Payment settlement is the stage at which a transaction is finalized and the funds are transferred from the buyer’s account to the seller’s account. For businesses, this is when the money from sales or services rendered becomes available in their bank account. Payment settlement is an important part of worldwide digital payments, which are projected to reach $11.5 trillion US dollars (USD) in 2024.

When a customer makes a purchase, the transaction goes through different stages, including authorization and batching, before reaching settlement. Settlement signifies the completion of a financial transaction and enables businesses to access the funds. The payment settlement process’s speed and efficiency can impact a business’s cash availability and financial management.

Below, we’ll cover what businesses should know about how payment settlement works, how long payment settlement takes, and payment settlement best practices.

What’s in this article?

• The payment settlement process
  
• Who is involved in payment settlement systems?
  
• Timing and cycles of settlement periods
  
• Security and fraud prevention during settlement
  
• Legal and compliance considerations around payment settlements
  
• Payment settlement best practices for businesses
  

The payment settlement process

• Authorization: After a customer initiates a payment, a point-of-sale (POS) system sends an authorization request with transaction details to the acquiring bank. The acquiring bank forwards this request to the card association (e.g., Visa, Mastercard), which routes it to the issuing bank.

• Verification: The issuing bank verifies the transaction’s validity (verifying security details such as the card’s expiration date and card verification value, or CVV); checks for sufficient funds or credit limit; and assesses the risk parameters before approving or declining the transaction. The issuing bank then sends a response back to the business.

• Approved/declined: Based on the verification, the issuing bank either approves or declines the transaction. If approved, the bank reserves the transaction amount in the cardholder’s account, reducing the available balance or credit. This reserved amount is earmarked for the upcoming transaction. If declined, the business receives a reason from the issuing bank.

• Capture: The business may not immediately capture the transaction after authorization. This is common in scenarios where the final purchase amount might vary (for example, at a gas station) or when the goods or services are delivered at a later time (such as in online shopping). When the business is ready to finalize the transaction amount, it initiates the capture process. This can take place at the end of the business day or after the service is provided. The capture request is sent to the payment processor or acquiring bank, instructing that entity to finalize the transaction for the authorized amount.

• Batching: Batching is when businesses send all the authorized transactions from that day, grouped together as a batch, to their payment processor at the end of the day. It’s the precursor to settlement.

• Clearing and interchange: The acquiring bank forwards the batched transactions to the card networks. The card networks route these transactions to the respective issuing banks and calculate interchange fees (fees paid between banks for the acceptance of card-based transactions).

• Settlement: The issuing bank transfers the appropriate funds to the card networks. The card network transfers these funds to the acquiring bank.

• Funding: The business’s account is credited with the net transaction amount (gross transaction amount minus interchange fees, acquiring bank fees, and any other applicable charges). While settlement marks the transfer of funds between banks, funding is when the money becomes available in the business’s account.

• Reconciliation: Businesses reconcile their accounts by matching the transaction amounts they have recorded with the amounts that have been settled and funded. This process identifies any discrepancies and helps resolve issues related to transaction processing.

Who is involved in payment settlement systems?

Payment settlement involves several different entities with specific responsibilities and functions. These entities collaborate to create secure and reliable payment systems that process millions of credit card transactions every hour.

• Business: This is the entity that sells goods or services. Businesses accept payments from customers using merchant accounts, a type of bank account that allows businesses to accept debit and credit card payments. A merchant account holds funds before the money is transferred to the business’s primary business bank account.

• Customer (cardholder): This is the individual or entity that purchases goods or services using a payment method such as a credit or debit card.

• Acquiring bank (business’s bank): The acquiring bank is the business’s partner in processing credit and debit card transactions. It provides the business with the necessary tools and bank accounts to accept card payments. The acquiring bank passes along the business’s transactions to the applicable issuing banks to receive payment.

• Issuing bank (customer’s bank): This is the bank that issued the customer’s credit or debit card. The issuing bank is responsible for paying the acquiring bank on behalf of the customer and, later, collecting the payment from the customer.

• Payment processor: Often a third-party company, the payment processor is the entity that manages the transaction flow between businesses, acquiring banks, and card networks. It provides the technology and services needed for processing transactions including authorization, batching, and settlement functions.

• Card networks (payment networks): These networks facilitate the electronic transfer of financial information and funds between parties. Examples include Visa, Mastercard, American Express, and Discover. Card networks set the rules and standards for card transactions and provide the infrastructure for processing them.

• Payment gateway: Payment gateways process credit card payments for businesses. They facilitate the transfer of information between a payment portal (such as a website or mobile phone) and the payment processor or acquiring bank.

• Central banks: In the broader context of payment systems, central banks regulate and oversee the national payment system, ensuring overall financial stability and the integrity of the settlement process.

• Regulatory bodies: These entities establish the legal framework and standards for payment systems, monitor compliance, and ensure consumer protection. They can be national or international organizations, depending on the scope of the payment system.

• Clearing houses: In certain payment systems, especially in interbank transfers, clearing houses act as intermediaries that facilitate the clearing and settlement of payments, securities, or derivatives transactions. The Automated Clearing House (ACH) network is one example.

