The Basics of Debit Card Processing

Debit cards look like credit cards. The key differentiator between the two is where the funds to pay originate. With a debit card, payment is linked to the cardholder’s bank account and the amount is immediately deducted from their account balance, whereas credit cards extend a line of credit from the cardholder’s card-issuer.

Here are four different types of debit card processing

• PIN Debit - Cards are programmed with a personal identification number (PIN) needed to make purchases. This form of debit adds a layer of fraud protection to cardholders, merchants, and banks.
• PINless Debit –Transactions below a certain dollar amount (or other criteria) don’t require a PIN or signature.
• Signature Debit - Cardholders sign a receipt or the signature screen of the point-of-sale terminal to complete their purchase.
• Contactless Debit - Customers wave or tap their card, wearable (smart watch), or mobile device over a near field communication (NFC) terminal that communicates with the radio-frequency identification (RFID) technology in the card or device. With a wearable or a mobile device, the debit card is linked to a mobile wallet, such as Apple Pay®, Google Pay™ or Samsung Pay®. The transaction moves through the debit network just as it would with a PIN debit purchase.

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Credit Card Networks: What are they and how do they work?

When you use your credit card or a digital wallet to make a purchase, a credit card network goes to work behind the scenes. In seconds, it connects your card issuer and the merchant’s bank to process the transaction. In general, credit card networks manage the systems needed for credit card transactions. But there’s plenty more to understand.

What is a credit card network?

Credit card networks build and maintain the technology behind credit card authorization and payment processing. These networks connect card issuers and banks to help make purchases possible. For example, the network must check with the issuing bank to make sure there’s enough available credit to approve the purchase. American Express, Discover, Mastercard and Visa are the four major credit card networks in the U.S. The credit card network logo can usually be found on the front or back of a credit card.

Credit card network vs. credit card issuer: What’s the difference?

Credit card issuers are financial institutions that supply credit cards. Credit card networks run the technology that processes card payments—among other functions. In other words, the credit card issuer is the one you’ll be paying back for your purchases. For example, Capital One is a credit card issuer that works with the networks Mastercard and Visa.

Can a credit card issuer also be a credit card network?

Credit card issuers and networks are usually separate entities. But there are two exceptions—American Express and Discover. These credit card networks also issue credit cards. And they’re referred to as closed credit card networks. Networks that also issue cards act as the acquirer, which means they process the transactions and also pay the merchant for what’s owed for each transaction, minus any fees.

Types of card networks

Generally speaking, there are two major types of credit card networks:

Four-party networks: In a four-party network—also known as an open network—the credit card network relies on third-party financial institutions, such as banks, to issue and distribute cards to customers. Examples of four-party credit card networks include Visa and Mastercard. 

Three-party networks: In a three-party network—also known as a closed network—the credit card network acts as the card processing network and the card issuer. Three-party networks process payments on behalf of merchants and generally don’t allow third-party institutions to issue their credit cards. Examples of three-party credit card networks include Discover and American Express.

How do credit card networks work

To better understand how credit card payment networks work, it may help to look at an example transaction.

Let’s say you’re filling up your car at the gas station. Here’s how a credit card network makes the purchase happen:

• Using a card or digital wallet, you tap, swipe or insert a credit card at the gas pump or inside the store at the register. 
• The gas station’s point-of-sale (POS) system reads your card information and sends it to the gas station’s bank—called the acquiring bank—to request a charge.
• The acquiring bank sends the request to the credit card network.
• The credit card network contacts the card issuer to authorize and approve the transaction.
• If the card issuer approves, the credit card network gives the go-ahead to the POS system and charges a processing fee.

Credit card networks work with credit card issuers and merchant banks to process cardholder transactions quickly and securely. It helps to know which credit card network is linked to your card—just check the logo on the front or back. And keep in mind that it can be smart to have cards from different networks so you’re more likely to be able to pay with a card anywhere you go. Source

What is a Card Reader and How Does it Work?

A card reader is an electronic device that enables businesses to more securely accept and process credit, debit, or gift card transactions. It can come in various forms, such as part of a countertop POS system, as a smartphone attachment, mobile reader, or even as a handheld or wireless device.

Credit card terminals work by decoding the information stored on the card, encrypting it, and then transmitting it to the payment processor for authorization. The process involves several steps:

• The cardholder initiates the transaction by either swiping, inserting, tapping, or waving their card or mobile device over the card reader.
• The card reader decodes the card’s information and encrypts it for secure transmission.
• The encrypted data is sent to the payment processor, which routes it to the cardholder’s bank for verification and authorization.
• The card-issuing bank approves or declines the transaction, and the response is sent back to the card reader.
• The card reader displays the transaction result and, if approved, the sale is completed.

What is a magstripe reader?

