The Inner Workings of Credit Cards
Singapore’s majority cannot survive without a credit card, yet most of us don’t understand how a credit card works. This post is dedicated to explaining the working principles of a credit card.
What the word credit card means?
These are famously (or infamously, depending on your experience using credit cards) defined as “plastic money”. It enables the user to spend the money without actual cash in hand. Credit cards come with a pre-approved credit limit from the bank and this limit indicates the amount that the bank can lend you for that month for your purchases.
How credit card works after you made a purchase with it?
There are many associated bodies which work jointly to process each transaction smoothly. The following will give you an idea about this process.
It’s hard to believe but this process is complicated. To make it simple we can consider an example of you entering a shop with a credit card to purchase something.
You pick something you want and you hand over the credit card to the cashier to slot into a credit card reader.
The credit card reader decodes the information on the magnetic strip or sim card of the credit card and sends that information to the shop owner or merchant’s bank. (That magnetic strip contains information like credit card number, credit limit, expiry date etc.).
The merchant’s bank receives this information and validates the transaction.
The bank forwards this purchase order to the relevant credit card company ((i.e. Visa, MasterCard or American Express).
Now, that credit card company contacts your bank for card validation.
After receiving the confirmation from your bank, the credit card company approaches the merchant’s bank and approves the deal.
Now you paid for your deal with your credit card… What next?
You will notice that still there is no cash exchange between you and the merchant. You might be wondering how the shop owner gets paid after all this. What’s going on behind the scenes? How the shop owner going to charge you for this purchase?
How the credit card payment system works
At the end of particular period say one month, the merchant or shop owner produces all the receipts to his bank (remember the slip you signed after the transaction) and the bank transfers the entire bill amount to his account.
Simultaneously, this bank sends a payment request to your credit card company and the credit card company pays the merchant on your behalf. Once it has done so, it sends a payment request to your bank.
Your bank processes the request of your credit card company and pays the amount and charges you for the purchase.
This is how a credit card works.
Want to learn more? Read more articles about credit cards here.