How payments work: cards, real-time payments, wallets, BNPL, and remittances
The players in a card payment, the fee flow, and the newer payment methods that compete with cards.
Industry brief, with a one-minute summary: Payments and fintechKey takeaways
- A payment is a chain of companies, and each takes a small fee. Payments businesses earn tiny amounts per transaction, so they win through very large volume, low cost per transaction, and low fraud.
- Authorisation: the merchant's terminal sends the payment through the acquirer and the scheme to the issuer, which checks the balance or credit limit and fraud risk, and says yes or no in about a second.
- Clearing: later the same day, the transaction details are exchanged and fees are calculated.
- Settlement: money moves from the issuer to the acquirer, usually within one or two days, and the acquirer pays the merchant minus its fee.
Key idea
A payment is a chain of companies, and each takes a small fee. Payments businesses earn tiny amounts per transaction, so they win through very large volume, low cost per transaction, and low fraud.
A card payment has four parties plus a network. The cardholder is the customer. The issuer is the cardholder's bank, which gives out the card and takes the credit risk on credit cards. The merchant is the shop or website. The acquirer (often with a payment processor) signs up the merchant, accepts its card payments, and pays it. The card scheme, also called the network (for example Visa, Mastercard, UnionPay, RuPay in India, mada in Saudi Arabia, or Jaywan in the UAE), sets the rules and connects issuers and acquirers. American Express traditionally acts as both issuer and acquirer itself, which is called a three-party model.
What happens when you tap a card
- 1Authorisation: the merchant's terminal sends the payment through the acquirer and the scheme to the issuer, which checks the balance or credit limit and fraud risk, and says yes or no in about a second.
- 2Clearing: later the same day, the transaction details are exchanged and fees are calculated.
- 3Settlement: money moves from the issuer to the acquirer, usually within one or two days, and the acquirer pays the merchant minus its fee.
- Merchant discount rate (MDR): the total fee the merchant pays, as a share of the sale
- Key: Interchange feePaid by the acquirer to the issuer. Set by the scheme, and capped by law in some places. Funds card rewards and fraud costs.
- Scheme feesPaid to the network by both issuer and acquirer, per transaction and as a share of value.
- Acquirer marginWhat the acquirer keeps to cover processing, terminals, fraud checks, support, and profit.
The merchant pays one fee. It is split between three groups.
| Market and card | Interchange (to issuer) | Typical total merchant fee (approximate) |
|---|---|---|
| EU, consumer debit card | Capped at 0.2 percent by EU law | Often about 0.3 to 1.5 percent, depending on merchant size |
| EU, consumer credit card | Capped at 0.3 percent by EU law | Often about 0.5 to 2 percent |
| US, credit card | Not capped; often around 1.5 to 2.5 percent | Often about 2 to 3.5 percent |
| US, debit card from a large bank | Capped by Regulation II at 21 cents plus 0.05 percent, plus a 1 cent fraud adjustment (the cap is being challenged in court; see the trends lesson) | Lower than credit |
| India, UPI and RuPay debit | No merchant fee (zero MDR) under government policy since January 2020 | Zero for most payments; the government pays some incentives for small payments |
So-what
Fee levels depend on regulation. On a consumer credit card, a US issuer often earns about 2 percent of the sale against a 0.3 percent cap in the EU, several times more, which is why US credit cards offer rich rewards and EU cards rarely do.
Real-time payments, wallets, BNPL, and remittances
- Real-time account-to-account payments move money directly between bank accounts in seconds, day and night, often with a phone number or QR code. Examples: UPI in India (run by NPCI), Pix in Brazil (run by the central bank), PayNow in Singapore, FedNow in the US, SEPA Instant in the euro area, and Aani in the UAE. They skip the card scheme, so merchant fees are low or zero.
- Wallets store a way to pay on a phone. Some only hold a card (Apple Pay, Google Pay with a card), so the card economics still apply. Others hold money themselves (stored value), such as Alipay, M-Pesa in Kenya, or GCash in the Philippines, and earn from fees, lending, and other services.
- Buy now pay later (BNPL) splits a purchase into a few instalments, often four, usually with no interest for the shopper. The merchant pays the BNPL firm a higher fee than a card, because BNPL can raise sales. The BNPL firm carries the credit risk and the cost of funding the loan.
- Remittances are money sent home by migrant workers, for example from the Gulf to India, Pakistan, the Philippines, Egypt, and Bangladesh. Providers earn a fixed fee plus a foreign exchange (FX) margin: the gap between the market exchange rate and the rate they give the customer. Players include exchange houses, banks, money transfer companies, and digital apps.
| Metric | Plain definition |
|---|---|
| Total payment volume (TPV) | The value of all payments processed in a period |
| Transaction count | The number of payments; many costs are per transaction, not per unit of value |
| Take rate | Net revenue divided by TPV, usually in basis points (1 basis point is 0.01 percent) |
| Net revenue | Fees earned minus the fees passed on (interchange and scheme fees) |
| Authorisation rate | Share of attempted payments that are approved |
| Fraud rate and chargebacks | Share of value lost to fraud, and payments reversed after a dispute |
| Cost per transaction | Processing, support, and fraud cost for one payment |
| Active users | People who made at least one payment in the period (for wallets and apps) |
So-what
Always ask whether a revenue number is gross (before interchange) or net. Gross numbers can look ten times bigger than the money a payments company really keeps.
In the four-party card model, who receives the interchange fee?
Sources for this lesson (4)
- EUR-Lex: Regulation (EU) 2015/751 on interchange fees for card-based payments (official)
- Federal Reserve: Regulation II, debit card interchange fees and routing (official)
- Press Information Bureau, Government of India: incentive scheme for low-value BHIM-UPI payments, notes zero MDR since January 2020 (official)
- Recognized public explanations of case-interview concepts and frameworks
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