Four-Party Model: Self-Assessment Quiz
Last Updated: 2025-12-18
Status: Complete
Test your understanding of the four-party model with these comprehensive questions.
How to Use This Quiz
Work through each question before reading the answer. These questions are derived from the four-party model documentation and test critical concepts you'll need to understand payment systems.
Question 1: Interchange Fee Flow
In a credit card transaction, who pays the interchange fee and who receives it?
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Answer:
The acquiring bank pays the interchange fee, and the issuing bank receives it. This fee is deducted from the transaction amount before the merchant is funded. The interchange fee compensates the issuer for:
- Credit risk (lending money to the cardholder)
- Fraud protection
- Card rewards programs
- Transaction processing costs
Example: On a $100 transaction with 1.80% interchange:
- Issuer receives: $1.80
- This is deducted from what the acquirer pays to the merchant
- Merchant receives: $97.50 (after all fees)
Question 2: Acquirer Risk
Why does the acquiring bank take on risk when a merchant accepts a card payment?
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Answer:
The acquiring bank takes on risk because:
-
Chargeback Liability: If a cardholder disputes a transaction and wins, the acquirer must return funds to the issuer. If the merchant can't cover this (bankrupt, fraudulent, or disappeared), the acquirer absorbs the loss.
-
Merchant Fraud: If a merchant processes fraudulent transactions or doesn't deliver goods/services, the acquirer is ultimately responsible.
-
Settlement Timing: The acquirer often funds merchants before receiving money from the issuer, creating a timing risk.
-
Contractual Position: The acquirer's agreement with the card network makes them responsible for their merchants' behavior.
This is why acquirers perform underwriting and require reserves from high-risk merchants.
Question 3: Decline Message Origin
What happens to a transaction if the issuing bank declines it? Where does the decline message originate?
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Answer:
When an issuing bank declines a transaction:
- The decline message originates from the issuing bank (issuer)
- The issuer sends a decline response code through the card network
- The network routes this to the acquirer/processor
- The processor sends it to the payment gateway
- The gateway communicates it to the merchant's POS/website
- The customer sees "Card Declined"
Common decline reasons:
- Insufficient funds (code: 51)
- Incorrect CVV (code: N7)
- Expired card (code: 54)
- Suspected fraud (code: 59)
- Over credit limit (code: 61)
The merchant never knows the exact reason, just a generic code, to protect cardholder privacy.
Question 4: Fee Breakdown
A customer buys a $100 item. The merchant receives $97.50. Break down where the $2.50 went.
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Answer:
| Recipient | Fee Type | Amount | Percentage |
|---|---|---|---|
| Issuing Bank | Interchange Fee | $1.80 | 1.80% |
| Card Network (Visa/MC) | Assessment Fee | $0.16 | 0.16% |
| Acquirer/Processor | Markup | $0.54 | 0.54% |
| Total Fees | MDR | $2.50 | 2.50% |
Breakdown:
- Interchange ($1.80): Non-negotiable, set by Visa/Mastercard, goes to issuer (e.g., Chase)
- Assessment ($0.16): Non-negotiable, goes to Visa or Mastercard for network usage
- Markup ($0.54): Negotiable, this is where the acquirer and processor make their profit
Note: Only the acquirer markup is negotiable. High-volume merchants can negotiate this down to 0.1% - 0.3%.
Question 5: Authorization vs Settlement
What is the difference between authorization and settlement?
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Answer:
Authorization:
- Happens in real-time (milliseconds to seconds)
- Issuer approves or declines the transaction
- Places a HOLD on cardholder's available credit/balance
- No money actually moves yet
- Example: Hotel authorizes $500 when you check in
Settlement:
- Happens later (typically T+1 to T+3)
- Actual movement of funds between banks
- Merchant receives funds (minus fees)
- Cardholder's statement shows final charge
- Example: Hotel settles $350 when you check out
Key difference: Authorization is a promise to pay; settlement is actual payment. A merchant can authorize but never settle (transaction voided), or settle less than authorized (hotel example).
