How does payment processing work?


Any businesses and websites that want to receive online payment must involve payment processing. Or else, online payments from your clients or customers can’t be processed so they simply won’t arrive in the business’s bank account.

Here, we will discuss how payment processing works, the steps involved in the process, and other details you might want to know.

What is Payment Processing

Payment processing, in a nutshell, is the process in which a payment made by a customer on an eCommerce website makes its way to the website owner’s bank account.

Most of us are already familiar with the process of purchasing something on the internet, and for us buyers especially when purchasing on a popular (professionally-made) site, the process might seem quite simple at a first glance: enter our credit card details, click submit, and voila!

However, in reality, the process is much more complicated and will involve more parties than the merchant and the customer alone, including but not limited to: 

  • Payment gateway: a secured connection between an eCommerce website’s shopping chart and a payment service provider
  • Payment service provider (PSP): the processor that authenticates the transaction with the bank that issues the credit card. Will check the validity of the credit card, availability of funds in the customer’s account, and so on. The merchant’s bank can be the payment processor, but it can also be a payment facilitator company (i.e. PayPal or Stripe).
  • Issuing bank: customer’s bank, from which the customer’s funds will be transferred
  • Acquiring bank: merchant’s bank that will receive funds after the process is finished

Below, we will further discuss the major parties that might be involved in payment processing, and how each of them works.

As discussed, the actual payment processing process takes just a few seconds, but in reality, it will involve several steps:

Step 1: The customer clicks on a product/service listed on the eCommerce website, puts the product in the chart, and proceeds to checkout

Step 2: The customer chooses the preferred method of payment (credit card/debit card/others) and completes the payment information (i.e. credit card number, VCC, etc.)

Step 3: After the payment details are submitted, the payment gateway encrypts this information to protect this data, and then will forward it to the payment service provider.

Step 4: The PSP relays the information to the credit card publisher or the issuing bank to check the validity of the card and whether the customer has the sufficient fund to complete the transaction

Step 5: The bank either approves or rejects the transaction

Step 6: if the payment is accepted, the issuing bank will transfer the fund to the merchant’s account on the acquiring bank

Primary Parties In Payment Processing

  • Card Publishers

Most online transactions nowadays are still performed via the help of credit cards, and so card publishers (networks) like Visa, MasterCard, Discover, and American Express are still at the center of the online payment niche.

These card networks receive fees from both the issuing and acquiring bank, typically a small percentage of the total transaction volume. Billions of credit card transactions are processed each year, and so being a card publisher is a very profitable business.

However, the barrier of entry is very high due to technological and partnership requirements in this niche, and it’s very difficult if not nigh impossible to start your own card network at the moment.

  • Issuing Bank

There are banks that issue credit cards to consumers, and in an online transaction are also responsible for issuing payment to the merchant’s acquiring bank. These issuing banks receive an interchange fee from the merchant acquirer, which is set by the card network.

  • Merchant Acquirers

Merchants must partner with at least one acquirer before they can accept payment from credit cards, and they can come in two basic forms:

  • Payment processor

A payment processor is a company that works with card networks and banks as the merchant’s partner so they can process and accept payment. A payment processor is responsible for verifying the validity of the transactions and performing anti-fraud measures.

Chase or Bank of America are banks that are also payment processors, but there are also independent payment processors like Vantiv or First Data. Some of these processors also work with various financial institutions to offer other services, and they typically charge fees based on the merchant discount rate (a percentage of the sale amount) or a fixed fee per transaction.

  • Payment facilitators

Also called ISOs (Independent Sales Organizations) or PayFac, payment facilitators technically resells the service of payment processors so merchants can receive payment by being PayFac’s sub-merchant (while the payment facilitator is a master merchant).

There are traditional payment facilitators that provide POS (Point-of-Sale) technology to offline merchants, but there are also newer online players like Stripe, Square, and Paypal.

There are various ways a payment facilitator can make money, making it a lucrative business opportunity, and technically everyone can become a payment facilitator business. For example, a payment facilitator might be paid the remainder of the merchant discount after the card network and issuing bank get theirs.

End Words

Although an online transaction might seem simple and typically only take a few seconds, the underlying process actually involves several important parties and can be relatively complex with many potential issues. At the same time, with how eCommerce businesses are booming in recent years, the payment processing industry is now a lucrative opportunity with a high potential profit.