Today, credit card processing has turned into an industry worth billions of dollars. How did credit card processing come so far? What’s the history of credit cards and credit card processing? Find out today in our history of credit card processing.
The Early Beginnings of Credit Cards
As mentioned above, credit cards first started with consumers using credit coins in the late 1800s. These consumers would use credit coins (and, in some cases, charge plates) to pay for purchases without immediately using cash.
The credit card processing we know today, however, didn’t enter the picture until over a century later.
In the early 1900s, certain oil companies and department stores across America began giving customers their own proprietary cards. These cards had limited functionality and were mostly designed to foster customer loyalty and improve customer service.
Out of all these companies, Western Union’s “credit card” is probably the most famous. In 1914, Western Union began issuing a metal plate or card to company employees instead of giving them a traditional paycheck. This metal plate could be used to make purchases at company-owned stores. The card operated on a closed loop system, which means that no other companies could participate.
In contrast, today’s modern credit card processing systems are known as an “open” loop systems because multiple members from different companies can participate.
Early Credit Cards Start to Emerge in the 1940s and 1950s
One of the world’s first true credit cards, however, was introduced in 1946 by a banker named John Biggins. That card was called the Charg-it card. Consumers would make a purchase with this card, and the invoice for that purchase would then be forwarded to Biggins’ bank. The bank would then obtain payment from the cardholder. The card was only usable at a small number of local retailers and customers had to bank with Biggins.
The next major credit card would be the Diners Club Card. Launched in 1949, that card was created by businessman Frank McNamara and a partner. The story goes that after the pair had had a business dinner at a fancy New York restaurant, they found themselves embarrassingly short on funds. Unwilling to have another experience like that, they decided to create a card that would push forward purchases to a later date.
The Diners Club Card wasn’t actually a “true” credit card. Diners would charge the purchase to their card and then pay the amount in full at the end of each month. Nevertheless, Diners Club is considered the first credit card processing industry acquirer because it was the first to charge merchants a discount rate, which is the percentage taken from each sale as a fee from the issuer to the acquirer.
The Introduction of the Remove Authorization System
The two early era “credit cards” listed above gave rise to a new banking system. Starting in 1951, the Charg-it system led to the introduction of the first “bank” credit card. That card was only circulated by Franklin National Bank in Long Island. Here’s how that first bank credit card worked:
-A bank customer would apply for a credit card through the bank
-Once the consumer submitted the application for credit worthiness, a credit card was issued
-Consumers would pay with this card at merchants around New York. When a merchant received the card as payment, they would have to copy the information from the card onto a sales slip before calling for approval for each transaction over a specific limited. This limit was known as the “floor limit”. The higher your credit worthiness, the higher your floor limit.
-After calling the bank, the bank would add money to the merchant’s account. That money would be the total of the sale price minus a discount fee to cover the cost of providing the loan.
American Express Releases the First True Credit Card in 1958
American Express was next to enter the early credit card industry. That company is credited (get it?) with creating the first true plastic credit card in 1958. The card had a distinctive purple color and was primarily used to pay for travel and entertainment expenses, also known as “T&E” expenses.
The idea behind a T&E card was that a businessperson could take it on the road and pay for “travel and entertainment” expenses without needing to carry large amounts of cash.
Over the next few decades, American Express would launch its travel and entertainment credit card into local currencies in countries around the world. However, it wasn’t until the 1990s that American Express would release a credit card that could be used for any expense.
American Express is considered one of the chief architects of the credit card industry in America. After issuing its first T&E card (BankAmericard), Bank of America wanted to expand out of California. In 1960, Bank of America started to float around the idea of a bank card association. This association licensed other banks across America to issue their own BankAmericards while also being able to process BankAmericard transactions.
Soon after American Express released its credit card, other merchant account financial institutions across America launched their own credit programs. At the same time, revolving credit systems became more common. Revolving credit meant that the cardholder wasn’t obligated to pay off the amount in full at the end of every month: they could roll the amount owed over in exchange for a finance fee.
