Hey there! This is the first in my Black Box series, where we unpack the technical details of Financial Technology in a thousand words or less. I'll attempt to balance the brevity of these articles, with diving deep into details, so subscribe if you enjoy this content! This week, we'll be talking about credit card transactions.
Have you ever been in the checkout line, swiped your credit card, and thought to yourself, "How on earth does this work?"
The Moving Parts
A bit of housekeeping first. Who are all the different players in a transaction, and why do they matter?
Merchant: The seller of what you're buying. Let's take my pharmacy for exampleProcessor/Acquirer: The business behind the actual Point of Sale terminal, allows the merchant to accept your card!Card Network: They connect all the different processors on the merchant's side to your bank.Issuing Bank: The bank that issues your credit card to you. Where you see your transaction, apply for credit, and manage your account.
There is some nuance here - sometimes the Processor will be separate from the Acquiring Bank, other times they are the same (details for a future article!)
The Basics
My trip to the pharmacy to relieve my upset stomach
Alright, let's get started. I make my trip to the local pharmacy and grab my tub of antacids to make up for all the fried foods I ate last night. Walk to the counter, and decide to put it on my credit card. *Enter the chip*. The clock starts.
The processor decides which card network to use and forwards details to the network about the merchant, the transaction (such as the amount) and your credit card itself. This is called an authorization.
The card network determines your issuing bank, and sends along the details of the authorization to your issuing bank.
Your issuing bank runs a few checks, all of which need to be completed under or around 1 second.
Does this account even exist? Is it open?
Whats the available credit limit on this account?
Is this fraud? Does this match this account's spending patterns? (ex: This transaction happened in Alaska - but you made purchases in Florida an hour ago!)
Your issuing bank responds with either an approval or decline - or a conditional decline if they're unsure if it's fraud. (Ever receive a text from your bank asking if you purchased something, then asking you to retry the transaction after confirmation?)
If your transaction for antacids (no - your bank normally doesn't have line item data of your transaction) is approved, you're on your merry way.
This isn't the end yet! Your transaction is still pending. The bank just said they will honor the movement of money at some point in the future.
Post-stomach relief
Clearing time. The processor/acquirer sends a clearing file to the card network. This contains the result of the many authorizations that happened recently. These transactions are communicated in a batch, typically 1-2 times a day, depending on the merchant.
These clearings are routed to your issuing bank by the card network, similar to the authorizations.
This tells your bank that yes, you did actually buy that tub of antacids. The industry speak for this is posting a transaction. Your account balance is now updated!
Oh you thought we were done? Nope - there's still settlement, where your bank sends the money to the merchant's bank.
This is done as a net settlement, facilitated by the card network.
Net settlement allows only the total amount of all transactions between the merchant and issuing bank to be exchanged. This is more cost effective (and easier to reconcile!) when compared to moving money for each transaction individually.
The Nitty Gritty
Whew, that's a lot. I imagine you have some questions right? Well let's get into some technical details here.
You: This is great and all... How does the processor know which card network to use? What about which issuing bank the card network should contact?
BIN details! The card networks are typically signified by the first couple of digits of your card number. Your issuing bank is signified by your BIN itself. Let's break it down.
Major Industry Identifier: I'm going to keep it brief here and link you to wikipedia on this one as while interesting, it's not terribly relevant.Bank Identification Number: Sometimes also called an Issuer Identifier Number or IIN, this identifies the issuer.
Wait, where's the card network defined? That's a bit more confusing and there's no easy answer. Some examples:
American Express: Numbers start with 37 or 34.
Visa: Numbers start with 4.
Mastercard: Numbers start with 51-55.
Discover: Numbers start with 6011 or 65.
You: So... What happens when I return an item? What if my purchase is never *actually* made?
Great question. The beauty of it is that it's the same as the flow described above. Refunds can be (loosely) thought of as the opposite of clearings. Cancellations are known as reversals and can be (again, loosely) thought of as the opposite of authorizations. This information makes it to the issuer known as MTI codes.
MTI codes are 4 digit codes that are somewhat complex (another future article incoming!). We'll link the spec (ISO 8583) below, as the mapping of scenario to MTI code is nuanced and not always one to one, but in the most basic scenarios:
x10x: Authorization requiring issuer approval
x42x: Reversal
x20x: Clearing requiring issuer approval
x22x: Refund
You: I ❤️ distributed systems. I know things fail. What happens if the issuer is unavailable?
The card network is configured with some light rules by the issuer explaining what transactions to accept and decline when the issuer is unable to be reached.
The card network responds to the merchant based on those rules. When the issuer comes back into service the network passes through the same transactions as advice. The issuer is required to accept these transactions per the card network agreement. This is reflected via the MTI codes.
xx2x: Advice on an action already taken, no approval required.
Dig Deeper
Want to dig deeper but don't want to wait for upcoming letters? Some relevant specifications: