Most everyday payments made between different parties rely on open loop payment systems.

These open systems allow merchants to process payments from customers using any card regardless of which financial institution each party banks with. That makes them great for everything from ecommerce to inter-city transport networks.

The alternative to the open loop payment model is the closed loop payment system, which has its own distinct use cases and benefits.

This article from Checkout.com delves into the concept of open loop payments, outlining their mechanics, distinctions from closed loop payments, and the significant benefits they offer to merchants.

What is an open loop payments system?

An open loop payments system is one that processes payments between cards, parties, or accounts that don’t belong to the same financial institution.

Open loop payments enable merchants to accept payments from any customer, regardless of which bank they hold an account with. Open loop payment models also permit a wide range of payment types, including all major electronic payment methods, debit and credit cards, gift cards, and prepaid cards.

The most common example of an open loop system is a credit or debit card that’s issued in conjunction with a major card network like Mastercard or Visa
and can be used to make payments with any participating merchant.

How do open loop payments work?

Open loop payments can be made using credit cards, debit cards, or prepaid cards, and rely on a shared network such as the Real-Time Payments (RTP) Network.

In a typical example, a customer discovers a product on a website that they want to buy. They decide to pay using their Visa credit card.

Because they’re using an open loop card, provided the correct payment processing infrastructure is in place, the payment can be accepted regardless of the customer’s location and chosen payment method. The payment is then processed, authorised, and captured in the conventional way: the payment gateway encrypts the cardholder’s information, and the processor submits it to the card network (in this case Visa) for authorisation. The funds are then transferred
from the customer’s to the merchant’s bank.

What is an open loop credit card?

An open loop credit card is a card authorised by a particular network that can be used at any location, or with any merchant, that accepts cards on that network.

Open loop credit cards are widely used to make everyday purchases and typically bear the logo of the card network that they’re affiliated with.
Unlike debit cards, which draw funds directly from the customer’s bank account to make a purchase, or prepaid cards, which have to be loaded with funds,
open loop credit cards allow consumers to borrow against a pre-arranged line of credit from a card network.

Open loop payment vs. closed loop payments

In contrast to open loop payment cards, closed loop payment cards can only be used to make purchases with a particular company. For example, closed loop cards could be affiliated with a particular retail or coffee chain and usually bear the logo of that brand. Consumers may benefit from first purchase discounts by using a branded closed loop payment card.

However, it’s important to note that, while closed loop cards can drive brand loyalty, they are not the same as loyalty cards. That’s because closed loop cards can extend credit to consumers, while loyalty cards cannot.

To process closed loop payment cards, merchants need to partner with a card-issuing merchant acquiring bank. The main difference between open and closed loop payment processing is that, while the former requires the participation of the merchant, issuer, acquirer and card network, only the merchant and the merchant’s acquiring bank are involved in verifying a closed loop transaction. This can result in lower transaction fees.

Public transport networks in cities offer a useful closed vs open loop payment example.

If a city transport network relies on a closed loop system, a passenger must buy a ticket or use a dedicated prepaid card to pay for a journey. The system will not accept contactless payments from open loop contactless cards.

For example, between 2003 and 2014, passengers on London’s transport network had to either buy a ticket or use a topped-up Oyster Card to pay for a journey on buses, the underground, and the rail network – a closed loop system. However, in 2014, Transport for London (TfL) introduced contactless payments, allowing travelers to pay by tapping in with any type of payment card – an open loop system.

Benefits of open loop payments

Open loop payments offer a number of benefits to merchants, including:

• Flexibility – with open loop systems, merchants aren’t restricted to only accepting customer cards that are associated with particular financial institutions, and can accept any kind of electronic payment, both in-person and online.
• Increased revenue – the more cards and payment types that can be accepted, the more successful transactions can be processed, leading to greater revenue. In contrast, on a closed loop system, if a customer doesn’t have the right card or hasn’t topped up their card, they won’t be able to make the purchase, potentially resulting in lost sales.
• Convenience – setting up a closed loop payment system requires partnering with a particular acquirer and implementing the right infrastructure to accept dedicated payment cards. However, by using an open loop payment system, merchants only need to partner with a card network to accept a multitude of card types and payment methods through a standard processing solution.

Explore open loop payments with a comprehensive payment processing solution. Merchants can leverage a platform that facilitates acceptance of a variety of card types and payment methods from consumers worldwide.

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This article was first published by Checkout.com and has been republished on our website with permission.

Checkout.com is a member of our Payments Service Provider Panel.

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