Full lifecycle:
- Authorization (real-time): Hold placed
- Capture (same day or later): Merchant claims funds
- Clearing (end of day): Network calculates positions
- Settlement (T+1 to T+3): Money moves between banks
Question 6: Premium Card Interchange
Why do premium rewards cards have higher interchange than basic cards?
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Answer:
Premium rewards cards (like Chase Sapphire Reserve, AmEx Platinum) have higher interchange because:
- Funding rewards: Higher interchange (2.5-3.3%) funds the 2-5% cashback/points programs
- Issuer economics: Issuers need to cover the cost of rewards they pay out
- Consumer behavior: Rewards cardholders spend more and prefer their rewards card
- No caps: Unlike the EU/Australia, US has no credit card interchange caps
- Cross-subsidy: Merchants pay more, effectively subsidizing rewards for cardholders
The cycle: Higher interchange → Better rewards → More card usage → Higher interchange. This creates an "interchange arms race" where card issuers compete on rewards funded by merchant fees.
Example comparison:
- Basic debit card: 0.27% (Durbin-capped)
- Standard credit card: 1.65%
- Premium rewards card: 2.95%
The merchant pays 10x more for a premium rewards card vs a basic debit card on the same $100 transaction.
Question 7: Card-Present vs Card-Not-Present
Why is card-present interchange lower than card-not-present interchange?
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Answer:
Card-present (CP) transactions have lower interchange because they have lower fraud risk:
Card-Present (CP):
- Physical card present
- Chip verification or contactless
- Customer present
- Lower fraud rate (~0.05% - 0.1%)
- Example: 1.43% + $0.05
Card-Not-Present (CNP):
- No physical card
- Manual entry or e-commerce
- Customer not present
- Higher fraud rate (~0.5% - 1.5%)
- Example: 1.80% + $0.10
Why it matters:
- Issuers bear more fraud risk on CNP transactions
- Higher interchange compensates for this risk
- PayFacs building e-commerce platforms face inherently higher costs
Typical difference: CNP interchange is 20-40% higher than CP
Question 8: Level 2/3 Data Benefits
What is Level 2/3 data and how does it reduce interchange costs?
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Answer:
Level 2 and Level 3 data provide additional transaction details that qualify for lower commercial card rates:
Level 2 Data:
- Tax amount
- Customer code / PO number
- Merchant postal code
- Merchant tax ID
- Savings: 0.10% - 0.25%
Level 3 Data:
- Everything in Level 2 PLUS
- Line item details (description, SKU, quantity, price)
- Product codes
- Commodity codes
- Savings: 0.30% - 0.50%
Why it reduces costs:
- Provides proof of legitimate B2B/government transaction
- Reduces fraud risk from corporate card misuse
- Networks reward transparency with lower rates
Example: $10,000 corporate purchase
- Level 1 (basic): $250 in interchange (2.50%)
- Level 3 (full detail): $200 in interchange (2.00%)
- Savings: $50 per transaction, $5,000/year on 100 transactions
Best for: B2B merchants, government contractors, corporate sales
Question 9: Durbin Amendment Impact
What is the Durbin Amendment and how does it affect debit card interchange?
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Answer:
The Durbin Amendment (2010, part of Dodd-Frank Act) caps debit interchange for large banks:
Who It Affects:
- Banks with $10 billion+ in assets ("regulated issuers")
- Examples: Chase, Bank of America, Wells Fargo, Citi
The Cap:
Maximum: $0.22 + 0.05% of transaction amount
(+ $0.01 fraud adjustment if eligible)
Impact on $100 transaction:
- Regulated debit (Chase): ~$0.27 (0.27%)
- Unregulated debit (credit union): ~$1.00 (1.00%)
- Credit card: ~$1.80 (1.80%)
Consequences:
- For issuers: Large banks earn ~70% less on debit vs unregulated
- For merchants: Significant savings on regulated debit (when passed through)
- For consumers: Big banks push credit over debit, reduced debit rewards
- For small banks: Competitive advantage with better debit rewards
Why it matters for PayFacs: Understanding regulated vs unregulated interchange is critical for pricing and economics.
Question 10: Honor All Cards Rule
What is the "Honor All Cards" rule and why does it matter?
