Credit Card Processing: A Look Inside the Black Box
Economic Review, Vol. 91, No. 1, pp. 27-42, 2006
16 Pages Posted: 24 May 2006
Each year, hundreds of millions of credit and debit cardholders make billions of transactions worth trillions of dollars. Yet few consumers are aware that such transactions travel through, and are made possible by, a highly evolved group of intermediaries. Those intermediaries sign up merchants to accept cards, handle card transactions, manage the dispute-resolution process, and, with regulatory agencies, set rules that govern card transactions.
I examine the transaction process for debit cards with an eye toward demystifying this "Black Box." I explain the two major parts of the transactions process - one, authorization, and two, clearing and settlement. I consider the complications introduced by general-purpose cards, such as Visa and MasterCard, emphasizing the key roles of merchant acquirers and card processors. I also discuss the risk of fraud in the transaction process. While the risk is low for face-to-face transactions, it is far higher for business done by mail, telephone, or over the Internet. Merchant acquirers, who sign up merchants to accept cards and who provide or arrange for processing, bear most of the risk of loss if merchants fail to make good on transactions disputed by customers. To guard against such losses, acquirers evaluate the credit quality of merchants seeking or using the acquirers' services. I identify some of the risk factors associated with specific industries, merchant types, and transactions that influence the price merchants pay for acquirers' services. Finally, I discuss some ways that merchant acquirers and merchants manage risk, especially the risk of fraud.
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