According to the UK Cards Association, in 2016 there were 14.8 billion card transactions, which equals 40.5 million transactions per day, or 469 transactions per second. As more cards come into circulation in the UK, this figure is set to grow in the coming decade.
With an increasing number of consumers using cards to pay for both online and in-store purchases, it is critical to understand how these payments are authorised and processed. A necessary part of this process is the merchant account, a specialised account that is used to temporarily hold money that has been transferred after a credit card payment has been approved. Once money from a sale has made its way through the payments ecosystem – from point-of-sale to approval – it can be deposited from the merchant account into the seller’s bank account.
Merchant accounts are required for a seller to accept card payments, whether the transaction takes place in a physical store or on a website store. In this article, we will explain what a merchant account is, and how merchant accounts and services work within the broader payments ecosystem.
What Are Merchant Accounts?
A merchant account must be set up through a financial institution, which is referred to as the acquiring, or merchant, bank. On the other side of this transaction is the issuing bank, which issues the credit/debit cards to consumers, who then apply the cards towards purchases.
After a customer’s credit card payments have been processed and approved, they are paid out to a merchant account, where they are held for a short period of time. Only then can they be deposited into the seller’s regular bank account, at which point the process is complete, and the funds become fully accessible.
Individual merchant accounts are identified using a merchant account ID, an identifier that is uniquely tied to specific accounts. It can be used as an alternative to other identifiers, such as an email address, particularly with online payment gateways provided by Payment Service Providers (PSP), such as PayPal.
There are two main types of merchant accounts, dedicated merchant accounts and aggregated merchant accounts. These two different types are explained in further detail below.
Methods of Transaction Processing
To understand merchant accounts, it is useful to consider how card transactions are processed, a complex procedure involving multiple different entities. You can think of merchant accounts as the second-to-last step in the transactions process, right before the money gets deposited into the seller’s bank account, which is the final step.
First, a customer pays using a credit card. In a brick-and-mortar store, this happens at a physical card terminal at the point of sale. In an online store, this takes place on the site’s checkout page. For the payment to go through, it must be approved by a payment processor, the system that links the respective banks and credit card company’s payment processor, the system that links the respective banks and credit card companies, must approve it. The terminal is connected to the processor via a payment gateway.
In e-commerce, a payment gateway is an online transaction that is used to process credit or debit card payments. When customers enter their credit card details on the secure checkout page, the payment gateway – which can be embedded or on a separate page – processes this information, then verifies and authorises the payment.
If there are no issues, the money is deposited into the seller’s merchant account, where it is held for a brief period of time before it can be deposited into a regular bank account. Widely used online payment gateways for e-commerce include Stripe, PayPal, and Braintree Payments.
Online payment gateways are often attached to aggregated merchant accounts, meaning it isn’t necessary for a seller to have a dedicated merchant account, which is more complicated to obtain. Processing card payments online, or using an online payment provider software in-store, removes the need to buy a stand-alone terminal or PDQ machine.
What Is a Dedicated Merchant Account?
Dedicated merchant accounts, which are set up by merchant account providers for businesses, are the more traditional type of account. There are several advantages to having a dedicated merchant account, and they are of particular use to businesses that have high sales volumes. Advantages include:
- Greater control – credit cards can be accepted directly without an additional third-party payment gateway provider
- Customisable – often more favourable rates
- Standalone status if a business does not want to use a payment gateway
- Accompanying merchant services provided by the merchant account provider
Because dedicated merchant accounts need to be underwritten, and they function more or less like escrow accounts, the application process for obtaining one is quite stringent. The bank may require extensive documentation, which could take time and effort. Numerous factors need to be taken into consideration, such as the business’s perceived risk and overall creditworthiness.
What Are Aggregated Merchant Accounts?
While dedicated merchant accounts are complex and time-consuming to obtain, aggregated merchant accounts are more straightforward. They are particularly useful for smaller businesses, especially those that are interested in selling online. In an aggregate merchant account, money from several merchants is pooled by a provider (such as Stripe or PayPal).
Advantages of aggregated merchant accounts include:
- Convenience – the solution is ready-made
- Time savings – there is no need for an extensive processing period
- One product that includes an integrated payment gateway
On the other hand, because these accounts are not customised, they offer less control and are often accompanied by higher rates and fees.