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Answer:
The Rule: If a merchant accepts Visa, they must accept ALL Visa cards, including premium cards with higher interchange.
Implications:
- No selective acceptance: Can't accept only low-interchange cards
- Can't refuse premium cards: Must accept Chase Sapphire Reserve even though it costs 2.95%
- Cross-subsidy effect: Cash/debit customers effectively subsidize rewards cardholders
- Merchant power limited: Can't discriminate based on card profitability
Allowed under Durbin Amendment:
- Set $10 minimum transaction amount
- Offer discounts for different payment types (cash vs card)
- Surcharge for credit cards (in states where legal)
NOT allowed:
- Refuse specific card types within network (e.g., accept Visa but not Visa Signature)
- Surcharge based on specific card (must be network-level)
Why it matters:
- Merchants can't optimize by accepting only profitable cards
- Creates incentive for issuers to offer better rewards (funded by merchants)
- Contributes to the "interchange arms race"
Question 11: PayFac Risk Position
In the PayFac model, what happens if a sub-merchant processes fraudulent transactions and disappears?
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Answer:
The PayFac absorbs the chargeback losses first, not the sponsor bank.
Risk cascade:
- Sub-merchant - First responsible for transaction validity
- If sub-merchant can't pay → PayFac uses sub-merchant's reserves (if any)
- If reserves insufficient → PayFac pays from its own capital/reserves
- If PayFac can't cover → Sponsor bank pays from PayFac's reserves with sponsor
- If all else fails → Card networks can fine/terminate sponsor relationship
Why this matters:
- PayFacs must maintain significant capital reserves ($500K - $5M+)
- One fraudulent sub-merchant can wipe out months of profit
- Underwriting and fraud prevention are existential requirements
- This is why PayFac margins are thin (0.2% - 0.5%)
Example:
- Sub-merchant processes $500K in fraudulent transactions
- Disappears before chargebacks hit
- PayFac must cover $500K in chargebacks
- At 0.3% margin, PayFac needs $167M in legitimate volume to recover
Key takeaway: PayFacs inherit acquirer-level risk while typically having less capital than traditional banks.
Question 12: Batch Timing Impact
Why does batching transactions late cause higher interchange rates?
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Answer:
Late batching causes interchange downgrades because networks view delayed settlement as higher risk:
Qualification tiers:
| Timing | Rate | Example |
|---|---|---|
| Within 24 hours | Qualified | 1.43% + $0.05 |
| 24-72 hours | Mid-qualified | 1.95% + $0.10 |
| Over 72 hours | Non-qualified | 2.30% + $0.10 |
Why networks penalize late batching:
- Higher fraud risk (fraudulent transactions often delayed)
- Increases chargeback window
- Creates settlement complications
- Violates network best practices
Cost impact:
- $100 transaction batched within 24h: $1.48 fee
- Same transaction batched after 72h: $2.40 fee
- Penalty: $0.92 (62% higher cost)
Best practices:
- Batch daily before cutoff (typically 5-6 PM EST)
- Automate batch closing
- Monitor for failed batches
- Capture promptly after authorization
Exception: Hotels and car rentals are allowed to authorize early and capture later due to business model.
Question 13: Cross-Border Fee Structure
Why are cross-border transactions significantly more expensive than domestic transactions?
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Answer:
Cross-border transactions include additional fees beyond domestic interchange:
Fee stack for cross-border:
Domestic fees: ~2.5%
+ Currency conversion: 1.0% - 3.0%
+ Cross-border assessment: 0.40% - 1.00%
+ International service fee: 0.20% - 0.40%
─────────────────────────────────────────
Total cross-border: 4.0% - 7.0%
Why they cost more:
- Currency conversion risk: FX rate volatility
- Higher fraud risk: International fraud harder to detect/pursue
- Regulatory complexity: Different laws in different countries
- Settlement complexity: Moving money between countries
- Limited recourse: Harder to recover losses internationally
Additional considerations:
- Different interchange schedules by region (EU caps at 0.2%/0.3%, US no caps)
- Strong Customer Authentication (SCA) in EU
- Data localization requirements (GDPR, etc.)
