In payment processing, issuing banks and acquiring banks play crucial roles in facilitating smooth and secure transactions. While these two entities might seem similar, their functions, responsibilities, and relationships with your business and its customers cause them to differ significantly.
In this article from Payment Nerds, we’ll examine the roles of issuing and acquiring banks, their key differences, and how they work together to ensure seamless payment processing for your business. Read on and dive in to learn more!
What is an Issuing Bank?
According to the Cambridge Dictionary, an issuing bank is[1]:
“A bank or other financial [institution] that makes credit cards available.”
In more detail, an issuing bank, or “issuer,” is a financial institution that provides credit or debit cards to consumers. These banks are responsible for extending credit to cardholders and managing the accounts tied to those cards. In terms of payment processing systems, many would consider the issuing bank to be the “customer’s bank.”
Wells Fargo, Chase, and Bank of America are good examples of major issuing banks. These institutions are directly tied to cardholders and work to ensure their satisfaction and financial security.
What is an Acquiring Bank?
Under the definitions of the PCI Security Standard Council, an acquiring bank, also known as an “acquirer,” is[2]:
“[An] Entity, typically a financial institution, that processes payment card transactions for merchants.”
Acquiring banks are financial institutions that work with merchants to process card payments and manage every transaction involving the merchant. Unlike issuing banks, which focus on consumers, acquiring banks cater to businesses by providing them with merchant accounts. These accounts hold all funds from a merchant’s customer transactions before final approval and then are transferred into the business’s bank account.
Prominent acquiring banks include First Data (now part of Fiserv), Worldpay, and Square. These institutions play a pivotal role in supporting businesses through efficient payment processing.
Ways an Issuing Bank & Acquiring Bank are Different
Though both issuing and acquiring banks are essential to payment processing, their functions are hugely different. Here are the primary differences they have:
Stakeholder Focus
Issuing banks cater primarily to consumers by providing them with payment methods — such as credit and debit cards — and managing the accounts tied to them. For example, when a consumer receives a Visa card from Chase Bank, Chase is the issuing bank responsible for managing that cardholder’s account.
Acquiring banks, on the other hand, focuses on merchants, which, in the case of payment processing, is your business. They ensure businesses can accept electronic payment methods via credit and debit card payments and also safely receive funds from such transactions.
These banks are also known to establish merchant accounts and provide payment infrastructure (like point-of-sale systems or payment gateways) as well as contactless and ACH payment solutions for a wide range of payment methods. Because they are closely linked with the card networks, acquiring banks are strict with processes and businesses about complying with payment regulations, especially the PCI-DSS.
Financial Role
Issuing banks extend credit to cardholders by setting credit card limits. They take on financial risk by trusting cardholders to repay balances, whether in full or through monthly payments. For debit cards, issuing banks manage the funds directly from the cardholder’s checking account. These banks also authorize or deny transactions based on the cardholder’s creditworthiness or available balance.
Acquiring banks facilitates the transfer of funds from the issuing bank to the merchant’s account. They play a key role in ensuring that merchants receive payment for goods or services sold, minus applicable fees. Acquiring banks do not lend money to merchants. Instead, they provide the infrastructure to process and settle card transactions, which makes acquirers critical to a business’s ability to operate in today’s cashless economy.
In short, the financial relationship for issuing banks centers on extending credit. For acquiring banks, it’s about facilitating payments.
Risk Management
Issuing banks manage risks related to cardholder payment default or fraud. For instance, a cardholder might default or fail to pay their credit card bill, leaving the issuing bank to absorb the loss.
A different example may involve a stolen credit card, which results in fraudulent transactions, which the issuing bank would need to monitor and resolve. This is why many issuing banks invest heavily in fraud detection systems and provide zero-liability policies to reassure their customers.
Acquiring banks address risks such as chargebacks or fraudulent transactions on the merchant’s end. In the case of a chargeback, a cardholder disputes a transaction, and the acquiring bank must work with the merchant to resolve the issue. If the merchant cannot prove the transaction was valid, the acquiring bank may be held liable for reimbursing the issuing bank.
Acquirers must also deal with fraudulent merchants who engage in malicious acts like processing fake transactions. If this occurs, the acquiring bank could face large fines or lose its ability to process payments through certain card networks.
Revenue Streams
Issuing banks earn revenue from a variety of channels, including:
- Interest on Credit Card Balances: Cardholders who carry balances pay interest, which is a significant source of revenue.