Magstripe readers, also known as magnetic stripe readers, are card terminals designed to read the information stored on the magnetic stripe on the back of credit and debit cards. These card readers use a magnetic head to decode the card data, which is then sent for authorization. While magstripe readers are still used in the U.S., they are less secure for in-person shopping than EMV card readers because the data on the magnetic stripe can be easily copied or cloned.

What is an NFC card reader?

NFC card readers, or near-field communication readers, allow for contactless payments using cards or mobile devices with NFC technology. These card terminals use short-range wireless communication to exchange data between devices. To make a payment, the customer simply needs to hold their card or mobile device near the reader. Contactless mobile wallet payments, like Apple Pay® and Google Pay™, continue to increase in popularity due to their speed and convenience.

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Why Merchant Fees Are So Important For Businesses To Understand

Merchant fees directly impact a business’s profitability. The cost that comes with every swipe of a credit or debit card can eat into a business’s bottom line if they are not managed properly.

Here’s why understanding merchant fees is so important:

They affect pricing: Merchant fees are a business expense, just like rent or employee salaries. To cover these costs, businesses need to absorb them into their profit margins or pass them on to customers in the form of higher prices. Understanding your merchant fees helps you make informed decisions about pricing strategies and avoid losing money on transactions.

They can vary substantially: Different types of cards, transaction amounts, and industries have different interchange fees. For example, debit cards typically have lower interchange fees than credit cards, and online transactions often have higher fees than in-store purchases. Learning these variations allows you to choose the payment methods and processing options that are most cost-effective for your business.

They can be negotiable: While some fees, such as interchange fees, are set by the card networks, others—such as merchant account fees—can be negotiated with your payment processor. Understanding the different types of fees, and how they are calculated, can give you the power to negotiate for better rates.

They can help you identify fraud: Some merchant fees, such as chargeback fees, are incurred when a customer disputes a transaction. Learning about the fees associated with chargebacks can prepare you to deal with potential fraud and prevent it from eating into your bottom line. Source

Types of Merchant Fees

Merchant fees encompass a variety of charges that businesses face when processing electronic payments, such as credit or debit card transactions. The main types of merchant fees include:

Interchange fees: These are fees that the bank issuer of the customer’s credit or debit card charges. The amount is a percentage of the transaction value and may include a fixed fee. Interchange rates vary based on factors such as the type of card used, the transaction’s risk level, and whether the transaction was in person or online.

Assessment fees: These fees, which are charged by the credit card networks (e.g., Visa, Mastercard, American Express, etc.), are usually a fixed percentage of the transaction amount. The business’s bank pays assessment fees to the card network.

Payment processor fees: These fees are charged by the payment processor company handling the transaction processing on behalf of the business. They can be structured in a variety of ways, including as a percentage of each transaction, a flat fee per transaction, monthly fees, or a combination of these.

Monthly statement fees: Some payment processors charge a fee for providing a monthly statement of transactions.

Payment gateway fees: Businesses often use a payment gateway for online transactions, and this service may come with its own set of fees. This can be a per-transaction fee, a monthly fee, or both.

Minimum monthly fees: Some processors charge a minimum monthly fee, which is the lowest amount a business must pay in processing fees per month. If transaction fees don’t add up to this amount, the business pays the difference.

Setup and equipment fees: These fees cover setting up a merchant account or renting or purchasing necessary hardware (such as POS systems or card readers).

Chargeback fees: When customers dispute a transaction, it can result in a business needing to return funds, which is known as a chargeback. When a chargeback occurs, businesses are often charged a fee. This fee covers administrative costs associated with handling the dispute.

Early termination fees: Some merchant service agreements have a contract term, and terminating the contract early can result in fees.

Incidental fees: These fees can include fees for additional services such as paper statements, batch processing fees, or fees for noncompliance with security standards.

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Payment Submission: The Starting Line

When a consumer submits a card payment online or at a physical terminal, the unsung hero of the interaction is the payment gateway.

The payment gateway is the software that captures and transmits the sensitive data from a customer’s card (along with other key transaction information) to the acquirer so the authorization process can happen. For online and software-based payments, the gateway runs in the background behind the checkout page. In-store, the gateway software is built into the merchant’s physical payment hardware.

In addition to facilitating the flow of data to and from the merchant, the payment gateway is also the first line of defense against bad actors looking to steal valuable customer data.

Several initial security measures begin at the gateway level. The first and most universal is encryption. All gateways encrypt customer payment data before sending it. At the most basic level, they use legacy protocols like SSL (Secure Sockets Layer) and TLS (Transport Layer Security). However, modern gateways increasingly employ a more advanced and secure method known as tokenization.

A gateway can also require additional security steps that must be met before submission, like 3DSecure or the European Union’s Strong Customer Authentication (SCA). The former requires online shoppers to enter a PIN before a transaction can go through. This step ensures an authorized holder is using the card.

