TheRodinhoods

The Mystery of Card Payments 101 – for the “want to know” types!

As a small retailer who accepts card-based payments in India, one often asks the questions – how does this work and why does Visa charge me 2%?

Even as a consumer who had used cards, until I got into the Payment industry, I didn’t realize what a sophisticated system this is all about. The term Visa is often a pseudonym for cards – Visa, MasterCard, American Express, Diners, Discover,JCB, or the new Indian brand, RUPAY.

I thought I should explain what really happens and where does the so-called 2% really go.The examples below are for physical retailers – but the concepts are similar for Internet or Mobile Payments.

First and foremost – the rate isn’t 2%, and the majority of it doesn’t go to Visa. Both Visa & MasterCard are organizations that work through members – typically banks. Rupay is the Indian Card network that is being launched as a competitor to Visa & MasterCard. American Express, while similar in concept to the consumer, is run very differently – so some of the details may not be applicable.

These members issue cards to consumers – these may be Credit or Debit Cards (Prepaid cards are a variation of Debit Cards). Typically all members issue cards totheir consumers – these are called issuing banks.

Some of the banks may also sign up merchants – these are called acquiring banks – and often the merchants get a terminal called a Point of Sale (PoS) machine. The rate charged to the merchant is entirely governed by regulation and a negotiation between the Acquirer and the Merchant. In India the typical rates are ~1.6% for Credit Cards and between 0.75 and 1% for debit cards – the latter as per an RBI mandate. On the Internet, the rates may be higher – sometimes even as high as 7%.

How does a transaction work?

When you visit a merchant and choose the pay by card option, all the merchant needs to see is whether the card is Visa/MasterCard/AMEX and soon in India, Rupay – i.e. a card that his business has been acquired for. Which bank issued the consumers card is irrelevant as long as the card has a logo that the merchant has signed up for. All card-accepting merchants typically accept Visa & MasterCard – American Express today is typically with a smaller and more exclusive set of merchants.

When the merchant swipes (or dips in case of a Chip card) the card, the PoS contacts the server of the acquiring bank which in turn routes the transaction to Visa and from there on to the issuing bank. The issuing bank validates the user and blocks the amount from the users card and sends a confirmation response to the merchant, who then lets you walk out the store. All this happens in under-30seconds typically, and the money magically makes its way into the merchant’s bank account in 24 hours. 

It’s fascinating that this complex system that talks across any of 25,000 banks in the world actually works – and we now take it for granted. But needless to say a LOT of robust and scalable technology, security, policies, standardization and marketing and consumer education is required behind the scenes, in order for the transaction to work 99.99% of the time.

So where does the transaction fee go?

In reality, neither Visa nor MasterCard makes the bulk of the money. The money goes primarily to the consumer’s bank – i.e. the issuing bank. For Credit Cards this is typically ~1% although it is higher for Gold, Platinum & Signature cards. The logic for this is simple – 1% is approximately the cost of funds forthe initial credit period (30-45 days). This is typically called the “Interchange”. The remaining money is shared between Visa (or MasterCard) and the Acquiring bank and covers the cost of program management – in many cases, for large merchants, acquirers actually lose money.

In the caseof debit cards, given that the bank isn’t lending you the money, these rates are significantly lower – the upper limit on the rates are mandated in India by the Reserve Bank to be 0.75% for small value and 1% for transactions above 2000 rupees. Correspondingly the interchange is about 2/3 of the fee – this is whatgoes to the issuing bank.

Visa & MasterCard don’t make a lot per transaction – but the sheer global volume of transactions helps them add up being multi-billion dollar companies.

As a merchant, why would a merchant want to accept cards? 

Granted there is a cost – but there are several benefits to merchants to accepting cards.The key benefits are security & fraud, access to consumers and access to credit.

Security & fraud – are almost never factored in by merchants – the fact is every merchant ends up getting fraudulent bills, thefts, runnerboys who don’t bring back the 1Lakh rupees they collected etc. Additionally exact change,paying 100 rupees for 95 rupees of coins and other such issues can be minimized. These problems are largely eliminated in an electronic payments world. 

Access to consumers – in a day of instant gratification and impulse purchases, as a consumer, one often spends more with a card in hand.Often, one doesn’t have cash in one’s pocket – but more often than not, when you pay by card, you don’t think twice to add an extra item or two to the grocery basket, even if it wasn’t in the list. From the merchants perspective, that additional sale is itself worth the transaction fee – but many merchants do not realize this initially

Access to credit – Most retailers are forced to fund their businesses themselves – especially in India. For example, telecom recharge, issold by the distributor to the retailer on a cash/prepaid basis. The same holds for most of the goods a retailer stocks – whether from an FMCG or Pharma-company.

A recent pilot done with small Kirana stores in Bangalore (who were equipped with atablet to become more “organized”) showed that retailers bought and sold 30% more when allowed to borrow from a bank. More importantly the retailer was able to stock what he felt the market wants, rather than whatever the distributor was willing to give him credit for. For banks to lend however, they need to know that the money will come back to them – and card-based payments are a sure way to facilitate the repayment.

Consumer Financing & EMI’s

For credit-card customers, EMI’s are what often decides if you buy a product or don’t – or if you can buy the product you want or the product you can currently afford. This is yet another reason why, in many cases, consumers are starting to prefer cards over cash for any big-ticket high-value purchase. I had never personally used EMI’s until a couple of months ago – and now I’m hooked. 

Card acceptance as a marketing tool

I talked earlier about access to consumers in the context of people who might buy despite not carrying cash etc. This is only one side of the story. The banks and card companies are truly focused on spending a lot of the money they earn into programs such as loyalty, discounts, cash-back offers, special deals etc. 

For merchants the choice is simple – accept cards and do more business – or ignore them and risk staying small. 

I hope the above article is an easy read – I’ve tried to not use too many technical terms which often makes it very difficult to write about and understand for someone who isn’t from the industry. I’ll save the details for next time around.

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