Early Credit Card Processing Technology
In terms of the credit card processing technology, these early credit cards worked quite a bit differently than modern credit cards. The cards used a closed-loop system, which means that no other company participated. That loop included three people:
- The consumer
- The merchant
- The card issuer
There were no merchant accounts, no merchant services providers, and no credit card processors required. The system was simple and effective but impractical for widescale credit card use.
The idea of having a revolving balance and finance charges wasn’t introduced until 1959.
MasterCharge Enters the Market in 1966
Unwilling to let Bank of America have a monopoly over the exploding credit card industry, a group of 14 banks met in Buffalo, NY and formed the Interbank Card Association in 1966.
That organization created a card known as MasterCharge. That card would later go on to rebrand itself as MasterCard.
The main advantage of MasterCard was that the associated banks had the ability to exchange information on credit card transactions across their network. Unlike with American Express and other credit card issuers, no single entity dominated the Interbank Card Association or its members.
The ICA would later establish member committees to run the association. These member associations established most of the rules for the credit card, including marketing, rules of authorization, clearing, settlement, security, and various legal aspects of the card.
Over the next few decades, the credit card processing industry evolved largely around BankAmericard and MasterCharge.
Third-party companies started selling processing services to both these companies. This reduced the banks’ role in settling credit accounts and paying merchants. Both Visa and MasterCard would eventually establish rules and standardized procedures to facilitate international payments and reduce fraud.
Both companies also created arbitration systems to settle disputes.
Eventually, these systems and procedures would morph into the open-loop credit card processing system we know today.
MasterCharge Goes International in the 1960s
MasterCharge (later MasterCard) exploded with growth in the years after its release in 1966. In 1967, four banks in California opened memberships to other financial institutions in America. These banks had previously purchased the right to use the “MasterCharge” name across America. Faced with an impending legal battle, the ICA purchased the MasterCharge name from the four California banks in 1968 and officially changed its name and logo.
By the end of 1968, MasterCharge had grown into a huge global network of credit card processing technology.
The ICA began its internationalization by affiliating itself with Banco Nacional in Mexico. Later that year, the ICA formed an alliance in Europe and launched Eurocard. Japanese banks also joined the ICA later that same year.
1970 – Bank of America Creates Its Own Association
The Bank of America was watching the ICA take over the global credit card processing industry. They decided to do something about it. Bank of America formed its own association in 1970 and invited all of the banks that were actively licensed to issue the BankAmericard.
That association would go on to be called National BankAmericard, Inc. (NBI). The founding members of that organization were the banks that had supported BankAmericard since its inception.
1970: The First Credit Card Battle
1970 marked a turning point in the credit card processing industry. In 1970, a bank named Worthern Bank & Trust Co. of Little Rock, Arkansas sued NBI (the association responsible for BankAmericard). Worthern Bank was a founding member of the NBI and was not able to offer the new MasterCharge card to its members.
One of the restrictions for NBI members was that they had to exclusively offer the BankAmericard and could not offer any competing cards. Worthern Bank argued that NBI’s exclusive membership clause placed Worthern Bank at a “competitive disadvantage”.
In spite of these claims, Worthern lost its case. The bank would appeal the case and then lose again. Not to be discouraged, Worthern threatened to take the case to the Supreme Court.
At this point, NBI decided to change its rules to allow member banks to offer both the BankAmericard and the MasterCharge card.
Later, it would be discovered that NBI only changed its rules after receiving a recommendation from the U.S. Department of Justices’.
In any case, the credit card system that let banks issue both credit cards was known as the “duality” and it would permanently change the credit card processing industry going forward.
Credit Card Companies Move Away from Paper-based Systems in the 1970s
Understandably, the credit card processing industry was overwhelmed by its paper needs. Paper-based systems were becoming too cumbersome to handle the large numbers of customers.
Both major credit card organizations (NBI and ICA) pushed for a more efficient industry. Throughout the 1970s, the two companies would both start to introduce electronic payment systems in two stages.
