Card networks: an explainer

Card networks are at the heart of every transaction.

Whenever we pay electronically for anything in-store or online, card networks encrypt and coordinate our transaction data through a complex web of digital pathways.

They do this over a billion times a day. And in customers' eyes, this process is invisible and instant.

This blog explains why understanding the debit and credit card network processes is pivotal for understanding the wider payment processing system.

What is a card network?

A card network (also known as a 'card scheme') is an organization, like American Express, that provides a key component of the technological infrastructure for credit card payments.

Their main task is to authorize and process credit, debit and online card payments. They do this by providing a communication system to facilitate transactions between customers' issuing banks and the merchants' acquiring banks.

They also set transaction terms, which are another key element of the payment processing chain.

Credit card networks vs debit card networks

Card networks typically cover both credit card transactions and debit card transactions.

The choice of card network (Visa, Mastercard, American Express, Discover, etc.) is usually determined by the issuing bank and the merchant's point-of-sale terminal.

When a cardholder uses their card, the bank that issued the card (e.g., Bank A) may have agreements with multiple card networks (e.g., Visa and Mastercard) to process transactions.

The bank's system, along with the cardholder's choice (if applicable), will determine which network is used for a specific transaction.

In practice, both credit and debit cards can use a variety of card networks, and the specific network used for a given transaction depends on various factors. These include the cardholder's bank, the merchant's terminal, and the network agreements in place.

Examples of major credit card networks

Globally, the four major credit card networks are Visa, Mastercard, American Express and Discover.

However, other networks are increasingly popular in other regions. For example, China primarily uses UnionPay, while Japan uses JCB.

What's the difference between a card network and a card association?

Though these phrases are often used interchangeably, especially in the U.S., there is a distinction

A card network, such as Visa or Mastercard, is primarily responsible for the technical infrastructure and processing of card transactions. It manages the routing of transactions to reach the appropriate banks and facilitates the exchange of payment information.

A card association establishes and enforces the rules and standards for member banks that issue their brand of payment cards. They also set interchange fees.

They don't directly process transactions or handle funds. Instead, they work with member banks to ensure everyone follows their card brand's rules and maintains consistent standards.

The same company often operates both as a network and an association. This contributes to the confusion between the two terms.

What's the difference between a card network and a card issuer?

The fundamental distinction between card networks and card issuers is their respective roles in the payment process.

Card networks are a main player in the infrastructure of card payment transactions. They generate revenue through merchants' transaction fees.

Card issuers are responsible for cardholder accounts. They profit from charging cardholders fees on interest, late payments, foreign exchange, and processing fees and more.

Can card networks also be issuers?

In certain cases, card networks can also be card issuers. For example, American Express and Discover, both operate as card networks and card issuers. They issue their own credit and debit cards directly to customers under their own brand.

Types of card networks

Open card networks

Open networks, like Visa or Mastercard, maintain relationships with multiple card issuers.

Closed card networks

Closed networks, like American Express or Discover, are exclusively linked with one financial institution. No other company can issue cards that are tied to a closed network system.

Closed card networks play the role of acquirer and disburse funds directly to the merchant’s account.

How do card networks work?

Card networks work by facilitating the connection and communication between the main financial institutions involved in the payments process. This is the issuing bank (the customer’s bank) and the acquiring bank (the merchant’s bank). It typically takes place as follows.

1. Transaction is initiated

When a cardholder uses a card reader device at the point of sale (POS) in a store, or presses 'pay' on an online checkout page, they usually believe that this is a complete transaction.

However, it is not. It is actually the initiation of a transaction. In other words, they are submitting their payment information (typically card details and name) along with a request for approval of a payment.

2. Verification

Next, the physical or online payment terminal passes the payment information and request onto the payment gateway for verification.

3. Encryption

If the verification is successful, the payment gateway encrypts and then passes on the verified customer and transaction information to the payment processor. They then transfer it to the card network.

4. Authorization/disapproval and confirmation

The card network authorizes or declines the transaction. They then inform the payment processor of the outcome via the card network. The payment processor then in turn notifies the merchant and cardholder of the decision.

5. Holding and reserving of funds

The funds are now temporarily held in a 'pending' status whilst the acquiring bank (merchant's bank) verifies the transaction. Once this verification is complete, the processor notifies the card network, which routes the transaction to the cardholder's bank (via their issuer processor) for approval.

If approved, the funds are held in a 'reserve' until the settlement process is completed. This usually take a few days.

6. Settlement

Settlement refers to the final transfer of funds from the cardholder's account to the merchant's account.

Conclusion

Card networks are an indispensable part of electronic payments. They act as the critical link between issuing banks and merchant acquirers in the payment processing ecosystem.

They facilitate the seamless flow of transactions, acting as the bridge between issuing banks and merchant acquirers.

Card networks play a pivotal role in the payment verification and authorization process, ensuring both the security and efficiency of electronic payments. Their contribution enhances the security of fund exchanges.

Open card networks, like Visa and Mastercard, collaborate with multiple financial institutions. And closed card networks, such as American Express, are exclusively tied to a single institution.

Understanding card networks' nuances is crucial for comprehending the intricate machinery governing electronic payments.

In July 2023, the Federal Reserve Payments Study (FRPS), reported that credit card payments experienced the second largest increase, rising to 51.1 billion, or about one-third of all card payments in 2021.

This demonstrates that the popularity of card payments is still increasing, particularly in the U.S. The card networks have solidified their position as the current linchpin of electronic commerce and financial transactions.