February 20, 2025

How Payment Processing Works (and Why a Direct Processor Matters)

Megan Best, VP of Business Operations

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Payments 101

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Every time a customer swipes, taps, or hits “Pay Now,” their money takes a backstage journey through the payment process. The details of that process are often a bit opaque to those who aren’t in the payments industry, but they can have real consequences that impact merchants, including the fees they pay, how long they wait for funds, and who they rely on for support.

In this guide, we clear up the who, what, and why of the process to help you get your bearings and make an informed decision about the best setup for your business.

What is Payment Processing?

Payment processing is how money transfers from customer to merchant in non-cash transactions. While the term “credit card processing” is commonly used, payment processing also includes debit card transactions, digital wallets like Apple Pay, and even alternative payment methods like ACH or Buy Now Pay Later (BNPL) solutions.

Who’s Involved in the Process?

To set the stage, here’s a quick overview of the parties involved in payment processing:

• Issuing bank – The bank that issued the customer’s credit/debit card.
• Cardholder (customer) – The person making a purchase with their credit card.
• Merchant – The business accepting the card payment.
• Acquiring bank (acquirer) – The merchant’s bank that receives funds on behalf of the merchant. Acquirers sometimes also act as payment processors.
• Payment processor – The company that communicates with card networks and banks and manages the payment process on behalf of a merchant. See the next section for an in-depth look at the role and responsibilities of the processor in your transactions.
• Card networks – The company that routes transactions between banks and processors, creates card technology (like chips and EMV), and sets the security standards and fees for transactions within their networks. Some card networks (e.g., American Express) are also card issuers; in this case, they may act as the issuing bank in this process.
• Agent or ISO (Independent Sales Organization) – A representative who partners with processors to sell (and support) payment solutions to merchants. 

You may also work with a separate merchant account provider and/or payment gateway provider if your processor does not bundle these services with their basic offerings. (At EPI, we support account and gateway functions in addition to processing.)

The issuing bank, cardholder, merchant, and card networks are always entities within the payment processing system, but you may see slightly different configurations of the other parties in this list. For example, the role of acquirer, processor, merchant account provider, and payment gateway may sometimes be managed by a single provider or several multi-service providers.

A Deeper Dive on Payment Processors

If you want to understand how payment processing works, getting to know the role of the actual payment processor is essential—and it can help you better assess your provider options.

What Do Payment Processors Do?

The core responsibilities of the processor include:

• Providing payment technology and processing solutions (e.g., point of sale (POS), terminals, online gateways, etc.).
• Initiating transactions via the merchant POS
• Connecting the POS to card networks
• Communicating information from card networks and banks
• Authorizing transactions by ensuring the customer has sufficient funds or credit to cover the transaction
• Coordinating the clearing and settlement of funds from the acquiring bank to the merchant’s bank account
• Supporting secure transactions through PCI compliance and encryption
• Mitigating risk with chargeback and fraud prevention support

Indirect vs. Direct Processing

There are different types of processors. Depending on their business model, your processing provider may also support acquiring, merchant account maintenance, pricing management, and funding. The distinction typically concerns whether you work with a direct or indirect processor.

While indirect processors perform the same core duties as direct processors, their system relies on third-party processing networks that handle authorization and settlement on behalf of the processor. In contrast, direct processors have proprietary networks, meaning they can handle the whole process without involving third parties. As a result, direct processors can cut third-party fees, move funds faster, and provide better support. Still, some merchants might work with an indirect processor due to existing technology integrations, contractual obligations with an acquirer, or risk classification. For example, some high-risk industries (gaming, international transactions, etc.) may require specific indirect processing solutions due to regulatory constraints.

The 3-Step Payment Processing Process

To better understand what occurs during a card transaction, we’ll walk through the payment process step-by-step and discuss how it changes based on whether you’re working with a direct or indirect processor.

1. Transaction Initiation

The customer taps, inserts, or swipes their card at a point of sale (POS) or terminal (or enters card details online). The POS system, terminal, or gateway then sends transaction data to the processor. Direct processors handle this transaction directly, while indirect processors forward transaction details to a third party.

2. Authorization

Next, the processor contacts the card network (Visa, Mastercard, etc.), which then communicates with the customer’s issuing bank. This step is the same for direct and indirect processors.

The issuing bank approves or declines based on available funds/credit limit and potential fraud detection.

Since direct processors own their networks, they can connect and communicate faster with card networks and issuing banks. The extra touchpoint created by an indirect processor’s external network can slow things down.

3. Clearing & Settlement

If the issuer approves, the processor forwards the transaction to the acquiring bank. The issuing bank transfers funds to the merchant’s bank account. In some cases, the processor, acquirer, and merchant account provider may all be the same provider.

Settlement is faster for direct processors—merchants may get funds the same day. Indirect processors may delay settlement, often one to three business days or longer.

Next Step: Explore Your Options

So, when would you choose an indirect processor rather than a direct processor? Often, the choice isn’t obvious to merchants because so many distinctions are only clear on the backend. When assessing your options through an agent, the choice often comes down to specific technology integrations available and industry regulations.

Of course, some direct processors can address these concerns. With extensive integration capabilities, support for frequently underserved, “high-risk” businesses (adult retail and entertainment, smoke, vape, CBD, MOTO guns and ammo), and world-class support, Cygma®, EPI’s wholly-owned processor, delivers the benefits of direct network ownership while addressing the potential drawbacks that might drive merchants and agents toward indirect processors.

Plus, a partnership with EPI comes with more than just Cygma; we provide comprehensive payment services that support you through the whole payment process, including processing (direct and indirect), acquiring, providing payment technology, merchant accounts, and payment gateways, and supporting agents and ISOs.

By understanding how payment processing works, you’re already ahead of many business owners. Now, take the next step and assess whether you can benefit from lower costs, faster funding, and more control over your transactions: explore direct processing with Cygma.

800-966-5520 | www.electronicpayments.com