The companies started by changing the authorization system in 1973. That authorization system was in charge of making sure a customer’s card had credit available. Then, once the purchase was made, the amount of that authorized sale would be reduced from the customer’s amount of available credit.
The two companies had two different electronic authorization systems:
-National BankAmericard (NBI) released an electronic online authorization system called Base I
-Interbank Card Association (ICA, known simply as MasterCharge at this point), introduced a system called INAS that performed the same basic task
The following year, NBI would introduce the new and improved version of their electronic authorization system (Base II). MasterCharge would introduce a similarly improved system called INET.
1974 Bank of America, the NBI, and the ICA Go More International
In 1974, the Bank of America instructed its international licensees to charter an international organization. This organization would be responsible for administrating BankAmericard, Inc. company activities outside of America. The international company was known as IBANCO.
Both IBANCO and the international division of ICA/MasterCharge would span across the world in the coming years, reaching as far as Australia and Africa.
Another landmark moment was reached in 1976 when one bank used the duality agreement to become a member of both the ICA and NBI simultaneously. That bank was the first to do so.
1976 and 1977 Introduce Name Changes
Why haven’t you heard of National BankAmericard to this day? It’s because in 1976, National BankAmericard officially changed its name to Visa USA. At the same time, IBAMO (the international division of National BankAmericard) changed its name to Visa International.
Not to be outdone, MasterCharge changed its name in 1977 to the company we now know as MasterCard International.
Discover Enters the Industry in 1986
Discover is considered a latecomer to the credit card industry. Nevertheless, the card is nearly 30 years old. Discover – which was originally created by Sears – was introduced in 1986 during the SuperBowl.
The card is primarily only popular in the United States. After being a part of Sears, Discover would then be a part of Dean Witter and then Morgan Stanley before becoming an independent entity known as Discover Financial Services in 2007.
Modern Point of Sale (POS) Machines and ATMs
ATMs started to appear in the 1980s, giving customers access to their cash and credit accounts 24 hours a day around the world.
Point of sale machines originated throughout the 1980s, starting with a small Hawaiian company called VeriFone. That company debuted its first Point of Sale machine in 1981 before releasing the popular ZON terminal in 1983. That POS machine would establish a foundation on which all other POS machines are based, and many ZON terminals are still in use to this day.
Over the years, new companies would come to compete with VeriFone, including Hypercom (which released credit card processing terminals called the T7P and T7Plus in 1982) and Lipman Electronics Engineering (which released its Nurit 2070 in Israel in 1994 before branching out internationally).
Today, VeriFone, Hypercom, and Lipman Electronics remain the most popular POS machine distributors around the world. All three companies use the same basic technology to authorize credit card payments electronically, cutting down on considerable payment processing costs.
Modern Credit Card Processing Technology
Modern credit cards have the same basic functionality as early credit cards. The technology used, however, is far more advanced thanks to advances in communication infrastructure over the years.
Starting in the 1970s, electronic credit card processing started to vastly improve. Banks began offering electronic dial up terminals while also putting magnetic strips on the backs of credit cards.
These magnetic strips allowed retailers to swipe customers’ credit cards through the dial up terminal. That dial up terminal would then access the customers’ banking information remotely, allowing authorizations and settlements to be completed in minutes (instead of manually over the phone).
Today, financial institutions make roughly 2% from each credit card purchase, although the actual percentage depends on the size of the sale. Financial institutions that issue credit cards also make money through outstanding balance fees, annual fees, and late payment fees.
The fees charged by banks are known as interchange fees. Small businesses have started to fight back against credit cards because interchange fees have risen by 117% in the last 5 years alone. Interchange prices are also fixed regardless of the volume – so whether your business makes 10 sales per month or 1 million sales per month, you still pay the same roughly 2% fee.
Today, roughly 80% of families in America have some type of credit card.
Credit card processing technology has turned from a smallscale operation offered by a few New York banks to a globally-recognized institution in roughly half a century. We’ll have to wait to see if credit cards continue to remain as ubiquitous around the world in the future.
