By James Lewes —

Card processing overview

Note

This post outlines generic card processing. Card schemes and regions within card schemes vary widely. For example, I will assume dual messages, i.e. separate phases for authorisation and clearing. In a number of regions, this is done as a single phase.
Also, in reality there are institutions who offer services for both acquiring and issuing, but for our purposes we will assume that only banks have a relationship with the card schemes and clearing.

The need for card schemes

When I first started working with card processing in New Zealand back in the Stone Age, card schemes were not widely used for domestic transactions, i.e. each acquirer had a direct relationship with each issuer bank. Therefore, banks had to settle directly with each other even though there were few banks. This situation created a nightmare where we had to settle with each bank individually.

What do card schemes do?

The card scheme acts as the man in the middle between acquires and issuers. This means that a bank can issue a credit card which can be used at banks throughout the world with the issuing bank only needing to know about the card scheme.

The card scheme certifies both acquirers and issuers to ensure they will process transactions efficiently according to the card scheme's rules.

The processing phases

Authorisation

The authorisation is a real-time message between the acquirer and issuer to check the validity of the transaction and to reserve funds.

Clearing

This is a batch process which details the actual financial transactions from the cardholders' accounts.

Settlement

This is the final movement of funds where the card issuers pay funds to the card scheme and the acquirers receive funds from the card scheme.

Detail

As an example, we will look at a goods purchase transaction using a physical card using chip and PIN technology.

Authorisation

  1. The cardholder enters their card in the merchant's Point of Sale (POS) device.

  2. If capable, the POS device requests the cardholder to enter a PIN which it passes to the chip on the card for verification. Once verified the chip passes a cryptogram and other tags to the POS. The POS then passes an authorisation request message to its acquiring bank.

  3. The acquiring bank verifies the request and checks the card number to ascertain which card scheme should process this request, formatting an authorisation request to that scheme.

  4. The card scheme determines which bank issued the card by its Bank Identification Number (BIN - The first 6-8 digits of the card number). Depending on the relationship with the issuing bank, the card scheme may perform additional screening of the transaction. The card scheme then passes the authorisation to the issuing bank.

  5. The issuing bank performs authorisation checks on the transaction. This will normally include:

  • Card status checks

  • Verification of the cryptogram from the card

  • Screening (is this card allowed to perform these sorts of transactions, e.g. gambling)

  • Limit checking

If all of the above checks are successful, the issuer reserves funds from the cardholders account to cover the transaction.

  1. Once the funds are reserved, the issuer generates a response cryptogram to the card and formats an authorisation response message to the card scheme.

  2. The card scheme forwards the authorisation response to the acquiring bank.

  3. The acquiring bank checks the authorisation response from the card scheme and formats a response to the merchant's POS device.

  4. The POS device passes the response cryptogram to the card.

  5. The card verifies the cryptogram from the issuer.

  6. The POS device displays the final result of the transaction.

Clearing

  1. At the end of the processing period (usually each business day), the merchant correlates all their completed transactions and sends a clearing batch file to their acquiring bank for payment.

  2. The acquiring bank verifies the clearing files from their merchants, then correlates clearing files for each of the card schemes they use.

  3. The card scheme accepts clearing files from each of their acquiring banks, works out how much they are due and formats clearing files to each of the issuing banks, at the same time working out how much they owe.

  4. The issuing bank accepts a clearing file from the card scheme and performs authorisation matching, using key fields from the clearing file to match the authorisation request. If a match is found, the funds that were held during the authorisation phase of the transaction will be released and the amount requested within the clearing funds taken from the account.

If no match is found the issuer still takes funds from the account as it is likely that this is a direct clearing transaction.

If there is a problem with the transaction, the issuer can raise a charge back request to dispute the transaction, but they will still initially have to pay it through the settlement process.

Settlement

This is the final phase of the process where funds move from the issuers to the acquiers via the card scheme.

Because these payments can involve thousands of banks and other institutions, the amounts have to be based on the calculations from the card schemes. If a bank has an issue with a transaction, it needs to resolve this through the charge back process, it cannot affect the settlement.