Payment Scheme : Global : Visa
What does Visa do
Visa Inc. is an American multinational financial services corporation.
Visa facilitates electronic funds transfers through the world, most commonly through Visa-branded credit cards, debit cards and prepaid cards.
Visa does not issue cards, extend credit or set rates and fees for consumers; rather, Visa provides financial institutions with Visa-branded payment products that they then use to offer credit, debit, prepaid and cash-access programs to their customers.
Visa is now the worldwide second-largest payment network (second? Yes, the first is now China UnionPay which surpassed Visa since 2015 based on total transaction volume and card issued). However, as China UnionPay is based primarily domestic market in China, Visa is still considered the dominant payment network in the rest of the world.
Have you ever wondered How is Visa formed, evolved? What happens underlying when you pay using your Visa card?
To clear above questions, we need go back to history and walking through it.
General purpose card by Diners Club
The word ‘credit’ has a far long history than ‘credit card’, it can be explained in a very simple way: buy now pay later, or, sell now collect later.
Economy activities based on credit already existed before electronic payment:
A small stall owner adds one item to his ledger that Alice bought one pack of salt for 0.99 dollar on 1 Jan 1856, with Alice’s signature for authorization for future money collect.
Big retails provide their premier customers with special accounts that they can pay the commodity by installment.
……
The above-mentioned credit is given by specific merchant and can only be consumed in that merchant. With the development of modern economy activities, image what will happen when all merchants issuing their own ‘credit’ to their consumers.
That is the greatness of Diners Club, it solves this potential issue by introducing world’s first general spending card (well to be more precisely, world’s first multipurpose charge card) in 1950. You can read the full story of Diners Club here .
It is very hard to build a network (especially for trust) as you need to be persuasive for both sides: consumer and merchant, especially considering this is the very first of its kind. Without enough consumers the merchants will not accept your cards and vice versa.
There are some interesting thoughts/facts.
Banks earn people’s trust and it seems they should be the natural choice to issue such cards, yet history show not.
Diners Club charges around 7% to their assigned merchants which is far high compared today.
General purpose card by Banks
After Diners Club, banks start to issue general spending cards of which Franklin National Bank issued the first in 1952.
In 1958, Bank of America, the largest bank in United States at that time, enters the credit card industry with brand ‘BankAmericard’.
Unlike the services provided by Diners Club, which card holder shall pay full statement balance before due date, services provided by Bank of America allows part of the card holder to pay partial of their statement balance if they choose to bear the interest of remaining stated balance.
The former is now commonly recognized as ‘charge card’ while the latter as ‘credit card’.
Visa is born
After issuing BankAmericard, Bank of America started licensing agreements with a group of banks outside of California due to the cross-state operation restriction of federal law.
With more and more licensees started to issue BankAmericard under the licensing agreements, they started to ‘feel not treated equally’ as the licenser. Consider the following two scenarios: for a card issued directly from Bank of America, the bank will collect the whole ‘Interchange Fee’ while for a card issued by Bank A under the licensing agreement with Bank of America, Bank of America will cut a piece of the ‘Interchange Fee’.
Dee Hock, a manager at the National Bank of Commerce which is one of the licensee, formed a committee in 1968 with other licensees to investigate and analyze the various problems with the licensing program. After length negotiations, the committee was able to persuade Bank of America that a bright future lay ahead for BankAmericard — outside Bank of America. In 1970, Bank of America gave up control of the BankAmericard licensing program and agreed for a new membership program. The various BankAmericard issuing banks took control of the new program and formed National BankAmericard Inc. (NBI) which eventually involved to Visa.
The great honor is given to Dee Hock who is also the first president and CEO of Visa. Same honor should also be given to the management team of BankAmericard in Bank of America for the step down of the licenser role and to accept the new role as a membership. It is actually a rare case when making a business decision and for that, they deserve the great honor.
Roles inside Visa ecosystem
Visa connects consumers to merchants. Different roles cooperate inside this payment ecosystem to achieve this.
Cardholder, who spends money using cards
Merchant, who accept cards from cardholder
Issuer, who issues cards to cardholder to whom they maintain financial relationship
Acquirer, who maintains business relationship with merchants and help them to process electronic payments.
Visa, who builds/maintains payment network on top of which the payment information / settlement information runs.
Depending whether the Issuer and Acquirer is the same entity, payment system is categorized as open-loop and closed-loop.
Open-loop, the payment network, who does NOT issue cards, connects Issuer and Acquirer which in turn connects Cardholder and Merchants. Visa falls to this category.
Closed-loop, the payment network also functions as Issuer and Acquirer. American Express and Discover fall to this category.
Processing flow of a Visa transaction
How the money is moving from cardholder’s account to merchant’s account when you making a transaction at Merchant’s POS machine? The following diagram depicts a simplified processing flow.
Step 1: Cardholder swipe/insert/tap card at merchant’s POS machine.
Step 2: The POS machine collects transaction related information and transmit them to Acquirer.
