How do payment processor works?

Payment processors and are companies that work with merchants to process financial transactions. Merchant accounts allow businesses to accept card payments from their customers with the aid of payment processors as an intermediary. For a payment processing transaction to be successful, there are interplays of steps that must occur between different stakeholders in the payment process.

How do payment processors work?

Payment processing involves moving funds from a cardholder account to the merchant’s account. The payment process includes 3 main sequential steps; transaction processing, authorization, and payment clearance.

1. Transaction Processing

The different players involve in processing payments and their roles are discussed below:

i. Cardholder: The cardholder is the customer who wants to make a payment. The payment process begins when cardholders enter their card details into the merchant’s online form or Point of Sale(POS) for the purchase of goods or services. For online transactions, the transaction details are routed through the payment gateway.

ii. Payment Gateway: It helps authorize transactions for e-commerce websites. It usually comes with a merchant account or can be acquired separately. The payment details received from the merchant is encrypted and securely sent to the payment processor.

iii. Payment Processors: Payment processors serves as data transfer link between the merchant, issuing bank (cardholder bank) and acquiring bank (merchant bank). They also provide the credit card machine or technology for accepting payments. After the transaction information from the payment gateway is received by the payment processor, the next step is the combination and formatting of the customer’s details including customer’s bank account, card details, and price. The processed data is then sent to the credit card company.

iv. Card Associations Card associations include credit card companies such as Master card and Visa card which act as fee setter and arbiter between the cardholder and the merchant’s bank. They route the transaction request to the cardholder’s bank for authorization using the appropriate card network.

v. Cardholder Bank: Cardholder banks are responsible for paying the merchant’s bank for every transaction made by the cardholder. They approve or decline a transaction after confirming the details. The state of the account, transaction validity and account balance are checked to ensure that the transaction can be done. A transaction response is then sent back to the payment processor.

2. Authorization
The authorization response from the cardholder bank is sent in a reverse order to that in which the transaction details were processed, first to the payment processor. The payment gateway receives the authorization code from the payment processor and then send it to the merchant’s terminal or website. The response is stored on the merchant’s server while the payment is being cleared.

3. Payment Clearance

The clearance begins with the forwarding of approved authorizations to the merchant’s bank which then credits the merchant’s accounts with the fund from sales and debits the account for processing fees. This is followed by the debiting of the cardholder bank account and the crediting of the merchant’s bank by the card company. Finally, the account of the cardholder is reconciled by the issuing bank while the merchant bank sends the approved funds to the business’ bank account. Both merchant accounts and payment processors are needed to process payments, the two services are usually offered separately but some payment service providers now combine their functions into one.