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Payment Processing Internals

Payment Processing Internals

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Payment Processing Internals

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  1. Payment Processing Internals This presentation contains a deep dive on the internals of payment processing. It describes BASE I authorizations, BASE II settlements, clearing, funds transfer and more. It will show how a simple credit card transaction causes so much more to occur behind-the-scenes. Finally, It will "follow the money" to understand who the players are and where the monetary opportunities lie when processing payments. By Frank Haggar SLIM CD, Inc

  2. Brief History of Payment Processing • Charge Plates – Western Union in the 1800s • Credit Cards were started by Diners Club in 1950 as a charge card, then turned into a credit card. • Visa was started as BankAmericard in 1958 • MasterCard was started as Master Charge in 1966 • Discover was started by Sears in 1985 • Federal Reserve began moving payments electronically in 1915 • FedWire was created in 1918 • ACH (Direct Debit) was started in the 1970s

  3. Bank AmeriCard

  4. Credit Card Imprinter and Plate

  5. Paper Deposit Slip – Treated like cash deposit

  6. BASE I and BASE II

  7. Signature Capture Multi-Lane Devices

  8. Mobile Platforms & Payments

  9. Four Party System

  10. Credit Card Data Flow - Simplified CARD HOLDER 4. Bill Card Holder 1. PURCHASE ISSUER ACQUIRER 3. VISA NETWORK VISA is just a BRAND and a NETWORK! 2. Contact Acquirer for approval MERCHANT

  11. Credit Card Data Flow – Processors CARD HOLDER 4. Bill Card Holder 1. PURCHASE Processor ACQUIRER ISSUER Processor 3. VISA NETWORK Databases and computer operations are outsourced to processors MERCHANT 2. Contact Processor for approval

  12. Credit Card Data Flow – Gateways CARD HOLDER 4. Bill Card Holder 1. PURCHASE Processor ACQUIRER ISSUER Processor 3. VISA NETWORK 3. Contact Processor for approval Gateway Message formatting performed by gateways. First started to allow payments on the internet, but changed to allow POS systems to avoid formatting and certification MERCHANT 2. Connect to Gateway

  13. Credit/Debit Processors Gateway Routing & Value Processor 1 • Chase Bank Processor 2 • Bank of America • Suntrust MERCHANT Processor 3 Gateway • Gas Stations Processor 4 • E-Commerce One Connection type and message format used by merchant XML JSON HTTP POST (name/value COM object Web Page Popup Check Processors Processor 5 Processor 6

  14. Independent Sales Organizations (ISOs) CARD HOLDER 4. Bill Card Holder 1. PURCHASE Processor ACQUIRER ISSUER Processor 3. VISA NETWORK 2. Contact Processor for approval Gateway Databases and computer operations are outsourced to processors MERCHANT ISO sells to merchant for acquirer or processor

  15. Big ISO/Processors – Dominate industry CARD HOLDER 4. Bill Card Holder 1. PURCHASE Processor/ISO ACQUIRER ISSUER Processor 3. VISA NETWORK 2. Contact Processor for approval Sales rules because it generates income. Sales organizations take over processors OR processors buy ISOs and the ISO management takes over processor MERCHANT

  16. PayPal / Square / Stripe (PSPs) CARD HOLDER 4. Bill Card Holder 1. PURCHASE PayPal Issues sub-accounts under a real account ACQUIRER ISSUER Processor 3. VISA NETWORK PayPal was against the rules, called “factoring” when it was established. Visa made an exception and made a new rule. PayPal is it’s own processor NOW, but really used other processors at first. MERCHANT 2. Contact Processor for approval

  17. BASE I and BASE II – In Action

  18. Authorizations – Hold the funds BASE I AUTHORIZATION CARD HOLDER A. Cardholder has $1000 in available credit B. Subtract $100and cardholder now has $900 in available credit 1. $100 PURCHASE ACQUIRER ISSUER 3. VISA NETWORK 2. Contact Processor for approval • $100 purchase is not actually PAID. • It reduces the OPEN-TO-BUY balance of the cardholder • It is held “in limbo” waiting for merchant to “settle” the transaction as an “end of day” procedure MERCHANT C. $100 is reserved for merchant, if they settle the batch BASE I – Bank of America System Experiment #1

  19. Settlement – Get the funds VISA NETWORK ACQUIRER ISSUER BASE II SETTLEMENT All transactions for the day are sent to the acquirer (“settled” in the batch) $100 purchase is sent in an end-of-day procedure to close out any open authorizations, along with all of the OTHER transactions. MERCHANT “Batch” database BASE II – Bank of America System Experiment #2

