Inside the Black Hole

Participants. Every credit card transaction is the result of a series of interactions among several participants.

The full transaction cycle is represented in the diagram below.

• Cardholder. Cardholder is an authorized user of a credit or debit card.
• Card issuer. Card issuers are financial institutions that are members of Visa and MasterCard, which issue payment cards on behalf of the two Credit Card Associations and contract with their cardholders for the terms of the repayment of transactions.
• Acquiring bank. Acquiring banks (also called acquirers, processing banks or merchant banks) are financial institutions, members of Visa and MasterCard, that contract with merchants to enable them to accept debit and credit card payments for their products and services. They can also, and that is the case most of the time, contract with third parties to provide some of these services.
• Payment processor. Payment processor is an organization that has contracted with an acquiring bank to provide merchants with card payment processing services on behalf of the acquirer. Payment processors must be registered with Visa and MasterCard and must identify on all of their marketing materials, including their websites, the name of their bank partner.
• Merchant. Merchant is a business or a non-profit organization that has contracted with an acquiring bank or a merchant processor to accept card payments.
• Credit Card Associations. The Credit Card Associations of Visa and MasterCard are member-owned associations of banks that govern the issuing of Visa and MasterCard cards and the acquiring of Visa and MasterCard card transactions. Both organizations have developed payment systems to facilitate the processing of transactions between member banks.
• Service provider. A service provider can be any third party that provides a service used in the card payment transaction process: point-of-sale (POS) terminals, payment gateways, web hosting, SSL certificates, shopping carts, etc.

Transaction processing stages. The processing of card payments may vary depending on the particular procedures employed by the issuer, acquirer or merchant but they all involve the following stages:

• Authorization. Authorization is the process by which the card issuer approves or declines a card transaction.
• Authentication. Authentication is the process of establishing the validity of the credit or debit card account information provided by the customer. Authentication is done by utilizing various fraud prevention tools, including Address Verification Service (AVS) and Card Security Codes (CVV2, CVC 2 and CID).
• Clearing. Clearing is a process through which a card issuer exchanges transaction information with an processing bank. Clearing and settlement occur simultaneously.
• Capture. Capture is the process of collecting and organizing information of credit and debit card transactions for submission for settlement.
• Settlement. Settlement is a process through which a card issuing bank exchanges funds with a processing bank to complete a cleared transaction.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Both Visa and MasterCard publish interchange fee tables with the various payment processing rates that apply to credit and debit card transactions. The application of these rates is based on a variety of factors related to the particular circumstances of the sale and the way the payment is processed, as well as on the type of the card that was used. Typically payments processed in a card-not-present environment (e.g. online or over the phone) are assessed higher processing fees than payments processed in a face-to-face setting. Payments made with regular consumer types of cards are generally processed at lower rates than payments made with rewards, business-to-business or commercial cards. Debit cards are processed at lower interchange rates than credit cards. In order to simplify the pricing for their merchants, the majority of the processing companies have elected to use various tiered pricing models (two-tiered, three-tiered, six-tiered, etc.). Please see Interchange Plus Pricing vs. Tiered Pricing for a detailed comparison between the tiered and the interchange-based pricing models. There are three general classifications used in the various tiered pricing models:

1. Qualified rate.
   • When a transaction is processed in accordance with the rules and standards established in the Payment Processing Agreement, signed by the merchant and the processing bank, and
   • It involves a regular consumer credit card,

   
   It is processed at the most favorable rate. This rate is called a “Qualified Rate” and is set in the merchant’s Payment Processing Agreement. The Qualified Rate is set based on the way a merchant will be accepting a majority of their credit cards. For example, for an internet-based merchant, the internet interchange categories will be defined as Qualified, while for a physical retailer only transactions where cards are swiped through a terminal will be Qualified.

