How Credit Cards Work- A Guide For UAE Residents
The history of credit cards is replete with events and interesting facts. The modern credit cards and credit card processing systems are not something which have been dug out of ground in its finest form but have evolved over the years. The modern credit cards are successors of ancient charge coins and charga plates and the modern credit card processing system has evolved from ‘close loop’ and ‘open loop’ payment systems.
So,how credit cards work or how credit card processing works?
Credit card is a plastic card with embedded component parts which play different roles in authorizing and authenticating information. I suggest you to have a look at the standard parts of a credit card and their function before you go through credit card processing.
Even though UAE is a small country, credit card usage is rampant. But gone are the days where individual credit histories were not maintained. In September 2014, Al Etihad Credit Bureau was officially launched. This credit monitoring agency will maintain individual records of credit history. So there is a good chance of your finance needs being rejected if you have maintained a poor credit track record. Having said this, lets get into nitty-gritty of credit card transaction processing.
In this article, I am going to give a layman’s (which is me!) understanding of how credit card processing works.
There are lot of things that happen within the 2-3 seconds that takes to process a credit card transaction. We, the common people like me, pay little attention to the virtual world of credit cards where 7 invisible parties work tirelessly to process credit card transactions. Jokes apart, the world of payment processing is very complex, involves several parties but the fascinating fact is that it just takes a few seconds for an e-commerce credit card transaction to be processed.
How Credit Cards Work- Deciphering a credit card transaction:
A typical credit card transaction is an interaction between 7 parties who have their own integral roles to play at different stages of the transaction. These 7 parties
- You, the Card Holder (UAE resident, Emirati, Expat)
- Merchant– Eg- KFC, IKEA, Carrefour, McDonalds, LULU
- Payment Gateway– Payfort, Innovate Payments, Network International
- Acquiring Bank’s Processors– Visa Middle East, Master Card UAE
- Credit Card Interchange– Processors, Acquirers, Issuers
- Credit Card Issuing Banks– Rak Bank, Emirates NBD, Mashreq Bank, ADCB, First Gulf Bank
- Merchants Acquiring Bank– Visa, MasterCard
Layman’s Understanding of a Credit Card Transaction:
- After purchase you swipe your credit card at the store
- The credit card reader disseminates information to merchant’s bank
- The transaction is verified by merchant’s bank and then the merchandise information is sent to credit card company
- The credit card company validates your card by contacting your bank
- Once confirmed, the merchant’s bank is notified by the credit card company. The merchants bank then approves the transaction.
- The shop owners hands over all the transaction receipts to his bank on payment due date.
- The total receipt amount is paid to the shop owner by the bank. The bank also sends a payment request to credit card company at the same time.
- The merchant’s banks is paid by the credit card company and then it sends a payment request to your bank.
- Your bank pays the credit card company and then finally proceeds to request payment from you.
Anatomy of a credit cards transaction or How A Credit Card Works (In Detail):
There are mainly two phases to Credit card payment processing or processing of a credit card transaction:
. Authorization- Transaction approval
. Clearing & Settlement- Sale processing
Credit Card Payment Processing Steps:
Phase 1: Authorization
1. The place where your credit card details are keyed in when making a purchase is called ‘Point Of Sale’or ‘POS’. This place can either be an actual counter of a retail store with electronic card reader or merchant’s online website.
For example, if you swiping your credit card at Carrefour counter in City Centre or any other mall, then that counter is POS or point of sale. If you buying something on Souq.com, then you will be keying in your credit card details on the Ecommerce site.
2. When the card is swiped or when the payment card details are keyed in (in case of online purchase), the data is recorded and transmitted through ‘Payment Gateway’ like PayPal.
3. The Payment Gateway acts as a facilitator who transmits sensitive information by securing and encrypting, between the POS and the merchant’s acquiring bank.The crucial information includes the credit card number, expiration date, billing address, amount of the order and cvv number (if required).
4. A third party known as Payment Processor like Visa or Mastercard, who acts on merchant’s acquiring bank collects this sensitive information and transmits it to issuer or issuing bank for authorization or approval.
5. The issuer bank’s processor (Visa, Master etc) will validate the credit card number, expiration date, bill amount to available credit, submitted billing address against billing address on file and also validates the CVV number if provided.
6. Once the verification and security screenings are done, the issuer bank’s processor will send the authorization response, again through the Payment Gateway to the merchant bank.The authorization response could be an approval or a decline. The approval will contain Card Verification Value (CVV) codes and Address Verification System (AVS) codes.
7. Upon receipt of these authorization codes, the acquirer bank approves the transaction and accordingly, the merchant will receive an alert and the credit card reader will produce two automated receipts, one for the merchant and the other for you, the cardholder or customer.The merchant’s copy has to be signed by the cardholder and returned to the merchant. The customer copy is given to the you. (Note: No such credit card receipt is received in case of an online transaction which is also called card not present transaction like e-commerce,telephonic sales.That is the reason, the CVV number is asked to key in to ensure that the card holder possesses the card physically while entering the details online).
Phase 2: Clearing & Settlement
1. The merchant stores all the credit card receipts against sales and will submit the receipts to the acquiring bank at the end of day for payment.
2. The merchant’s bank sends the batch of credit card receipts through the Card Network, requesting payment from the card issuer.
3. Since the receipts could be of varied card issuers, the Card Network distributes these receipts to the appropriate card issuer or issuing bank.
4. The issuing bank charges a small fee namely interchange fee and transfers the amount to the Card Network. The Card Network will have a share in interchange fee.
5. The transferred amount is in turn routed to merchant’s acquiring bank by Card Network.
6. The merchant is paid after the acquiring bank charges its percentage of discount.
7. Finally, the credit card holder has to pay the issuing bank either in full after a month or make a minimum payment as per the credit card terms and conditions.
The issuing bank and the credit card holder’s relationship is longer and more closer. Every month you will receive a statement detailing the purchases that you made during the month, total amount owed, minimum payment, interest charges and other fees. You have the power to dispute any charge which you think is fraudulent or is incorrect.
It is at you discretion to make the full payment or minimum payment on your card every month. On the outstanding balance, the issuing bank charges quite a huge rate of interest. The failure on the part of the credit card user to make minimum payment will attract an additional ‘late fee’ or some other penalty.
It is in your hands to mitigate this risk by intimating the issuing bank to charge your account every month automatically as long as sufficient fund are available.
So this is how credit cards work. So next time when you are swiping you card at Carrefour or LULU, just give a small thought to the virtual processing of your credit card transaction. Truly its one of most stunning human accomplishments.