What are Payment Rails? Their Inner Workings

When you transfer money to your friend’s bank account or swipe your card at the grocery store, you’re probably not giving too much thought to the precise payment systems behind your transfer. But these payment systems — “payment rails” as they’re known in the financial services world — play an increasingly pivotal role in our daily business transactions and personal affairs.

Business transactions on payment rails include supplier payments and other operating expenses and investments, including fixed assets and payroll. Payment rails also handle payouts to social media influencers and freelancers in the U.S. as well as international payments with local currencies.

What are Payment Rails?

A payment rail is a platform or network infrastructure that allows all digital money transfers to be made between payers and payees, regardless of country, currency, digital payment method, or whether the payer or payee is a business or consumer. Each payment rail differs in how it carries out this process based on the payment type, speed, technology, or geographical location.

Most Popular Payment Rails (and how they work)

The most popular payment rails include Automated Clearing House (ACH), Mastercard, VISA (and other major credit card providers), PayPal, the RTP Network, blockchain, SWIFT, and SEPA.

Automated Clearing House (ACH)

The ACH Network, regulated by Nacha, processed an astounding $72.6 trillion in payment value in 2021, making it one of the most popular payment rails worldwide for online payments. This transaction category includes automatic bill payments, brokerage account deposits, and direct payroll deposits.

ACH transactions tend to take two to three days, although Same Day ACH and Next Day ACH are available (if specified business-day time windows are met). The Automated Clearing House network handles both debit and credit ACH transactions.

ACH fees cost between $0.20 and $1.50 per transaction depending on your location, the financial institutions used, whether you’re making international or domestic ACH payments, and other factors.

How ACH Works

Every ACH transaction has three core steps (note — ACH is not a real-time payment method).

1. The party requesting the transfer sends their bank a copy of the transaction details.
2. The bank sends these details to the central clearinghouse in the ACH Network.
3. Once these details reach the clearinghouse, the bank will be notified, and the proper accounts will be debited or credited.

A bank must act as the Originating Depository Financial Institution (ODFI) for all ACH transactions, which are bank transfers. The responsibility for verifying the reality of the bank account and the presence of sufficient funds to fulfill the transfer falls to the individual or company transferring the funds.

Card Rails: Visa and Mastercard

Credit cards are another popular payment rails platform. They run on an independent network operated by companies that provide the technology to power their transactions. Visa, Mastercard, American Express, and Discover are major credit card companies in the United States. From October 2020 through September 2021, Mastercard and Visa processed a combined average of 86.7 billion transactions.

These card networks charge merchants fees to process payments using their payment infrastructures. The bank or company sponsoring the card for the customer is called the issuing bank or sponsor bank. In comparison, an acquiring bank is a financial institution that processes credit or debit card payments on behalf of a merchant.

As real-time payments are experiencing increased demand worldwide, card networks are also evolving to support new payment technology that allows faster payment settlement. Push-to-card is one way companies leverage the existing card networks. For example, Lyft and Uber have introduced push-to-card solutions (Lyft Direct and Uber Instant Pay) that allow drivers to instantly receive their earnings to their debit cards.

According to industry analysts, the average card processing fees range from 1.5 percent to 3.5 percent of each transaction.

How Card Rails Work

Card payments follow the same four basic steps.

1. When a customer presents a card or other digital means of payment at a merchant, that transaction goes first to the acquiring bank.
2. Once the acquiring bank receives the payment transaction, it routes it to the issuing bank on the consumer end of the transaction through the card network.
3. When the issuing bank receives a transaction, it reviews that consumer’s account to ensure that they have enough funds or available credit. If so, it authorizes the transaction.
4. The issuing bank then routes the transaction back through the card networks to the acquiring bank. The acquiring bank accepts the movement of funds from the consumer’s account at the issuing bank into the merchant’s account.

Push-to-card transactions also operate in the same manner. Transactions flow through the card network, from the merchant’s acquirer or payment processor to the consumer’s issuing bank in real time.

PayPal

PayPal is a global payments company that facilitates payments between parties through online transfers. PayPal is responsible for a huge portion of global payments made today, processing around 5.34 billion payments in the fourth quarter of 2021 alone. Founded in 1998, PayPal is an established global network, though it also owns Venmo, a mobile payment rail that operates only in the United States.