2. Mid-qualified rate.
   • When a consumer credit card is keyed into a credit card terminal instead of being swiped or
   • The cardholder uses a rewards card, business-to-business or another special type of card

   
   The transaction is charged a discount rate that is less favorable than the Qualified. This rate is called a “Mid-Qualified Rate.”

3. Non-qualified rate.
   • When a special kind of credit card is used (like a rewards card or a business card), or
   • A payment is not processed in accordance with the rules established in the Payment Processing Agreement, or
   • It does not comply with some applicable security requirements,

   
   The transaction is charged a discount rate that is less favorable than both the Qualified and Mid-Qualified Rates. This rate is called a “Non-Qualified Rate.”

As you can see from the descriptions above, the difference between the mid- and non-qualified rates can be very hard to identify so merchants should examine their pricing agreements very carefully and make sure they understand exactly when each rate applies before they sign anything.

Whenever a transaction is classified as mid-qualified or non-qualified and processed at a higher rate, the transaction is downgraded. Most likely, your payment processor will identify downgrades as either mid- or non-qualified transactions. But many payment processors simply put all of the downgrades together and report them as a miscellaneous fee.

You should closely monitor your mid- and non-qualified transactions. Generally, if your downgrade levels exceed 10 percent, you have a problem.

Visa and MasterCard do not publish their rules and regulations or the payment processing standards required to get the lowest interchange rate. It’s up to credit card processing companies to understand and implement them to their merchants’ benefit. A high downgrade rate may indicate that your processor does not know the standards, or may be reluctant to implement best practices or new rules changes.

Be advised that high downgrade levels may arise from the way you process your orders, and may have little to do with your processing bank. Yet, even if the cause originates within your business practices, your payment processing service provider should be reviewing your account activity and suggesting ways to reduce these downgrades.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Floor limit is the amount above which credit card transactions must be authorized before being processed. The floor limit can vary from business to business and is specified in the merchant processing agreement. All card transactions conducted in a non-face-to-face environment have a zero floor limit, which means that all of them must be authorized, regardless of the amount. Non-face-to-face transactions include e-commerce and MO / TO (mail order and telephone order) payments and refunds, but exclude transactions at cardholder-activated terminals (CATs), like the ones at gas or train stations, which are considered face-to-face, even though the merchant is not physically present to accept the card.

For example, if a store’s floor limit is $25.00, every purchase of $24.99 or less would not have to be authorized, while transactions of $25.00 or more would require authorization. Authorization is the process by which a card issuer approves or declines a transaction. In a face-to-face environment, the authorization occurs automatically when the cardholder swipes her card through the merchant’s point-of-sale (POS) terminal. In a non-face-to-face setting, the authorization occurs when the card account’s information is submitted online or over the phone. In both instances, once the card information is provided, it is routed to the card issuer through Visa’s or MasterCard’s network and then the card issuer’s response is routed back through the same channel, approving or declining the transaction.

Floor limits carried a much greater importance in the past when the merchant had to call for an authorization on any payment amount that was over a predetermined level. Back then payment card processing involved taking a physical imprint of the card and the authorization process required a personal review, making the process both time consuming and expensive. Today merchants can benefit from electronic authorization systems that payment processors provide at a very low cost. Once a payment is authorized, the merchant has an additional, and powerful, assurance against fraud. Still, even today, the floor limit concept comes into play occasionally.

For example, if unable to connect to the payment processor’s authorization system, a merchant will not be able to obtain an electronic authorization and will have no recourse against fraudulent activity or a customer dispute that will potentially lead to a chargeback. Yet, if the transaction amount is less than the floor limit, no authorization is required by the payment processor. If, however, the amount is over the floor limit, the merchant must authorize the transaction and can do this by making a telephone call to the payment processor and obtaining a “voice authorization.” In this case the merchant will be well advised to also take the card’s imprint and place it on the sales receipt. Voice authorizations should be used only as a last resort, as they bypass the processing bank’s systems and cannot be used as supporting evidence in chargeback re-presentments. You should avoid key-entering voice-authorized transactions.

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