- Multi-currency accounting complexity
Optimization strategies:
- Local acquiring in high-volume markets
- Multi-currency pricing
- Evaluate DCC (Dynamic Currency Conversion) carefully
- Understand regional interchange differences
Question 14: Master MID Model
What is the difference between a traditional merchant account and the PayFac master MID model?
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Answer:
Traditional Model:
Each merchant gets individual MID:
Merchant A → MID-001 → Acquirer
Merchant B → MID-002 → Acquirer
Process:
• Merchant applies directly to acquirer
• Underwritten individually (1-4 weeks)
• Direct acquirer relationship
• Separate settlement to each merchant
• Individual compliance requirements
PayFac Model:
All sub-merchants under one master MID:
PayFac Master MID-1000 → Sponsor Bank
├── Sub A (1000-A)
├── Sub B (1000-B)
└── Sub C (1000-C)
Process:
• PayFac onboards sub-merchants (minutes)
• PayFac underwrites with own criteria
• Aggregated volume under one MID
• PayFac splits settlement to subs
• PayFac handles compliance
Key differences:
| Aspect | Traditional | PayFac |
|---|---|---|
| Onboarding time | 1-4 weeks | Minutes to hours |
| Who underwrites | Acquirer | PayFac |
| Chargeback liability | Direct to merchant | PayFac first, then sub |
| Merchant descriptor | Merchant name | "SUB-MERCHANT * PAYFAC" |
| Compliance | Merchant responsible | PayFac responsible |
| Capital requirements | Low | High ($500K+) |
Why it matters: Master MID enables fast onboarding but concentrates risk with PayFac.
Question 15: Interchange Negotiability
Which components of merchant fees are negotiable and which are fixed?
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Answer:
Fee breakdown on $100 transaction:
| Component | Amount | Set By | Negotiable? |
|---|---|---|---|
| Interchange | $1.80 | Card networks | NO |
| Assessment | $0.16 | Card networks | NO |
| Acquirer markup | $0.54 | Acquirer/processor | YES |
Non-negotiable (78-80% of total):
-
Interchange ($1.80)
- Set by Visa/Mastercard
- Published in official rate schedules
- Changes April and October
- Same for all acquirers
-
Assessment ($0.16)
- Network fees for using Visa/MC infrastructure
- Published by networks
- Applies to all transactions
- Includes percentage and fixed components
Negotiable (20-22% of total):
- Acquirer/Processor Markup ($0.54)
- Acquirer's profit margin
- Can range from 0.1% to 1.5%+
- Based on merchant volume, risk, negotiating power
- This is what merchants negotiate
Negotiation leverage:
- High volume: $10M+/year can negotiate to 0.1% - 0.3%
- Low risk: Established businesses get better rates
- Card-present: Lower risk = better rates
- Low chargebacks: Under 0.5% = negotiating power
What merchants should ask for:
- Interchange-plus pricing (transparency)
- Competitive processor markup (0.2% - 0.5%)
- No hidden fees (PCI non-compliance, statement fees, etc.)
Reality: Most merchants overpay on the markup, not understanding that 80% of fees are non-negotiable.
Scoring Guide
- 13-15 correct: Expert level - You understand the four-party model deeply
- 10-12 correct: Proficient - You grasp the key concepts
- 7-9 correct: Intermediate - Review the detailed documentation
- 0-6 correct: Beginner - Start with the overview and work through each section
Next Steps
Based on your quiz results:
If you scored well:
- Move on to Card Network Role
- Explore Transaction Lifecycle
- Deep dive into Debit Networks & Routing
If you need review:
- Revisit Four-Party Model Overview
- Study Transaction Flows for authorization/settlement
- Review Fee Breakdown for interchange details
- Read Optimization for cost reduction strategies
- Check PayFac Position for Payment Facilitator model
Related Topics
Four-Party Model Series:
- Four-Party Model Overview - Core concepts and party roles
- Transaction Flows - Authorization, capture, settlement
- Fee Breakdown - Where fees go and why
- Interchange Optimization - Reducing costs through data
- PayFac Position - How PayFacs fit into the model
Continue learning: Card Network Role