From Swipe to Signature: How Credit Cards Actually Work

You swipe the magnetic stripe—or hopefully by now insert the EMV chip—of your card into the credit card terminal on the counter, wait a few seconds, politely decline a printed receipt from the friendly barista working the register, and walk out the door with your latte in hand. You don’t give what just took place a second thought until you receive your credit card statement showing a $6 charge for that caffeinated morning pick-me-up almost a month later.

You know enough about credit cards to understand the bank that issued your card essentially loaned you the money for that coffee and you’re obliged to eventually pay them back. But, if you’re like most people, it’s still a mystery as to what actually happens from the time you stick that magical piece of plastic into the card-reader to the point where you make a payment on that overpriced shot of espresso and steamed milk you enjoyed weeks earlier.    

Well, we’re about to explain that mysterious process in easy-to-understand broad strokes, but first let’s run down the list of the players involved. As the barkers who hawked glossy printed programs at sporting events used to say—before smartphones made printed rosters mostly irrelevant—“You can’t tell the players without a program!”

The Players

• You, the Customer: You are the card holder; the one using the credit card to purchase something. You set the whole process in motion when you hand over your card or run it through the card-reader.  

• The Merchant: This is the party selling you something. They accept your credit card as a valid form of payment for their goods and/or services.

• The Issuing Bank: The bank that gave you a credit card; their name should be on the card somewhere. They’re the party to whom you make a payment when you use your credit card.

• The Acquiring Bank: This is the bank that processes the Merchant’s credit card sales, including your latte purchase. They sign up merchants, and merchants pay them a fee to process customer purchases made with credit cards.   

• The Network: The Network facilitates the transaction by enabling the Issuing Bank to communicate with the Acquiring Bank. Major credit card networks in the U.S. include Visa, Mastercard, Discover, and American Express. 

The Transaction

Let’s say you use a Visa card issued by Credit One Bank (the Issuing Bank) to buy your coffee. You insert—“swipe” is still the popular nomenclature, but it’s “so a few years ago”—your Visa into the credit card terminal at your favorite coffee shop, which has signed an agreement with First National MegaBank (FNMB, the Acquiring Bank), to process customer purchases made with credit cards.

That terminal on the counter sends the credit card’s information to FNMB, and they promptly identify which network the credit card uses (Visa, Mastercard, etc.) based on the first number of your card. Once the card type is identified, its information is routed to the appropriate Network, in this case, because the card’s number starts with a “4,” to Visa.

Visa identifies the Issuing Bank based on the next few numbers of the credit card. Visa then sends the card number, the name of the merchant, and the transaction amount to the Issuing Bank, in this case, Credit One Bank. Now it’s Credit One Bank’s move to decide whether to approve or decline your coffee purchase.

If Credit One Bank believes the requested purchase is legit—as in it’s actually you and not a case of fraud—and the charge isn’t for more money than you have available credit and the account is still open and in good standing, they’ll tell Visa to let FNMB know the transaction is approved and to go ahead and process it.

FNMB then tells the terminal at the coffee shop that the transaction got a thumbs-up from Credit One Bank, and you get your fancy coffee and, if you so desire, a printed receipt. You may have to sign for the purchase if it’s over a certain amount, although most all of the major Networks are doing away with signatures altogether.

Who Pays Whom and When?

The above process all takes place in a matter of seconds, so you don’t need to worry about your coffee getting cold while you wait for everyone to do their part in the transaction. As for who gets paid when and in what order, it basically boils down to: 

1. The Merchant sends a “batch” of approved credit card authorizations to their Acquiring Bank, usually at the end of every business day.
2. The Acquiring Bank deposits funds from the approved credit card authorizations in the submitted batch into the Merchant’s account.
3. The Issuing Bank transfers funds to the Merchant Bank to reimburse them for the cup of coffee you charged on the credit card they issued you.  
4. You pay the Issuing Bank for your coffee and all other purchases made during that charge cycle, plus any interest or fees owed as stipulated in the credit card agreement you signed with Credit One Bank, the Issuing Bank.     

So there you have it. That’s essentially what happens when you use your credit card to achieve instant gratification by getting that thing you need or want within seconds of “swiping” your card. There are other bells, whistles, and specifics in the equation—including security safeguards like encryption—but now you at least get the gist of the overall process.

At least enough to ponder what actually took place the next time you have a few minutes to kill waiting for that extra-hot, extra-foamy mocha latte you just charged to be made.