  20. Auths for Multiple Customers VISA NETWORK ACQUIRER / Processor B of A Chase MERCHANT Customer 1 B of A Wells Fargo Customer 2 Chase “Batch” database Customer 3 Wells Fargo

  21. Settlement from Multiple Customers VISA NETWORK MERCHANT 1 1 BofA $100 ACQUIRER / Processor B of A 3 transactions - $400 2 transactions - $200 Chase MERCHANT 2 2BofA $300 1 Wells $50 2 transactions - $150 Wells Fargo Acquirer bundles all transactions into one large group, then sends then to each bank in a single per-bank batch. Issuers process the batch and match the “settlement” to the “authorization”, putting the charge on the statement. Acquirer receives funds from each bank, then splits the funds for each merchant, and pays merchant MERCHANT 3 2 Chase $200 1 Wells $100

  22. Follow the Money - The simple view CARD HOLDER A. Cardholder spends $100 B. Issuer pays $100 on behalf of cardholder 1. $100 PURCHASE ACQUIRER ISSUER 2. VISA NETWORK 3. Merchant Deposit MERCHANT

  23. What really happens in “settlement” • TIMELINE • Merchant closed batch by “cutoff time” for today’s transactions • Acquirer transmits data files to issuers after cutoff time but before VISA’s cutoff time. (Day 1) • Issuers reconcile batch, places charge on consumer’s account and create “funds transfer” for acquirer. • Issuer transfer funds to acquirer with associated response data file. (Day 2) • Acquirer process response file from ALL issuers, split funding and deposit into accounts (Day 3) • (The acquiring bank may not be the same bank as the merchant’s DDA / Checking account) Cardholder spends $100 CARD HOLDER 3. Create Funding (finalize charge) 4. Transfer to Acquirer ACQUIRER ISSUER (VISA) 2. Transmit to Issuers 1. Close Batch 5. Merchant Deposit MERCHANT’S BANK ACCOUNT

  24. Cost of funds – It’s a “loan” • TIMING FOR FULL FUNDING • Merchant gets paid in 2-3 days • Cardholder is billed monthly. • a. This means the “average” time until the statement is mailed is: (30 days / 2) = 15. • b. Cardholders are given about 20 days to pay their bill. • c. The total time is 15+20 = 35 days • Total time is 35 days – 3 days = 32 days • This means merchant gets paid the money on average 32 days BEFORE the issuing bank collects the money. • Paper deposit slips treated like “cash deposit” for the merchant • “Interchange fee” is the fee that includes “cost of funds” for one bank to interchange paper slips for funding the deposit Cardholder spends $100 CARD HOLDER Bill Cardholder • 15 days until billing cycle • 20 Days to pay Transfer to Acquirer ACQUIRER ISSUER (VISA) 2-3 DAYS FOR MERCHANT Merchant Deposit MERCHANT’S BANK ACCOUNT

  25. Nobody works for free • WHO GETS WHAT? • Issuing bank loans the money for 32 days. It gets a percentage of the transaction as it’s fees. • VISA facilitates the transaction, therefore it gets a per-transaction fee. • VISA needs to maintain it’s network, and has special “dues, fees, and assessments” for this. These are charged to the bank, and typically passed on to the merchant. • If a merchant uses ELECTRONIC Authorizations/Settlements, they get a discount on the Interchange. This is called the “discount rate”. • Processing the transaction by the acquirer costs computer time, so they also have a per-transaction fee. • Rewards cards cost MERCHANTS MORE! CARD HOLDER Cardholder spends $100 Transfer to Acquirer ACQUIRER ISSUER (VISA) 2-3 DAYS FOR MERCHANT Interchange Fees: Imprinter Deposit Slip: 2.75% Discount Rate for swipe: 1.59% VISA $0.10 per item Rewards card swipe: 2.59%* *Who pays the 1% cashback? The MERCHANT! Merchant Deposit MERCHANT’S BANK ACCOUNT

  26. All the players – Again, nobody works for free! CARD HOLDER Per AUTH: $0.02 Per Settled: 0.05% (Issuing processor is paid by issuer, fees not shown herein) Swipe 1.59% Per AUTH: $0.10 VISA Processor ACQUIRER ISSUER Processor Per Settled Item $0.10 Dues, Fees, Assessments: 0.11% Per AUTH: $0.03 Per Settled: 0.05% Gateway Total Per Transact: VISA: $0.10 Acquirer: $0.02 ISO: $0.03 Gateway: $0.05 ---------------------- TOTAL: $0.30* Total Percentages: Issuer: 1.59% VISA: 0.11% Acquirer: 0.05% ISO: 0.05% ---------------------- TOTAL: 1.80% MERCHANT ISO sells to merchant for acquirer or processor Per AUTH: $0.05 *assumes all auths are settled

  27. Card, Merchant and Data Affect Interchange INDUSTRY TYPES • Retail/Restaurant • Ecommerce/Mail Order • Lodging/Hotel • Supermarket • Gas Station. • (etc, etc, etc, etc) CARD TYPES • Check Cards • Credit Cards • Business Cards • Purchase Cards • Reward Cards • Business Reward Cards ALL of the above determine the data requirements and interchange rate for a specific card. Missing data causes a transaction to “downgrade” to a more expensive category. Incorrect data also causes downgrades. Untimely settlement of the batch causes ALL the transactions to downgrade.

