In the four-party model, exemplified by VisaVisa visa A leading global payment technology company connecting consumers, businesses, and banks. and MastercardMasterCard mastercard A global payments network enabling electronic transactions between banks, merchants, and cardholders., four main entities are involved in transactionsTransactions transactions Interactions where value is exchanged for goods or services.: (i) the customer making a purchase; (ii) the customer’s bank or issuing bank, which holds the customer’s funds and has issued the payments instrument (typically card) being used; (iii) the merchantMerchant merchant An individual or business that accepts payments in exchange for goods or services. accepting the payment; (iv) and the merchant’s bank or acquiring bank, which holds the merchant’s account, ensures that the merchant has the necessary facilities, such as point-of-sale (POS) hardware, and initiates the processing of transactions.
In a transaction, (1) the customer swipes the card and authenticates the payment, after which (2) the merchant sends the transaction to the acquiring bank, (3) which in turn processes the transaction by passing it to the relevant payments network (e.g., Visa or Mastercard), and the network, which also sets the overall rules for the payments scheme, runs automated fraudFraud fraud Criminal deception involving unauthorized payments or use of financial credentials. checks and forwards the transaction to the issuing bank for authorizationAuthorization authorization The real-time process of verifying that a payment method has sufficient funds or credit limit for a transaction. Results in an authorization code from the issuer..
If the issuing bank authorizes the transaction, (4) it debits the customer’s account and (5) settles the payment to the acquiring bank, minus an interchange fee. Finally, (6) the acquiring bank pays the merchant, minus a merchant discount fee, which covers the acquiring costs, including interchange, terminal depreciation, risk, merchant servicing, operating expense, and some profit margin for the acquirerAcquirer acquirer A financial institution or payment processor that manages the merchant account, enabling businesses to accept card payments. Acquirers receive all transactions from the merchant and route them to the appropriate issuing bank. itself.
Difference vs the Three-Party Model
In a four-party model, the transaction feeTransaction Fee transaction-fee Charges incurred per individual transaction by the merchant. relating to a merchant payment typically must be split among the issuerIssuer issuer A bank or financial institution that issues payment cards to consumers. Responsible for authorizations and chargebacks., the acquirer, and the payments network. In a three-party model, the payments provider doesn’t need to share revenue with anyone else; it retains the entire transaction fee. Since MDRs are not necessarily lower for three-party models, this can mean higher margins for payments providers. However, the three-party model also requires the issuer to grow its own merchant network, which increases the cost and challenge of scaling.