Credit card payments may seem simple on the outside, but when you dig further, you’ll find that it’s a complex web that includes several entities and levels. In fact, many people don’t know credit card processing levels even exist. The problem is, without this knowledge, it’s easy to lose money and time because you simply aren’t aware of what you can do to change the level at which your card payments are processed. While you can’t change it directly, there are some ways you can work with your payment processor to get to where you want to be.
Of course, that also means choosing the right high-risk merchant services in the first place, while having a deeper understanding of what happens when a customer taps or swipes their card in person or enters their details online. In this guide, we’ll talk in depth about credit card processing levels and give you all the background you need to know.
TL;DR
- Credit card processing is structured in hierarchical levels: Level 1, 2, and 3. Each requires an increasing amount of transaction data.
- Level 3 processing offers the highest detail, providing enhanced data fields for B2B and B2G transactions, often resulting in lower interchange fees.
- Implementing Level 2 and 3 processing requires integration of specialized software and data collection practices, including invoice numbers, tax amounts, and item descriptions.
- Businesses can strategically use advanced processing levels to reduce costs, streamline reporting, and strengthen relationships with institutional clients.
- Cross-border transactions introduce complexity, requiring awareness of varying international standards and compatibility with global payment networks.
- Innovations like blockchain, tokenization, and AI-driven fraud detection are shaping the future of credit card processing.
- Compliance with industry standards like PCI DSS and effective risk management are critical at all processing levels to prevent data breaches and maintain trust.
The Hierarchical Framework of Credit Card Processing Levels
Credit card processing levels are a hierarchical classification system that determine the amount of information a merchant must provide during a transaction. It’s not something people tend to focus on too much, but overlooking these levels is a mistake because it can affect the efficiency and cost of your payment processing services.
In the early 2000s, major credit card networks created the credit card processing levels we know today, namely level 1, 2, and 3. We’ll talk about what these mean as we move through this guide, but these levels were quickly adopted by other networks, albeit with slight variations in requirements.
In general, the structure creates a direct relationship between the amount of data provided and interchange rates. For instance, more data means lower payment processing fees, whereas less data may cause slightly higher fees. However, each level has specific criteria that must be met, and the transaction may be automatically downgraded if vital data is missing. All this is important because, according to research, businesses can save up to 1% on their processing costs by providing level 3 data.
Level 1 Processing: The Basic Foundation
Level 1 credit card processing is the basic tier that most retail merchants and customer-facing businesses use. These transactions require minimal data and it’s the simplest level to implement. However, it often results in higher interchange fees because there is less data and transaction information for card networks and issuers to work with. The increased risk of fraud therefore links to the higher fees.
However, research has shown that many merchants find themselves stuck at level 1 because of requirements by card networks. In general, they require at least one million transactions per year to move up to level 2. As you can imagine, not many merchants meet that criteria, causing them to deal with higher fees over the long-term.
Data Requirements for Level 1
Level 1 credit card processing data requirements include only seven mandatory fields. These are:
- Account number
- Expiration date
- Amount
- Merchant ID
- Terminal ID
- Authorization code
- Transaction date and time
This is all easy information to find and creates the foundation for any card payment.
The downside of this simple approach is that card issuers have little context to go on, so there is often a higher rate of decline for legitimate transactions.
Implementation Considerations
Level 1 credit card processing is the easiest to set up and is compatible with any payment gateway or terminal. Additionally, level 1 requires no specific certification, but the downside is the lack of interchange optimization options.
Risk Management at Level 1
As you may imagine, with less information comes a higher risk of fraud and general security vulnerabilities. When using level 1 credit card processing, it’s vital to use security measures such as encryption and tokenization, and have a strong fraud prevention strategy in place. At PayCompass, our merchant accounts all come with strong merchant fraud protection measures, giving you peace of mind from the start.
Level 2 Processing: The Corporate Bridge
Level 2 credit card processing requires more data and is designed for B2B (business to business) and corporate purchasing transactions. Due to the increased amount of data required, such as customer codes and tax amounts, merchants have access to reduced interchange rates, therefore saving money over the long-term. In effect, level 2 credit card processing is a bridge between the most basic retail processing and a higher business level.
The table below gives more detail about level 2 credit card processing:
Level 2 Processing Requirements | Description | Benefit |
Customer Code | Alphanumeric identifier (16-25 chars) | Links transaction to specific department/cost center |
Tax Amount | Actual calculated tax (not estimated) | Enables automated tax reporting and reconciliation |
Merchant Postal Code | Physical location identifier | Supports geographic spending analysis |
Merchant Tax ID | Business tax identifier | Facilitates tax compliance and reporting |
Merchant Category Code | Standardized business category | Enables spend categorization and policy enforcement |
Enhanced Data Fields Requirements
Level 2 and level 3 data levels are increased, which means more information needs to be given to the card issuer. In addition to everything mentioned in level 1, level 2 processing requires customer codes, merchant category codes, and tax amounts. All this gives merchants a 0.5-1% reduction in processing fees compared to level 1.
