Ever wondered how transactions work? When it comes to transactions using paper money, it’s simple: you hand over cold hard cash. But digital transactions are more complex. And they’re worth understanding. According to a Capgemini report, the world will conduct over 726 billion digital transactions in 2020 – that’s 1.36 million transactions every second.
So how does your bank move your money when you write a cheque, or swipe your debit or credit card to make a payment? How do e-commerce sites withdraw money from your account after you consent to a digital transaction?
Here’s an essential guide for understanding how basic transactions work!
How banks move your money
When you write a cheque to make a payment or receive a payment through one, there is movement along two different planes.
Let’s assume Jane is an account holder in Bank A and writes a cheque for $200 for John, who has a bank account in Bank B. Here is how the banks will proceed with moving the money:
- Bank A will notify Bank B that Jane is making a payment to John. This notification is sent through the fastest medium possible: such as a phone call or an automated system specifically developed for this purpose
- In parallel, Bank A debits Jane’s account by $200
- In addition to this, Bank A will also mark that it owes $200 to Bank B by marking a -$200 for itself and a +$200 for Bank B
- Bank B on the other hand, also marks that Bank A (-$200) owes it $200
- Because both Bank A and Bank B now know that Jane wishes to send $200 to John, and Bank B trusts Bank A to pay the difference sometime later, they will credit John’s account with $200, making the transaction between the two people complete.
This is the process of correspondence banking, with the absence of a central bank. A central bank is important as it makes this transfer of money smoother, simpler, and swifter. How money moves with the involvement of a central bank is very straightforward:
- Jane instructs Bank A to send $200 to John
- Bank A forwards these instructions to the central bank
- Central bank checks whether Bank A has at least $200 in their account. Once confirmed, the central bank takes $200 from Bank A’s account and puts it in Bank B’s account
- The central bank then sends a message to Bank B that Jane has paid John $200
- Bank B then gives the $200 to John
There are several upsides to this system, such as both the clearing and settlement happening at the same time. This happens with every single payment, one by one. Another advantage is that this works in real-time, which means the money Jane sends will be received by John almost instantly.
How Merchant Transactions Work
Merchant services refer to the financial services that make it possible for businesses to accept credit card transactions and other digital transactions through debit cards and mobile payments.
Merchant payments cover all aspects involved in making these transactions possible, be it hardware or software. Here’s a simple guide to how merchant transactions work:
- The customer pays for goods by swiping their card at the credit card terminal
- The terminal (owned by the business) sends these details to the business’ bank, i.e. the acquiring bank to request payment authorisation
- The payment processor sends the transaction to the appropriate card association. Some examples are MasterCard and Visa. They then pass the transaction on to the issuer’s or card holder’s bank
- The issuing bank (the bank in which the customer has an account) then approves or denies the transaction depending on the status of the account
- This approval or denial message then floats back to the business’ credit card terminal
How Electronic Fund Transfers work
One of the most contemporary and convenient ways to make a transfer is through an ETF. An electronic fund transfer enables you to move money across an online network, which can be between banks or people, or both. Electronic Fund Transfers have essentially replaced the traditional modes of transaction, such as cash and cheques. Here’s how a basic ETF works:
- An ETF requires two parties to take place: a sender and a receiver.
- The sender commits to sending funds to the receiver
- The payment goes out through an appropriate payment network or platform
- The money is moved from the sender’s account to the receiver’s account
With Electronic Fund Transfers, you can move money faster than through traditional methods such as cheques. You can essentially make an instant payment online or using your phone by performing an ETF.
Whatever your preferred mode of transaction may be, it’s worth understanding how transactions work behind the scenes because in every case, transfers involves your money and time. The advancement in tech calls for one to be more vigilant and avoid online fraud. You must always follow good case practices in terms of protecting passwords, PINS, and important details that are directly associated with your account. Check out our guide to fintech jargon here.