What Is Merchant Services in Banking?

Merchant services in banking encompass a range of financial tools and support structures that allow businesses to accept electronic payments from customers. These services are important for businesses in retail, e-commerce, or any commercial activity accepting electronic payments. Merchant service providers assist businesses in processing payments efficiently, whether in person or online.

Core Components of Merchant Services

Payment processing is the overarching function within merchant services, enabling businesses to handle electronic payments. This involves the secure transfer of funds between a customer and a business, covering transactions made with credit cards, debit cards, and other electronic methods.

Point-of-sale (POS) systems are combinations of hardware and software used by businesses to process transactions in physical locations. These systems can include cash registers, card readers, barcode scanners, and receipt printers. Modern POS systems extend beyond basic sales, often providing functions for inventory management, sales tracking, and customer data analysis.

Payment gateways are technologies that securely transmit customer payment information, particularly for online transactions. They encrypt sensitive data, such as credit card numbers, and send it to payment processors for verification. Gateways act as the front-end of the electronic payment process, linking a business’s website or app to the financial network.

Virtual terminals are software-based solutions that allow businesses to process credit and debit card payments without a physical card reader. These are particularly useful for “card-not-present” transactions, such as orders taken over the phone or by mail. Businesses can access virtual terminals through a web browser on an internet-connected device, manually entering customer payment details.

Chargeback management focuses on handling disputes when a customer challenges a transaction. This service helps businesses navigate the process of responding to chargebacks, which can arise from issues like unauthorized purchases or dissatisfaction with goods or services. Effective management can help mitigate financial losses and protect a business’s reputation.

How Payments Are Processed

A payment transaction begins when a customer initiates a purchase, providing their payment information to the business. This information is then securely transmitted through a POS system or payment gateway to the credit card processor. The processor acts as an intermediary, routing the transaction data to the appropriate card network, such as Visa or Mastercard.

The card network forwards the authorization request to the customer’s issuing bank. The issuing bank verifies the cardholder’s account, checking for sufficient funds and potential fraud. Based on this assessment, the bank either approves or declines the transaction, sending this decision back through the card network to the processor.

If approved, the transaction moves to the settlement stage. At the end of a business day, approved transactions are grouped and submitted for settlement. The payment processor or acquiring bank (the business’s bank) requests funds from the issuing banks through the card networks.

Funding occurs when the issuing banks transfer the approved funds to the acquiring bank. The acquiring bank then deposits these funds into the business’s merchant account, usually within one to three business days.

Who Provides Merchant Services

Traditional banks offer merchant services to their business clients, often partnering with payment processors. They provide a comprehensive suite of financial services, including merchant accounts, which are specialized bank accounts for holding transaction funds before they are transferred to a business’s regular operating account.

Independent Sales Organizations (ISOs) act as intermediaries, connecting businesses with merchant acquirers or processors. ISOs focus on sales and support, offering a variety of payment solutions. They work with multiple processors, which can provide businesses with diverse options. ISOs generally do not handle direct processing or risk management themselves, instead relying on their partnered processors.

Payment Facilitators (PayFacs) simplify the process by allowing sub-merchants to accept electronic payments under a single “master” merchant account. This model streamlines onboarding, making it faster for businesses to begin processing payments. PayFacs often manage compliance, underwriting, and risk, acting as the primary point of contact for their sub-merchants. Unlike ISOs, PayFacs often take on more direct responsibility for managing the entire payment process, from authorization to settlement.

Merchant Service Pricing Models

Interchange Plus is a transparent model where costs are separated into two main components: interchange fees and the processor’s markup. Interchange fees are set by card networks and issuing banks, typically a percentage of the transaction plus a fixed fee (e.g., 1.65% plus $0.10). The processor then adds its own fixed markup.

Tiered pricing models categorize transactions into different rate tiers, such as qualified, mid-qualified, and non-qualified. Each tier has a different processing rate, and transactions are assigned to a tier based on factors like card type or how the transaction was processed. This model can be less transparent, as the specific criteria for each tier and the associated rates may not always be clear to the merchant, potentially leading to higher costs.

Flat rate pricing charges a single, fixed percentage or amount for all transactions, regardless of card type or transaction method. For example, a provider might charge 2.9% plus $0.30 per transaction. While this model offers simplicity and predictability, the fixed rate is typically set high enough to cover all potential processing costs, which means businesses with lower interchange costs may pay more than necessary. This model can be attractive to smaller businesses with lower transaction volumes due to its straightforward nature.