PayPal allows customers to register an account with an email address connected to the user’s card or bank account. When identification and proof of funds are confirmed, users can begin sending or receiving payments to and from other PayPal accounts online or through the company’s app.

PayPal’s transaction payment processing rates range from 1.9% to 3.5% of the transaction amount, plus a fixed cost ranging from 5 cents to 49 cents.

How PayPal Works

PayPal verifies all the user information to ensure the person setting up the account is the rightful owner before the customer can use the service.

• A user links their bank account or credit/debit card to the PayPal system.
• When making an online payment, the user can select which account to debit, and PayPal will process the transactions.
• Behind the scenes, PayPal connects to the Automated Clearing House (ACH) and acts as the originating depository financial institution (ODFI) for the ACH transaction.
• PayPal serves as a wallet; monies received can sit in the PayPal account and be used for point of sale (with a PayPal card), e-commerce, transfer between users, or a bank account.

PayPal allows for instant transactions by placing a hold on the card when a transaction is initiated, thus ensuring PayPal can still acquire their money even if it’s initially declined.

The Clearing House — RTP

Real-Time Payments (RTP) is a payment processing network used to transfer money electronically and instantaneously between banks in the United States. The Clearing House RTP Network was launched in November 2017 to provide real-time payments serving retail and commercial customers.

Financial institutions that hold 75% of U.S. demand deposit accounts (DDAs) can use the RTP network’s real-time payment capabilities, and the network already reaches 61 percent of U.S. DDAs. In addition, through Third-Party Service Providers, Bankers Banks, and Corporate Credit Unions, financial institutions can directly connect to the RTP network.

RTP Network pricing is low, between $0.01 and $2.00, depending on the type of transaction or service used.

How RTP Works

The Clearing House is in charge of processing all RTP payments. RTP is based on a liquidity model in which member financial institutions are required to maintain a minimum account balance with the Federal Reserve in order to ensure immediate funds transfer.

For example, when you pay your utility bill for the month using RTP.

1. Your bank sends a message to the network that includes the payment details.
2. The Clearing House checks the liquidity of your bank.
3. The Clearing House processes the message and routes it to the utility company’s bank account.
4. RTP uses the ISO-20022 standard for the messages used to initiate payments and retrieve transaction status.

RTP transactions happen instantaneously. The RTP network will immediately decrease the sender’s financial institution’s balance and boost the receiver’s financial institution’s balance once a transaction has been completed.

Blockchain

A blockchain is an auditable, distributed database that’s shared across several computers linked together in a peer-to-peer network. Blockchains maintain a secure and decentralized record of transactions in cryptocurrency systems like Bitcoin and Ethereum.

Cryptocurrencies are the digital currencies exchanged on the blockchain network, and they’re growing in popularity as payment rails. For example, the volume of cryptocurrency transactions grew to $15.8trn in 2021, up 567% from 2020.

Blockchains allow digital information to be recorded and distributed but not edited. It guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party.

Fees for exchanging cryptocurrency on the blockchain vary depending on the exchange being used.

How Blockchain Works

While different cryptocurrencies exist, they are all based on the same blockchain technology.

1. When a new transaction takes place on the blockchain, a record of that transaction (as its digital signature) is transmitted to all the participating computers on that network.
2. Each computer in a blockchain network then solves complex equations (cryptography) to confirm the transaction’s digital signature and validity.
3. Once confirmed to be valid, the transaction is grouped in a block that holds sets of information about the transaction.
4. Each block has specific storage capacities and, when filled, is closed and linked to the previously filled block, forming a chain of immutable data known as the blockchain.
5. The transaction is then transmitted as completed to the entire network.

Verifying the transaction’s validity is known as mining, and each cryptocurrency blockchain has its own set of “mining rules.”

SWIFT

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a cooperative society providing services related to executing financial transactions and payments between banks worldwide. SWIFT is a popular payment rail worldwide. In 2021, more than 11,000 global SWIFT member institutions sent an average of 42 million messages per day across the network.

The SWIFT payment network allows individuals and businesses to accept/send international money via electronic or credit card payments.

As an estimate, you can expect the big banks to charge 3%-5% in exchange rate costs on a SWIFT transfer. However, this can vary with the amount you send and the number of banks involved in the transaction.

