Rating: 7.9/10.
Book about behind the scenes of payment systems, written by a senior employee at Marqeta, a payments startup, and it walks through various things that happen during credit card and debit card transactions. Overall, a high-level overview of many parts of the behind-the-scenes of payments. The book is relatively short and high-level and is an interesting read for anybody curious about what’s happening.
The steps of debit and credit payment: A customer uses a merchant terminal, which goes to the acquirer processor of the merchant bank. This routes into the customer’s issuer processor, where the customer’s bank checks quickly whether the transaction is allowed or not (authorization) and approves it. Then the customer’s bank must verify information about the customer before they can issue a card.
Authorization is the check by the issuer processor that the transaction is valid. When the customer uses the card, then the clearing and settlement process is done in a batch process typically 1-2 days after the purchase. The merchant clears all transactions, including adjustments like tips, and money moves in bulk between banks; network fees are also deducted at this time.
In case the customer files for a chargeback: the customer is always protected and never pays, so either the merchant pays it if they have documentation that the code was present, or the card issuer must pay it. The merchants try to use more secure methods like dip instead of swipe to minimize chargeback liability, but they generally pay the bulk of it and accept it as a business cost. Visa and MasterCard are just networks and never pay it.
Debit transactions use a different rail or network from credit cards and settle in one step instead of two. They have lower risk for merchants, and several networks exist, but they are generally interoperable with a fee. Banks are the only entities that can issue cards and move real money at settlement. Sometimes neobanks are actually tech companies that partner with banks, and Plaid is a startup that makes it easier to connect and get information from banks.
Payment facilitators like Square or Stripe allow a merchant to get started quickly and charge a percentage fee, and also help with analytics and chargeback documentation. Once a merchant is larger (about $500k a year), they can opt for a merchant acquirer. This has lower fees and money is settled directly into the bank account, but requires more paperwork. Payment service providers also allow merchants to accept more forms of payment like buy-now-pay-later or WeChat, etc.
The process of issuing a credit or debit card must be backed by an issuing bank, which handles compliance and connects to Visa and MasterCard. The issue processor quickly decides whether to approve a transaction, and they might call an API of the brand to decide, often based on specific business rules (eg: a card issued to a driver can only be used at a certain restaurant), and the brand is responsible for marketing and distributing the card.
KYC, or know your customer, are the rules that banks must follow to verify the identity of the customer in order to avoid fraud. This is most often difficult for new immigrants or new businesses, and technology is helping reduce friction in this process, eg by retrieving relevant financial records automatically.
Debit uses a single message that instantly completes a transaction, whereas credit uses two messages where the first one is pending and has higher interchange fees. Various factors determine the interchange fee, like whether a PIN is used. Private label retailers sometimes issue cards that incentivize spending at their stores and have lower interchange rates at these stores.
Other than cards, there are other ways to move money. ACH is used for bill payments and paychecks via batch bank-to-bank settlement, and it cannot confirm funds in real time, so it’s possible to have an overdraft. Venmo avoids the settlement period by having an internal ledger. For some cases, wire transfers are settled in real time but have human involvement, and that’s why the costs are relatively high. Some recent innovations have allowed instant money transfer, like businesses pushing directly to a customer’s debit card or issuing virtual credit cards that can be spent immediately without waiting for a bank transfer.