Content Summary: Level 2 processing requires everything from Level 1 plus customer codes, tax amounts, and merchant category codes. This additional data helps corporate clients with expense management and provides card networks with better transaction insights, typically resulting in a 0.2-0.5% reduction in processing fees compared to Level 1 rates.
Technology Infrastructure Needs
Level 1 requires very little infrastructure, however for level 2 credit card processing, compatible payment gateways supporting expanded data fields are required. The good news is that most modern payment processors have this, but it’s important to check before you make a final decision on which processor to go with.
Qualification Criteria and Merchant Benefits
It’s important to understand who qualifies for level 2 processing and what benefits it brings. This helps you make decisions about whether or not you should upgrade your infrastructure. Not all businesses will find use in level 2 implementation, but if you have a large B2B transaction volume, it may bring significant cost savings over time.
Qualifying for level 2 rates requires appropriate merchant codes and a consistent transmission of required data. In general, card networks decide whether a business qualifies for level 2 based on every transaction rather than at merchant-level.
Typical Qualification Requirements
To break it down, to qualify for level 2 processing, you will need to show that you have a significant amount of B2B transactions or corporate card acceptance. Then, the payment processor will look at your business model and transactions before making a decision. In general, payment processors seek between 10-15% of transactions to come from corporate cards.
The Advanced Tiers: Level 3 Processing and Beyond
Most retail businesses use level 1 credit card processing, yet level 3 brings the greatest cost savings.
Level 3 credit card processing is the highest level and requires considerable data. It’s mostly designed for large corporate purchasing and government use, and is a lot more complex than the first two levels. However, it does offer the largest cost savings possible, making it a quality choice for businesses who do qualify.
Level 3 Processing: The Government and Enterprise Standard
The larger amount of data required by payment processors gives a greater level of transparency to both merchants and card issuers. Enhanced data transmission uses specific message formats that have a larger payload size, often up to 4KB, compared to level 1 transactions which are often just 1KB.
Qualification depends on the card issuers, with Visa having the most robust requirements.
The video below dives deeper into level 3 credit card processing and explains what is needed to qualify.
Comprehensive Data Requirements
In addition to everything required for level 2 processing, level 3 asks for 100 more fields, including product codes, units of measure, tax breakdowns, customer references numbers, quantities, and shipping information. This deeper dive ensures better expense management and analytics for large businesses while also giving access to lower interchange rates.
Implementation Challenges and Solutions
As you may expect, level 3 implementation is complex and requires significant technical infrastructure. To work with this, you’ll need specific gateways that are built to support level 3 transactions. Integration can take anywhere up to eight weeks and could also require API implementation.
Before deciding whether level 3 credit card processing is the best option for your business, it’s important to have a full overview of payment processing costs, so you can budget accurately without any unwanted surprises.
Certification and Compliance Requirements
The differences between level 1, 2, and 3 credit card processing also comes down to the formal certification needed by payment processors to qualify for level 3. This process is time-consuming and involves testing transaction submissions, checking all fields are populated correctly, and validating data formats. The entire certification process can take several weeks to be completed.
The Business Case for Level 3 Implementation
With the number of complications involved, you might wonder whether level 3 credit card processing is even worth it. However, there are significant benefits for businesses that can afford to implement the infrastructure and meet the requirements. This includes accessing new market opportunities and building stronger relationships with government and large corporate clients.
Interchange Optimization and Fee Reduction
The larger amount of data required for level 3 credit card processing allows businesses to access lower interchange rates, and these can be significant. An example is a transaction with an interchange cost of 1.90% + $0.10, compared to 2.70% + $0.10 for level 1 and 2 transactions.
Yet, it goes beyond interchange fees because level 3 processing also allows businesses to access reduced assessment fees from cad networks. This increases savings and can accumulate significantly over time.
Strategic Competitive Advantages
Accessing level 3 credit card processing also leverages your business position and shows it to be enterprise-ready. This can open you up to new market opportunities, especially in light of the fact that many government contracts and large enterprise procedure systems require vendors to support level 3 processing.
Strategic Applications Across Business Models
Now you know more about the different credit card processing levels, let’s now turn our attention to different business models and how they can leverage the benefits for new opportunities and competitive advantage.
It’s important to note that strategic implementation varies widely across industries. However, the most successful implementations carefully align payment processing strategies with overall business objectives.
Vertical-Specific Implementation Strategies
Let’s take a deeper look at how different business sectors can strategically implement credit card processing levels in a way that suits their needs best. In this case, vertical-specific implementations usually required level 2 and 3 frameworks to be customized to accommodate industry-specific data requirements.
Government Contractors and Public Sector Vendors
Government contractors require level 3 credit card processing for more than just saving on fees, it’s also about greater market access. In fact, it’s becoming increasingly important as federal procurement regulations often ask for level 3 capabilities.
For this reason, it’s good practice to implement specific checkout flows for government purchases that can capture contract numbers, NAICS codes, and tax exemption details. It’s also a good idea to create specific payment portals for government clients, to streamline data collection.
