In this module, we'll examine a series of Innovations in the credit card market. If you have used your credit or debit card, you just insert it into a terminal or type in the number online and probably never thought about what actually happens after that. Turns out, there's quite a complex series of actions happening in the next couple of seconds that lend really well to innovation. We'll examine exactly what's going on in these couple of seconds, identify the key players involved, what functions they carry out, and what their respect to the business models look like. The next video will expand upon this and discuss the advantages and in efficiencies associated with these practices. We'll then turn to innovations that address these key in efficiencies. First, let's go back in time and talk about why and how quite a card came about in the first place. Say you're in a fancy restaurant in New York City, just had a good meal and are about to pay the bill. No, you forgot your wallet. Luckily., you had your checkbook on you. So you go tell the manager, why don't I write you a check or a electronic check? Are you going to take that? Well, unless you are regular there, chances are they're going to say no. We don't know you, your check might bounce, you can't take that risk. And therein lies the problem with the checking system, settlement is not real time. So, for time-critical transactions where parties need to know whether they're getting paid right away, it's not a good solution. Remember, this is the same issue with ACH system as well. You just can't walk into a grocery store and easily pay with a bank transfer either. Digital wallets that we discussed in module one is one way to speed this process up. And before that, credit card is another way to solve this problem. The basic solution boils down to using bank's money to temporarily front the purchase. Let's go back to the restaurant example. Instead of a checkbook, suppose you have a note from your bank saying this. We have extended along to this person, such that they can use it any way they want. They have enough balance left, so trust us, the bank, to pay this bill and send you the money. We'll worry about whether the customer actually pays us back the loan ourselves. If you're the restaurant manager, you'll be much more willing to accept the offer. Because although you don't know this person in front of you, you've likely heard about their bank and trust the bank a lot more not to renege on the promise of paying you. This is how the credit card was born. With the first generation actually called the Diners Club card that are geared toward primarily business meals and entertainment uses. The next generations of credit cards just make this arrangement electronic. The basic principle is the same. The bank extends the customer a revolving line of credit, which is essentially a flexible loan that they can use at any time for any purpose as long as it's not all used up. The card itself carries the identifying information for this loan and for this account. And when it's used either online or offline, the transactions, quote unquote, approval is essentially the bank's guarantee that money is available and the bank will paid the merchant. This is communicated in real-time over an electronic network connected to these terminals or servers so that transaction can proceed immediately. Shortly after, the bank will send the actual money to the merchant and send a bill to the customer to be paid back at the end of the month. But from the perspective of the merchants, their business is over as soon as the credit card charge is approved. Whether or not the customer pays back the bank is not their business. So, just like using cash, transactions can happen in real-time which dramatically increases the efficiency of the process. Trust of the bank is paramount in this case and this again shows the importance of financial intermediaries. For this convenience, the bank will charge the merchant a processing fee, which is eventually passed on to the consumers. After the success of the Diners Club card, Bank of America step into the game and built an alliance of banks and a communication network which the eventually spun off and became today's Visa. A competing alliance of banks in the western states built a competing communication network, The Master Charge network, which was also eventually spun off and became today's MasterCard.
