Issuing banks and cardholders

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

  • Nothing, start here.

Full article

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

Introduction

The purpose of this article is to give readers, regardless of their prior knowledge, a foundation for understanding how the credit card industry operates. We start with a basic, yet thorough, introduction to the industry and the entities involved behind the scene:

  • Issuing banks
  • Cardholders
  • Acquiring banks
  • Merchants
  • Card associations
  • Processors
  • ISOs

Familiarity with these entities will provide readers with the knowledge necessary to understand the follow-on articles where we dissect the industry in extreme detail.

Issuing banks and cardholders

Credit cards make it possible for consumers to buy goods and services from merchants without needing cash on hand. To do this, consumers need relationships with entities called “issuing banks”. Issuing banks, at a high level, are banks that do two things:

  1. Give consumers credit card accounts. The consumer whose name is embossed on the credit card is known as the “cardholder”.
  2. Pay merchants on behalf of cardholders. When a cardholder uses their credit card, the issuing bank uses its own money, not the cardholders’, to pay the merchant. What this means is that with every credit card purchase, an issuing bank is in fact loaning money to a cardholder. The cardholder then owes this money to the bank to be paid at a later date. The maximum amount of money that a cardholder can borrow from an issuing bank at any one time is called a “line of credit”.
Issuing bank
An issuing bank is the bank that gives consumers credit card accounts and pays merchants on behalf of cardholders.
Cardholder
A cardholder is the customer whose name is embossed on a credit or debit card.
Line of credit
The maximum amount of money that a cardholder can borrow from an issuing bank at any one time.

An important concept to note is that even though cardholders don’t have to start repaying their issuing banks until the end of the month, a merchant usually receives the money for the purchase between 24 and 48 hours after the purchase. There are instances, like purchases that occur on a Thursday or Friday and get deposited on Monday or Tuesday, where it takes longer than 48 hours for the purchase amount to be deposited into a merchant’s bank account. This timing can be influenced on many factors which we will explain at a later point.[1]

Issuing banks get their name from the fact that they send or “issue” payments to merchants on behalf of cardholders. When an issuing bank sends a payment on a cardholder’s behalf, the issuing bank is taking financial responsibility for a cardholder not being able to pay back a purchase. This assumption of financial liability is called “underwriting”. The term underwriting is derived from when a person or entity would sign their name on a document underneath the total amount of financial risk that they were willing to accept.[2]

Underwriting
When a bank or individual takes financial responsibility for a person or entity not being able to pay an amount that they owe.

Issuing banks decide if they want to underwrite a cardholder by evaluating the likelihood of a cardholder repaying the money loaned to them. A few examples of the information that issuing banks use to determine this likelihood are:

  1. Credit rating
  2. Amount of credit already in use (i.e. if accounts are maxed out)
  3. Number of times a cardholder has applied for more credit
  4. Length of time credit accounts have been maintained
  5. Number of late credit card bill payments
  6. If the cardholder is currently paying other loans or mortgages
  7. Cardholder’s personal income[3]

At this point it is important to note the difference between a credit card and a "debit card". A debit card looks just like a credit card but it is connected directly with a cardholder's bank account at an issuing bank instead of to a line of credit. What this means is that the cardholder's bank account actually has funds taken out of it and sent to the merchant during a debit transaction.

Debit card
A debit card is a card that is connected directly to a cardholder's bank account at an issuing bank and instead of to a line of credit.

The amount of time it takes for this money to be taken out of a cardholder's bank account depends on the method that the cardholder's account information is gathered: "online debit" or "offline debit". Online debit is when a cardholder enters their secure PIN code to authorize a transaction and the cardholder's account has funds removed and sent to the merchant in real time. Offline debit, which happens most frequently with what is called a check card, is when a cardholder does not use their PIN to authorize a transaction. In an offline debit transaction a merchant receives the money in a similar time frame as a credit transaction, 24 to 48 hours after the purchase.

Online debit
Online debit is when a cardholder enters their secure PIN code to authorize a transaction and the cardholder's account has funds removed and sent to the merchant in real time.
Offline debit
Offline debit is when a cardholder does not use their PIN to authorize a transaction. In an offline debit transaction a merchant receives the money in a similar time frame as a credit transaction, 24 to 48 hours after the purchase.

What you should read next

References

  1. Some of the most common factors include a merchant’s acquiring bank delaying funding because they deem a merchant’s business to be too risky to receive next day funding, if the merchant’s point of sale system is set up to send — or “batch” — out transactions at a specific time, and if the transactions are sent to the processor after a predetermined cut-off time for the processor’s platform.
  2. Investopedia: Underwriting definition
  3. Credit Karma: Credit card approval insights