- Annual Fees: Some credit cards charge annual fees for premium features like travel rewards or concierge services.
- Interchange Fees: When a cardholder makes a purchase, the merchant pays an interchange fee to the issuing bank via the card network.
- Late Fees: Issuing banks charge penalties when cardholders miss payment deadlines.
Acquiring banks also generate income through various transaction fees, such as:
- Payment Processing Fees: These fees are typically a percentage of each transaction, combined with a small flat fee.
- Chargeback Fees: When a cardholder disputes a transaction, acquiring banks charge merchants a fee to cover the administrative cost of resolving the dispute.
- Additional Merchant Services: Many acquiring banks offer value-added services like payment gateways, fraud prevention tools, and data analytics for an extra cost.
How Issuing & Acquiring Banks Work in Payment Processing Systems
Issuing and acquiring banks play critical roles in the payment processing system, working together to ensure seamless transactions between consumers and merchants. Their collaboration, facilitated by card networks and payment processor companies, is what underpins the millions of cashless payments we make every day.
Let’s explore in detail how all of these entities interact, as well as the specific steps that issuing and acquiring banks are involved in:
Payment Processing, Step By Step
The Purchase Initiation:
- A customer swipes, inserts, taps, or manually enters their card details at a point-of-sale (POS) terminal or online payment gateway[3].
- The terminal captures essential data — such as the card number, expiration date, and transaction amount — and encrypts it for security.
Authorization Request:
- The merchant’s payment terminal sends the encrypted transaction data to the payment processor, which then forwards that data to the acquiring bank[3].
- The acquiring bank acts as a middleman, passing the transaction request to the relevant card network (e.g., Visa, Mastercard, American Express).
- The card network identifies the issuing bank associated with the card and routes the transaction details to them.
Transaction Verification by the Issuing Bank:
The issuing bank verifies the cardholder’s account to ensure the transaction can be completed. This involves:
- Checking the cardholder’s credit limit or available balance
- Verifying the card’s validity and expiration date
- Assessing the transaction for potential fraud based on factors like location, purchase amount, and merchant category
If everything checks out, the issuing bank approves the transaction and reserves the funds or credit on the cardholder’s account. If not, the transaction is declined, and a reason (e.g., insufficient funds or suspected fraud) is sent back through the network.
Approval Communication:
- The issuing bank sends an “approved” or “declined” response back through the card network to the acquiring bank.
- The acquiring bank then informs the merchant of the transaction’s status, completing the authorization phase in seconds.
Settlement of Funds:
- Once the transaction is authorized, the settlement process begins. This involves moving funds from the issuing bank to the acquiring bank minus applicable fees.
- Settlement typically happens in batch processing, where multiple transactions are cleared, and funds are transferred in bulk, usually at the end of a business day.
Merchant Receives Payment:
- The acquiring bank deposits the funds into the merchant’s account minus interchange fees, acquiring bank fees, and payment processor fees[3].
Cardholder Billing:
- The issuing bank adds the transaction amount to the cardholder’s credit card bill or deducts debit card transactions from their checking account.
Payment processors are important in this process because they act as intermediaries, connecting issuing and acquiring banks. They handle the technical and logistical aspects of transmitting transaction data securely and efficiently.
To ensure your business runs smoothly, work with a reliable payment processing service like Payment Nerds.
Conclusion
Understanding the differences between issuing and acquiring banks is essential for business owners who want to navigate the payment processing landscape effectively. While issuing banks focus on cardholders by providing them with cards and managing their accounts, acquiring banks concentrate on merchants and ensuring seamless payment acceptance.
Together, these banks form the backbone of modern payment systems, ensuring transactions are processed securely and efficiently. By grasping their roles and interactions, you can make informed decisions about your payment processing needs and set your business up for success.
Ready to start processing debit and credit card payments through an effective merchant service provider? Apply now at Payment Nerds and discover how our advanced security, transparent price structure, and in-depth support can transform your business.
Sources
- Cambridge Dictionary. “Issuing Bank.” https://dictionary.cambridge.org/us/dictionary/english/issuing-bank. Accessed December 11, 2024.
- PCI Security Standards Council. “Acquirer.” https://www.pcisecuritystandards.org/glossary/acquirer/. Accessed December 11, 2024.
- NerdWallet. “What Is a Payment Processor?” https://www.nerdwallet.com/article/small-business/what-is-a-payment-processor. Accessed December 11, 2024.