that process payment card transactions.
  • The processor is an acquirer or an agent of an acquirer that provides the connection point for authorization and/or settlement services for merchants or network members. Often, the processor handles both the front end and back end connectivity for a transaction, but some handle just one or the other.
  • The merchant services provider (MSP) provides credit card processing services to a merchant. Typical providers fall into one of two groups: acquirers and resellers. Acquirers that act as processors as well, can directly market their services to merchants. Resellers are Independent Sales Organizations (ISOs) who resell the products and services of one or multiple processors and may even offer their own value-added services like point of sale (POS) terminals, online payment gateways and solutions in addition to the processing services. For example, CashLINQ is an ISO.The last players we will look at are more like the tools that make the processing connections possible.
  • The payment application/software is the front-end payment acceptance hardware and software that submits card transactions for processing. The hardware applications are most commonly in the form of physical swipe terminals or kiosks that connect directly with the processor. Software applications offer a wide range of payment pages and shopping cart options that connect through a payment gateway for processing.
  • The payment gateway is the on-ramp for the payment processing highway. The gateway connects the merchant to the bank or the processor to the card associations using dial up or internet-based connections. The vital role a payment gateway plays is in its ability to translate transaction information from the payment application’s format into a format that the processor recognizes for authorization and settlement. These gateways can offer additional added services like reporting, auditing and fraud controls, and can support different POS and software integration.

For more information on the payment card industry, check out our white paper Payment Card Processing: An Overview for Ministries and Nonprofits.