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Understanding Card Declines Due to Suspected Fraud

In today’s digital age, credit card fraud has emerged as a significant threat, costing billions annually and affecting millions of individuals and businesses worldwide. The ramifications extend beyond financial loss, damaging reputations, and eroding trust between consumers, businesses, and card issuers. As eCommerce grows, so does the number of legitimate transactions mistakenly rejected due to suspected fraud, a phenomenon known as false declines. 

False declines – also known as false positives in the realm of fraud detection – represent a significant challenge for both consumers and financial institutions. These declines occur when a legitimate credit card transaction is erroneously rejected under the suspicion of fraudulent activity. The reasons for such declines are varied and can include behaviors perceived as atypical for the cardholder, such as making high-value purchases that deviate from their normal spending habits, conducting transactions in geographic locations where they don’t usually shop, or making several online purchases in quick succession.

For example, consider a scenario where a consumer, typically making modest purchases in their hometown, suddenly attempts to buy expensive jewelry while on vacation abroad. Despite the transaction being legitimate, the sudden change in spending pattern and location might trigger a fraud alert, leading to a declined transaction. Similarly, during the holiday season, a shopper might purchase multiple high-ticket items online to take advantage of Black Friday deals. Such an unusual spike in online spending could also be misconstrued as fraud, resulting in declined transactions.

The real-world consequences of false declines are not trivial. According to research,  approximately 10% of all eCommerce dollars are rejected by fraud detection systems, but up to 70% of these declined orders are from legitimate customers. In some industries, payment decline rates can be as high as 20% or even 30%.  This highlights the financial impact false declines can have, even exceeding the losses they aim to prevent. In addition, the global reach of e-commerce and the increasing sophistication of fraudsters have exacerbated the issue. Fraud tactics are constantly evolving, with scammers finding new and innovative ways to bypass security measures.  The ongoing struggle for card issuers to refine their fraud detection algorithms—balancing sensitivity to suspected fraud (decline reason) with the need to minimize inconvenience to legitimate customers—remains a critical concern in the financial industry.

5 Fraud Monitoring Tools to Help Card Issuers Reduce False Declines Due to Suspected Fraud

To combat these challenges, card issuers are implementing more advanced fraud monitoring and authentication measures. These initiatives are not just reactive steps in response to the current threats but are also part of a broader strategy to improve the ratio between stopping the “good guys” vs stopping the “bad guys”. Through these concerted efforts, card issuers protect their customers and themselves from immediate risks while reducing the number of false positives that negatively impact the payment ecosystem.

1. Enhanced Authentication Techniques

• EMV Chip Technology: This technology has significantly reduced fraud by transmitting an encrypted, one-time code containing the card information to the card reader, making it nearly impossible to counterfeit cards.
• Biometric Verification: Incorporating fingerprints, facial recognition, or iris scanning adds an extra security layer, ensuring that the cardholder is the one making the transaction and reducing incidents of false declines due to suspected fraud.
• Two-factor Authentication: This requires the cardholder to provide two forms of identification (something they have, like a card and something they know, like a PIN), enhancing security.
• 3D Secure (3DS): A credit card security technology that helps card issuers check the authenticity of online transactions. The technology requires consumer action such as a one-time password (OTP) or other multi-factor authentication method via phone call, text message, or email before completing the purchase.

2. Real-time Transaction Monitoring and Analytics

• Machine Learning and AI: These technologies analyze transaction patterns to identify anomalies that could indicate fraud, enabling real-time decision-making and preventing unnecessary false positives that cause cardholders to experience a card decline for suspected fraud.
• Cross-channel Monitoring: This helps detect coordinated fraud attempts across different transaction platforms.

3. Tokenization and Network Tokenization

• Tokenization: This process involves replacing sensitive card details, such as the 16-digit account number, with a unique digital token. These tokens are then used to complete transactions without exposing actual card details, significantly reducing the risk of card data being stolen or misused.
• Network Tokenization: This involves the creation of tokens by the card networks (such as Visa, MasterCard, and American Express) that are specific to each transaction, merchant, or device. This means that even if a token were to be intercepted or stolen, it would be virtually useless outside of the specific transaction context for which it was generated. Network tokenization not only secures the cardholder’s data during the transaction process but also across the entire payment ecosystem, including online, mobile, and in-store environments.

4. Collaboration with Networks and Merchants

• Information Sharing: By exchanging data on fraud trends, card issuers, networks, and merchants can stay ahead of fraudsters. 
• Universal Security Standards: Implementing shared security measures creates a unified defense against credit card fraud.

5. Investing in Customer Education

• Awareness Programs: Educating consumers on secure transaction practices is crucial for preventing unnecessary instances of false declines.
• Practical Tips: Offering guidance on recognizing and avoiding fraud helps consumers protect themselves.

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