Card networks: Meaning, Criticisms & Real-World Uses

What Are Card Networks?

Card networks are the foundational infrastructure that facilitates electronic payment transactions globally, connecting various parties involved in a card-based purchase. These networks, operating within the broader financial services industry, serve as the intermediaries between consumers, merchants, and financial institutions. When a consumer uses a credit card or debit card to make a purchase, card networks are responsible for routing the transaction data from the point-of-sale to the appropriate banks for authorization, clearing, and settlement. Major global card networks include Visa, Mastercard, American Express, and Discover.

History and Origin

The modern card networks began to emerge in the mid-20th century, evolving from individual merchant charge accounts and early bank-issued cards. One significant development was the launch of BankAmericard by Bank of America in 1958, which later became the foundation for the Visa network. Similarly, the Mastercard network originated in 1966 as Interbank, a cooperative formed by several banks in New York to compete with BankAmericard.¹⁰, ¹¹ These early initiatives faced challenges related to processing transactions, which were often handled manually through telephone authorizations and physical paper drafts.⁹

The development of competing private credit and debit networks has been driven by the private sector, as the Federal Reserve ultimately opted not to build infrastructure for point-of-sale payments, instead focusing on supervision and regulation of banks and enforcement of consumer protection laws related to cards.⁸ As electronic payment technology advanced, these networks grew, establishing the complex systems necessary to handle millions of transactions daily across diverse geographical locations and currencies.

Key Takeaways

Card networks are the backbone of global electronic payment systems, enabling transactions between consumers, merchants, and banks.
They manage the authorization, clearing, and settlement processes for credit and debit card transactions.
Major card networks like Visa and Mastercard originated from bank-led initiatives in the mid-20th century to standardize and expand card usage.
Card networks play a crucial role in maintaining security standards and promoting innovation within the payments ecosystem.
Their business model often involves charging various fees, including interchange fees, which are central to their operation.

Interpreting the Card Networks

Card networks function as essential conduits within the payment ecosystem, facilitating the secure and efficient transfer of funds and information. Their role is to ensure that when a cardholder initiates a transaction, the request is routed from the merchant's acquiring bank to the issuing bank for approval, and then back again. This intricate process ensures that funds are eventually transferred from the cardholder's account to the merchant's account. The efficiency and global reach of a card network determine its value to participants; a wider network typically means broader acceptance for consumers and more potential customers for businesses. Beyond transaction processing, these networks also set operational rules, security protocols, and technical specifications for all parties involved, including banks and payment processors.

Hypothetical Example

Consider a consumer, Sarah, using her Visa credit card to buy groceries at a local supermarket. When Sarah swipes or taps her card at the point-of-sale terminal, the transaction data is sent to the supermarket's acquiring bank. This bank then routes the data through the Visa card network.

The Visa network receives the transaction request and identifies Sarah's bank as the issuing bank. It forwards the request to Sarah's bank for authorization. Her bank checks her account balance or credit limit and verifies the card's validity. Once approved, the authorization message travels back through the Visa network to the acquiring bank, and then to the supermarket's terminal, allowing the transaction to complete. Later, during the clearing and settlement process, the actual funds transfer occurs, with the Visa network facilitating the exchange of payment instructions and funds between Sarah's bank and the supermarket's bank.

Practical Applications

Card networks are integral to modern commerce, underpinning almost all non-cash retail transactions. They are critical for:

Global Commerce: Enabling seamless international transactions by providing a standardized framework for payments across different currencies and countries.
E-commerce: Facilitating online purchases by securely transmitting card data between online merchants and banks. Techniques like tokenization are often employed to enhance security in these environments.
Payment Security: Developing and enforcing stringent security standards, such as the Payment Card Industry Data Security Standard (PCI DSS), which applies to all entities that store, process, or transmit cardholder data. The PCI Security Standards Council, founded by major card brands, manages these standards to address rising cybersecurity risks.⁷
Innovation in Payments: Driving the adoption of new payment technologies like contactless payments, mobile wallets, and real-time payment systems.
Regulatory Frameworks: Working with governmental bodies and financial institutions to ensure compliance with payment regulation and consumer protection laws. The Federal Reserve, for instance, oversees the policies and operations of Reserve Banks as providers of financial services, aiming to foster the integrity and efficiency of the U.S. payment system.⁶

Limitations and Criticisms

Despite their critical role, card networks face various criticisms and limitations:

Fees and Costs: Card networks impose various fees on merchants, including interchange fees and network fees, which can reduce merchant profits and may indirectly lead to higher prices for consumers. This has historically been a point of contention and legal challenges.⁵
Market Dominance: A few large card networks dominate the global market, leading to concerns about lack of competition and potential for oligopolistic pricing.
Security Risks: While card networks invest heavily in security, they remain targets for cybercriminals. Data breaches, though often occurring at merchants or processors, can still undermine public trust in card payment systems.
Regulatory Scrutiny: Card networks are subject to increasing regulatory oversight, particularly concerning fees and anti-competitive practices. The Federal Reserve's Policy on Payment System Risk (PSR policy), for example, addresses risks that payment, clearing, settlement, and recording activities present to the financial system.⁴

Card Networks vs. Payment Processors

It is common to confuse card networks with payment processors, but they serve distinct functions within the payment ecosystem. Card networks (like Visa and Mastercard) provide the rules, infrastructure, and brand for transmitting transaction data and facilitating the movement of funds between banks. They are the conduits. Payment processors, on the other hand, are companies that handle the technical details of the transaction on behalf of merchants and banks. They provide the software and services that connect a merchant's point-of-sale system to the card networks and the banks. A payment processor might offer services such as transaction encryption, fraud screening, and reporting, effectively acting as an intermediary to the card network for merchants.

FAQs

How do card networks make money?

Card networks primarily generate revenue through various fees charged to financial institutions (both issuing and acquiring banks) and, indirectly, to merchants. These fees include transaction fees, assessment fees, and licensing fees for using their brand and infrastructure. A significant portion of these are interchange fees, which are paid by the acquiring bank to the issuing bank, and then passed on through the network.

Are prepaid cards part of card networks?

Yes, most general-purpose prepaid cards are part of major card networks like Visa or Mastercard. This means they can be used wherever those network brands are accepted. However, it's important to understand that prepaid cards may have different fee structures, such as monthly fees, transaction fees, or out-of-network ATM fees, which are typically disclosed by the card provider.², ³

What role do card networks play in transaction security?

Card networks set strict security standards for all participants in the payment chain. For example, they are founding members of the PCI Security Standards Council, which develops and maintains the PCI DSS—a set of requirements designed to ensure that all companies that process, store, or transmit credit card information maintain a secure environment. T¹hey also drive advancements in security technologies like EMV chip cards and tokenization to protect cardholder data.

Can a merchant operate without using a card network?

While a merchant can operate without directly connecting to a major global card network by only accepting cash or checks, to accept credit or debit card payments, they must interact with at least one card network. These networks are essential for the authorization, clearing, and settlement of card transactions, providing the necessary infrastructure for electronic payment processing.