Acquiring banks and merchants

What you will learn

  • What issuing banks are
  • What acquiring banks are
  • What merchant accounts are
  • What underwriting is
  • Why a merchant’s credit rating matters for accepting credit cards
  • What card associations are
  • What processors are
  • What ISOs are

What you should read first

Full article

This is part 1 of 6 of the credit card basics article. Here are links to each part:

Introduction

In the previous part, we discussed the relationship between a cardholder and their issuing bank as well as explaining concepts such as a line of credit and underwriting.

This part introduces the merchant side of the credit card ecosystem and relationship between a merchant and their acquiring bank including the processes in place for a merchant to be able to accept credit card payments.

Acquiring banks and merchants

When an issuing bank sends money to a merchant, it actually does not send the money directly to the merchant’s checking or savings account. Issuing banks have direct relationships with cardholders because they are the ones giving credit cards to their cardholders, but they must somehow pay merchants wherever cardholders decide to shop. The disconnect here is that issuing banks frequently do not have any relationship with the merchants where their cardholders shop and so they do not know what bank holds the merchant’s checking or savings account.

An entity called an “acquiring bank” solves this problem by being an intermediary and accepting (or “acquiring”) payments from the issuing bank on behalf of the merchant and then routing the money to the merchant’s checking or savings account. Again, money is deposited into the merchant’s checking or savings account usually 24 to 48 hours after a purchase.

We explain how acquiring banks and issuing banks are connected to one another in the next section, but for now, it’s important to understand that acquiring banks make it possible for a cardholder to use credit cards at many more merchants than just those that have direct relationships with the cardholder’s issuing bank.

Acquiring bank
An acquiring bank is the bank that acts as an intermediary between issuing bank and merchant and accepts payments on behalf of merchants when a cardholder makes a purchase.

An acquiring bank sets up what is called a “merchant account” when it agrees to accept payments on behalf of a merchant. Unlike a merchant’s checking or savings account that stores money, the primary purpose of a merchant account is to keep track of where to route money for each merchant.

Each merchant account is accompanied by a “merchant agreement” that spells out the contractual terms of the relationship between the acquiring bank and the merchant. Some examples of these terms are: which party is liable in case of credit card fraud and how quickly money is routed to the merchant. The merchant agreement also stipulates the fees that the merchant has to pay for accepting cards from cardholders. These fees are paid to all of the entities that facilitate the sending of money between a cardholder’s and a merchant’s bank account. Acquiring banks are responsible for charging the merchant these fees and distributing them to the rest of the ecosystem. We cover fees in more detail in our [transparencyx.com/wiki/Interchange next article].

Merchant account
A merchant account is an account with the acquiring bank that keeps track of where to route money for a merchant.
Merchant agreement
A merchant agreement is a contract that codifies the relationship between acquiring bank and merchant.

When a cardholder wants to cancel a purchase, and thus have the money returned, the money is returned to either the cardholder, the issuing bank, or both, depending on the cardholder’s outstanding debt with their issuing bank at the time the money is returned. Determining a merchant’s liability for returning money is a very complicated process that we will explain in further detail later, but for now it is important to understand that most acquiring banks hold merchants accountable for almost all money that cardholders and issuing banks want returned.

The acquiring bank / merchant relationship is very similar to the issuing bank / cardholder relationship in the sense that the acquiring bank underwrites merchants and thus takes on the risk of a merchant not being able to pay back cardholders in the event that they need to be reimbursed for their purchase. Before underwriting a merchant, many acquiring banks will evaluate a merchant’s ability to return money when the cardholder wants to cancel a purchase.

During the underwriting process, acquiring banks typically look at factors related to the likelihood of refunds, returns, fraud, and the merchant’s long-term financial stability, including, but not limited to:

  1. Owner’s personal information (social security number, home address, prior bankruptcies etc.). This information is frequently used to make a hard credit check on an owner's personal credit.[1]
  2. Length of time in business
  3. Type of business
  4. Length of time between when a transaction is made and when the services or goods are delivered to the cardholder
  5. The typical and maximum purchase sizes
  6. Whether the card information is accessed via the magnetic stripe or chip on a cardholder’s card ("swiped") or by entering in the digits on the face of the card ("keyed-in" or "key-entered")
  7. Proof of business’s existence (reviewing their physical location and / or website)
  8. Bank statements and tax returns
  9. Personal guarantees
  10. Articles of incorporation or organization

The more revenue that a business makes and / or the riskier its type of business is, the more documentation is required during the underwriting process.

We have thus far explained that issuing banks are responsible for giving credit card accounts to cardholders while acquiring banks are responsible for giving merchant accounts to merchants. These responsibilities are very different in their nature simply because cardholders and merchants have very different needs. Even if these two responsibilities are provided by the same bank, they tend to be in separate departments. The diagram below summarizes the two relationships between cardholders, merchants, and their respective banks.

BasicBankRelationships.jpg

What you should read next

References

  1. Note that while a soft credit check is when a person or company's credit rating is checked by another party (typically a potential employer), a hard credit check occurs when a person or company's is checked by a financial institution. Hard credit checks lower an individual's credit rating. Credit Karma: Hard inquiries and soft inquiries