Step 3: Acquirer forwards transaction information to Visa and request Visa to get transaction authorization from Issuer.
Step 4: Visa verifies current transaction against its own policy, then asks for Issuer’s authorization.
Step 5: Issuer grants the authorization to Merchant for current transaction. It is to be noted that there is no direct link between Issuer and Merchant, the authorization goes back to Merchant through Visa then Acquirer. Cardholder now gets the services from Merchant and ends transaction from his/her perspective. Merchants don’t receive money now, what they get is Issuer’s authorization on current transaction which they could use to collect money from Issuer in a future time through Acquirer.
Step 6: Issuer transfers money to Acquirer which then credits that money to Merchant’s account. It is till now the Merchant received the actual money.
In following sections, we demystify a Visa transaction from a technical point of view into two steps:
Information flow: authorization
Cash flow: clearing/settlement
Demystify a Visa transaction — information flow — authorization
Authorization is the process that Issuer received transaction information from payment network (e.g. Visa), analyzing that information against its own risk control parameters to either approval or decline the transaction.
Once the Issuer approves that transaction, what happens to Cardholder’s account (we use credit card as an example) is transaction amount being deducted from Cardholder’s available credit limit. What not happened (at the time being of Issuer approved transaction) is transaction being posted to Cardholder’s statement.
Detailed data flow for a transaction authorization is depicted follows:
Step 1: Cardholder taps card to merchant’s POS.
Step 2: Merchant’s POS receives respond data from Cardholder’s chip card and sends them to Merchant’s Acquirer.
Step 3: Acquirer sends transaction information to payment network (e.g. Visa) and asks for authorization.
Step 4: Payment network (e.g. Visa) sends transaction information to Issuer and asks for authorization.
Step 5: Issuer reverts authorization result, either approval or decline, to payment network (e.g. Visa)
Step 6: Payment network (e.g. Visa) relays authorization result to Acquirer.
Step 7: Acquirer relays authorization result to Merchant’s POS machine.
Step 8: Merchant notifies the result to Cardholder and ends the transaction.
Demystify a Visa transaction — cash flow — clearing/settlement
Clearing
Clearing is the process in which Acquirer credits transaction amount to Merchant’s account while Issuer debits transaction amount from Cardholder’s account.
Clearing is initiated by Acquirer.
Depends on Acquirers, batches of transaction records (from different Merchants that Acquirer serves) are sent to payment networks (e.g. Visa) for clearing. After receiving clearing request from Acquirers, payment network (e.g. Visa) will sort all transaction records Issuer-by-Issuer and send them to their corresponding destinations.
After receiving clearing request, with transaction records, from payment network (e.g. Visa), Issuers will debit Cardholder corresponding amount to his/her account. At this moment, as a Cardholder you need to pay back your Issuer for transactions on your statement.
Note that the actual money still NOT flow from Issuer to Acquirer.
Detailed data flow for a transaction authorization is depicted follows:
Step 1: Acquirer uploads all un-cleared transaction records to payment network (e.g. Visa).
Step 2: Payment network (e.g. Visa) sorts received transaction records Issuer-by-Issuer and sends them accordingly. Issuer will debit its Cardholders according to these transaction records.
Step 3: Payment network (e.g. Visa) also sends summarized ledger to both Issuer and Acquirer, like total amount of Issuer A for all the spending from its Cardholders, total amount of Acquirer B for all his Merchants should receive…
Now comes the actual money movement.
Settlement
Settlement is the process that Issuer pays the money (clear debts) to Acquirer under condition that they agree with the clearing results.
The settlement mode used by Visa is Deferred net settlement (DNS), which process periodic (one clearing cycle) batch settlement between settlement participants on a multilateral net basis. At the end of one clearing cycle the net obligations between settlement participants are calculated and presented to the Real-Time Gross Settlement (RTGS) System.
The money (net obligations) movement is performed by the RTGS System of that country inside which both Issuer and Acquirer doing their business. The RTGS is a large-value payment system which is one systemically important financial infrastructure for every country.
Payment network (e.g. Visa) uses different approaches in various countries. In some countries, the payment network (e.g. Visa) might open one settlement account to participate that country’s RTGS system, while in other countries they may designate one local bank as the settlement bank to process the fund settlement.
We use the former case in the following diagram to depict the processing.
Step 1: Issuer transfers money from his settlement account opened in his business country to payment network (e.g. Visa) designated settlement account (e.g. Opened/owned by Visa). These two accounts are participants for that country’s RTGS system.
Step 2: Payment network (e.g. Visa) transfers money from his designated settlement account (e.g. Opened/owned by Visa) in his business country to Acquirer’s settlement account. Again, these two accounts are participants for that country’s RTGS system.
Step 3: Both Issuer and Acquirer perform money movement (debit and credit) to their customers (Cardholder and Merchant).
A payment transaction is now closed.
What happens to BankAmericard
Surprisingly, Bank of America still issues BankAmericard. Just the card now runs on the Mastercard network.