How SWIFT Works

Although SWIFT has become a significant part of the global financial infrastructure, it’s not a financial institution. Instead, SWIFT is a messaging network that operates as a carrier of “payment instructions between financial institutions participating in a transaction.” It communicates transaction orders between these institutions using SWIFT codes.

SWIFT assigns every financial organization a unique code with 8 or 11 characters. For example, let’s assume a transaction involving a Citibank account in New York to a Deutsche Bank branch in Berlin.

1. The New York customer can walk into their Citibank branch with the receiver’s account number and Deutsche Bank’s unique SWIFT code for its Berlin branch.
2. Citibank will send a payment transfer SWIFT message to the Deutsche Bank’s branch over the secure SWIFT network. When Deutsche Bank receives the SWIFT message about the incoming payment, it will clear and credit the money to the receiver’s account in Berlin.

SEPA

The single euro payments area (SEPA) is a framework of transactions that harmonizes the way cashless payments are transacted between euro countries. It’s a popular payment rail across Europe, facilitating over 43 billion transactions per year in 36 member countries.

The SEPA initiative aims to make cross-border electronic payments as inexpensive and easy as payments within one country. European consumers, government agents, and businesses that make payments by direct debit, instant card transfer, and credit transfers use the SEPA architecture.

Transaction fees for a SEPA transfer are the same as domestic payments.

How SEPA Works

SEPA bank transfers come in three types, each with its own use case. To begin, all SEPA transfers employ the IBAN (International Bank Account Number) and, in some cases, the BIC (Business Identifier Code) numbers of both the sender and recipient’s bank accounts to transfer funds.

1. SEPA Credit Transfer — This allows for fund transfer between banks, typically within one business day.
2. SEPA Instant Credit Transfer (also referred to as SEPA Instant Payment — This mode allows for near real-time fund transfer (less than ten seconds). Once the Payment Service Provider recognizes that the SEPA transaction is an instant payment, it processes and clears the amount immediately instead of in batches like regular credit transfer.
3. SEPA Direct Debit Transfer — This allows for recurring payments such as monthly rent, internet or electricity bills, or regular loan repayment installments. Before the transaction can occur, the sender must sign a “mandate,” which is a contract that allows the recipient of the funds to repeatedly take money out from the sender’s account.

The recipient of the funds sends a request to the sender’s bank to pull the recurring amount. The sender’s bank validates the pull request and the mandate and settles the transaction. The whole payment process is performed between the sender’s and the recipient’s banks.

SEPA Core Direct Debit Transfer is available to individuals, and the SEPA B2B Direct Debit Transfer is available between businesses.

What is Multi-Rail Strategy?

A multi-rail payments strategy for business enables instantaneous digital global transfers between B2B buyers and sellers, as accomplished by Zelle on its payment’s platform. Mastercard launched a multi-rail strategy for U.S. companies that are buyers and sellers through Mastercard Track Business Payment Services (BPS) in November 2020.

What Are Real-Time Payment Rails?

Real-time payment rails enable instantaneous digital payments. Examples of real-time payment rails include the RTP Network from The Clearing House and Mastercard’s multi-rail strategy that uses RTP Network, ACH, SEPA Instant Payment, and Mastercard’s acquired infrastructure from VocalLink and Nets.

Real-time payments bring value in several ways.

• The first is their speed. Instant access is a game-changer for individuals or businesses that need their funds immediately.
• Real-time payment rails also bring end-to-end communication. Instant payment confirmation notifications and settlement result in a more efficient payment journey.
• Real-time payment fosters innovation and creates avenues for more business opportunities — as in the case of Uber Instant Pay and Lyft Direct for instant driver payment.
• With real-time payment, companies can receive funds faster, which improves cash management, forecasting, and business planning.

Importance of Payment Rails

Payment rails on payment platforms have great importance for both business and personal transactions.

The fintech community refers to payment rails as “the far side” of a payment transaction. The rail is the “hidden” portion of the transaction, instead of “the near side” of the transaction, consisting of you and the other party transferring or receiving funds.

New payment networks and strategies using payment rails, including real-time U.S. and multi-rail strategies for instant B2B global payments, continue to gain popularity. These payment rails use the latest digital and mobile technologies for customer convenience, reliability, and quick payment settlement.

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