Healthcare Providers and Medical Suppliers
Healthcare providers can use level 2 and 3 processing levels for several reasons, and one is to smooth insurance reimbursement and for payment billing. Capturing procedure codes, insurance information, and patient identifiers is part of level 3 and also requires careful consideration due to HIPAA compliant credit card processing regulations. For this reason, ensure that you use proper data encryption and storage limitations. At PayCompass, you can rest assured that our processing remains HIPAA compliant for all your medical billing needs.
Educational Institutions and Service Providers
Educational institutions can use enhanced processing to help them manage departmental purchasing, grant funding, and student billing more easily. It’s useful to implement student ID integration alongside level 3 processing as this can simplify many processes, including semester billing and financial aid purchases. Of course, this also gives you the accurate reports you need to follow grant guidelines.
Cross-Border Considerations and International Processing Levels
Cross border payments are usually performed online and pose challenges in credit card processing levels.
Credit card processing levels are not universal across borders. Many are slightly different from country to country, with different benefits, requirements, and compliance needs. If you operate across borders, it’s important to understand these requirements so you can optimize your payment processing.
Of course, that also means ensuring that you choose the right payment processor for multi-currency payments. At PayCompass, we understand how difficult it can be to operate across borders and accept payments in different currencies. We’ve designed our accounts to streamline the process and make it easier for you to expand beyond borders, with payments accepted in over 170 countries.
Regional Variations in Processing Level Requirements
There are major differences between processing levels across global regions and if you operate internationally, it’s vital to understand these differences. This can include different data requirements and completely unique approaches to categorization and qualification.
In this case, implementation usually requires region-specific configurations, which although complicated, will ensure compliance and smooth running. It’s also worth noting that processor capabilities vary by region, and some global processors support enhanced data in specific markets but not in others.
European Processing Level Frameworks
The EEA (European Economic Area) has different processing level regulations and these are influenced by PSD2 and Strong Customer Authentication in particular. Most European transactions require authentication data that is more succinct than North American requirements. This could include biometric verification and device fingerprinting.
Asia-Pacific Processing Hierarchies
Asian markets have their own unique frameworks that vary from country to country, with Japan, Singapore, and China having different data hierarchies to one another. To make life easier, it’s a good idea to partner with local processing specialists that are particularly familiar with the different requirements in that region.
Currency Considerations in Multi-Level Processing
Transactions in multiple currencies add additional complications to implementation, requiring specialized approaches. Let’s take a deeper dive into this and learn how to overcome these issues.
Dynamic Currency Conversion Impacts
DCC, or Dynamic Currency Conversion, transactions don’t usually qualify for level 2 and level 3 data requirements because of conversion-related limitations. In this case, when implementing these enhanced levels with DCC, make sure that your gateway supports supplemental currency information fields. This includes conversion timestamps, currency codes, and exchange rates. If you fail to provide this information, the transaction is likely to default back to level 1.
Emerging Technologies and Future Directions
New technologies, market demands, and regulatory shifts have changed, and continue to change, the credit card processing picture. To help you stay ahead of the curve, it’s useful to anticipate new developments based on trends and new information.
AI and Machine Learning Applications
AI and machine learning and two major players in the technological world and they’re changing how businesses implement and optimize their processing levels. This not only makes life easier but also creates new opportunities for prediction and automation.
AI applications vary across the board and they can be relatively simple systems based on rules, to more sophisticated machine learning models that improve as time goes on. Implementing this technology varies in complexity, but in most cases, it’s worth the time and effort. However, it’s vital to look at ROI and decide whether the benefits and indirect value create enough of a push toward implementation.
AI and machine learning are two technologies that could make credit card processing levels smoother to manage.
Blockchain and Distributed Ledger Implications
Blockchain technology is touted as an answer to many payment processing problems, yet it still has its challenges to consider.
Smart Contracts for Automated Compliance
transactions contain the correct data before being submitted. This technology is programmable, so you can enter the parameters you want to ensure completeness and compliance.
Learning Recap
Understanding credit card processing levels is a complex process, but it’s one that will certainly give you not only insights but opportunities for savings. Over time, qualifying for level 2 or 3 could become a growth strategy for high-risk merchants in particular, giving you access to new opportunities and market share. However, there are many data requirements to meet before qualifying for level 2, and many more before level 3 becomes a possibility.
It’s vital to weigh up the pros and cons and decide whether the ROI is worthwhile, especially when considering level 3 and the complex infrastructure required. Of course, qualifying for level 2 and 3 will bring savings on processing fees, but it’s key to ensure that it’s not a negligible saving that isn’t worth the time or effort.
The first step is perhaps the easiest, and that’s ensuring that you choose the best payment processor from the start.
At PayCompass, we’ve designed our high-risk merchant accounts to overcome the issues that cause daily problems for business owners. From chargeback prevention to dispute assistance, we’ve got you covered. When your payment processor choice is the right one, everything else is much easier and slots into place with little effort.
If you’re ready to switch to a smoother provider, reach out to us today.
