Credit Card Processing

Electronic Draft Capture Overview

The first step in a credit card transaction is the authorization. The cardholder presents the credit card or the card number to the merchant. The card is then swiped through a reader or the card is manually entered. The merchant's credit card processing system (whether it is software running on a PC, or single-function bank terminal) uses a modem to dial the number of the front-end processing system or host. There are many different front-end systems, and each has a different protocol associated with it.

When the merchant's system connects to the front-end host, it transmits information about the transaction in the format required by that host. The host computer system is connected directly to another computer system called a VAP, which is part of a wide-area network sponsored by Visa and MasterCard. It provides access to an on-line system tracking all open cardholder accounts, open-to-buy balances, and lost/stolen cards. When the host receives a transaction authorization request from a merchant system, it uses the VAP to verify the validity of the cardholder account and reduce its open-to-buy amount. If successful, it returns an authorization code to the merchant system; if unsuccessful, it returns a reason the transaction was declined.

The authorization does not transfer any funds. It merely reserves the transaction on the cardholder's account. To actually transfer funds to the merchant, a settlement step is required. There are two primary methods used to initiate settlement through front-end processing systems; terminal-based and host-based. A terminal-based system requires the terminal (the merchant's system) to retransmit all the transactions to the host for settlement. A host-based system retains a record of all the transactions on the host computer and can perform settlement automatically. The actual settlement is performed when the front-end system transmits all the transactions to a back-end processing system. Settlement is typically performed once a day.

The back-end system collates the transactions and sends them to three places: the merchant's acquiring bank, the cardholder's issuing bank, and to the Visa/MasterCard on-line system. The acquiring bank adds funds to the merchant's account (which in many cases are immediately swept into the merchant's regular bank account at another bank). The issuing bank adds the transactions to the cardholder's statement, and pays the acquiring banks for the transactions through the Federal Reserve System.

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