  28. Other Fees • Merchant monthly “statement fee” to print and mail statements • Merchant “terminal fee” for the processor to store the terminal on their system • Merchant “reporting fee” for web reporting • Retrieval fee ($6.00 each) asking merchant to produce a signed receipt • Chargeback fee – for disputes ($25.00 each) • Additional interchange fees for “downgrades” when transactions are “missing extra data”.

  29. Liability • Visa holds the Acquiring Bank liable for all activity occurring by • The processor • The gateway • The Merchant • Visa holds the Issuing Bank liable for some fraud • Card present merchants are harder to dispute if you have: • In person transaction • Swipe of the card • Signature in ink • Card-not-present merchants have little protection, except Verified by Visa • Issuers can charge back almost anything (there’s a “code for that”) • Acquirers get “stuck” if a merchant goes bankrupt. • Acquirers get “stuck” if a data breach occurs and the merchant cannot pay the expensive penalty fees ($xxx.xx per card for each issuer, plus fines)

  30. PCI Security • Service Providers must be PCI-DSS compliant (Level 1 or Level 2) • Merchants must be PCI-DSS complaint at one of four levels • Level 1 – National Chains or Large e-Commerce merchants • Level 2 – Large Retailers • Level 3 – e-Commerce • Level 4 – Small Merchants • Software Products must be PA-DSS compliant • Hardware terminals must be PCI-Validated • PIN entry devices must be PCI-Validated • End-to-end encryption solutions must be P2PE PCI Validated (For more information, attend the session on PCI Security)

  31. Fraud Fighting Features Card Not Present • AVS – Address Verification • CVV2 – Card Security Code • Amex – Name Matching Card Present • Track Data • CVV1 (data on the swipe) • Signature • In Person transaction Card Not Present - Options • VbV – Verified By Visa • MasterCard SecureCode Card Present – Newer Options • EMV Chip / Chip & Pin • Mobile Identification (coming) Even with all this, the MERCHANT is usually liable, as VISA’s board is run by ISSUERS

  32. Check Processing Types • Paper Check Verification / Guarantee (from cash register) • ACH - Direct Debit (monthly membership billing, ecommerce, mail order) • POP/ECC – Electronic Check Conversion at register • BOC – Back Office Conversion of check from cash register • ARC – Accounts Receivable Conversion aka Lock Box processing for mailed checks (FPL, AT&T) • WEB – ecommerce check data • TEL – take data over phone and record customer • PPD/CCD – Personal or Commercial signed authorization to debit once or recurring. • RDC – Remote Deposit Capture (Image/picture of check from mobile) • Check 21 – Interbank image exchanged now used by merchants

  33. Paper Check Conversion CHECK 21 The Check Clearing for the 21st Century Act (Check 21) was signed into law on October 28, 2003, and became effective on October 28, 2004. Check 21 is designed to foster innovation in the payments system and to enhance its efficiency by reducing some of the legal impediments to check truncation. The law facilitates check truncation by creating a new negotiable instrument called a substitute check, which permits banks to truncate original checks, to process check information electronically, and to deliver substitute checks to banks that want to continue receiving paper checks.

  34. Gift Cards or Stored Value • Closed Loop – Only work where the merchant decides • State Escheatment Laws- Be aware you may be subject to these • Usage Fees – New regulations about what is “fair” to take for a monthly fee. These fees were designed to “chew up” the stored value before having to turn the money over to the state. • Risk of Business – If business goes under and cannot honor card value, the original transaction (credit card) can be disputed, causing risk to the acquiring bank

  35. Lots of players in payments Consumers Merchants Banks / Issuers Banks / Acuirers Networks for credit Networks for debit Networks for checks/ACH (to pay the merchant) Federal Reserve (to move money) Gateways ISOs / Sales Organizations Aggregators (PSPs), like PayPal and Square Gift Card, Check Acceptance Bitcoin, emoney, iTunes, “point” systems and other providers Pay by phone bill (mobile and home phone) 15. App writers for payments (POS systems, restaurant, mobile) 16. App writers for wallets 17. Phone carriers (EMV)

  36. The Logos Payment Brands Processors Check Providers PSPs