Timing and cycles of settlement periods

Payment settlement systems operate along different timelines. In a typical timeline for credit cards, transactions are authorized instantly, batched transactions are sent out at the end of each business day, clearing is completed overnight, settlement is completed within one to three business days after the transaction, and funding is completed within two to three business days after the transaction.

The process and timeline for other types of transactions are outlined below.

ACH transactions

• Initiation: The originator sends a payment instruction to their bank, which can happen anytime.

• Batching: ACH payments are batched and processed by banks at scheduled times—every four to six hours or so—not once a day like card transactions.

• Clearing: The batches are sent to the central ACH operator, which sorts them and sends instructions to the recipient’s bank.

• Settlement: Settlement usually occurs on the next business day after the batch is sent.

• Funding: The recipient’s bank credits their account, often on the same day settlement occurs.

Wire transfers

• Initiation: The sender initiates the wire transfer with their bank.

• Transmission: The sending bank transmits the transaction details through a network, such as the Society for Worldwide Interbank Financial Telecommunications (SWIFT).

• Settlement: Wire transfers are usually settled within hours, making them one of the fastest methods for transferring funds internationally.

• Funding: The recipient’s account is credited on the same day or within 24 hours, depending on the banks’ cutoff times and time zones.

Digital wallets (e.g., PayPal, Apple Pay)

• Transaction: The digital wallet provider initiates the transfer process as soon as the payment is made.

• Processing: The wallet provider may briefly hold the funds to perform security checks and fraud analysis.

• Settlement: Settlement typically occurs within one to three business days.

• Funding: The business can access funds within two to three business days of the initial transaction.

Global payment networks (e.g., SWIFT for international bank transfers)

• Initiation: A bank sends a payment order through the SWIFT network.

• Processing: SWIFT forwards the message to the beneficiary’s bank. Banks may use intermediary banks to facilitate the transfer.

• Settlement: Settlement times can vary from one to four business days depending on the payment network and banks involved.

• Funding: Funds are made available to the recipient once the receiving bank has processed the payment.

Security and fraud prevention during settlement

Security and fraud prevention in payment settlement is a collaborative effort. Payment networks such as Visa and Mastercard have strong fraud detection systems, and they share information about suspicious activity with issuing and acquiring banks. Issuing banks monitor transactions for fraudulent behavior and might contact the cardholder for verification if suspicious activity is detected. Acquiring banks work with payment networks and issuing banks to identify and prevent fraudulent transactions. Security measures and fraud prevention tools that are commonly used to protect the payment process include:

Security measures

• Encryption: Sensitive data such as credit card numbers are encrypted during transmission, making them unreadable to unauthorized parties.

• Authentication: Authentication verifies the identity of both the payer and payee. This can involve multifactor authentication (MFA) or password verification for online transactions.

• Tokenization: Tokenization replaces card details with unique tokens during transactions. This reduces the risk that account information will be compromised, even if a breach occurs.

• Access controls: Access to sensitive financial data is limited to authorized personnel and systems.

• Firewalls and intrusion detection: These systems identify and prevent unauthorized access to financial systems.

Fraud prevention measures

• Transaction monitoring: Transaction patterns are analyzed for suspicious activity such as large purchases from unusual locations.

• Velocity checks: The frequency and volume of transactions are monitored to identify potential attempts to exploit stolen credentials.

• Address verification service (AVS): The billing address provided by the payer is compared with the information on file with their bank.

• Card verification value (CVV): Payers must verify the unique code on the back of their card to confirm they’re in possession of the physical card during online transactions.

• Risk scoring: Each transaction is assigned a risk score based on factors such as purchase history and location. Transactions with high-risk scores may be flagged for further scrutiny.

Legal and compliance considerations around payment settlements

Payment settlement processes are subject to a set of laws and regulations that govern their security and compliance with national and global standards. Businesses must comply with these laws and regulations in each jurisdiction in which they operate. For international settlements, businesses must consider the legal requirements of all involved jurisdictions, including currency controls, reporting requirements, and cross-border transaction regulations. All businesses must maintain accurate transaction records and be prepared to report to regulators when necessary.

Compliance requirements around payment settlement include standards set by financial authorities and regulatory bodies such as the Financial Crimes Enforcement Network (FinCEN) in the United States and the Financial Conduct Authority (FCA) in the United Kingdom. Regulated areas related to payment settlement are outlined below:

• Anti-Money Laundering (AML): AML regulations prevent the flow of funds related to illicit activities. Companies must implement effective AML programs, including Know Your Customer (KYC) processes, to verify the identity of their customers and monitor transactions for suspicious activities.

• Counter-terrorist financing (CTF): CTF regulations prevent the use of financial systems for funding terrorist activities. Companies must comply with CTF measures to prevent the misuse of payment systems.

• Data protection and privacy: Data protection regulations protect the privacy and integrity of customer information. Companies must comply with data protection regulations such as the General Data Protection Regulation (GDPR) in the EU.

• Consumer protection laws: Consumer protection laws protect consumers’ rights in financial transactions. Stipulations include transparent disclosure of fees, the right to dispute transactions, and protection against unauthorized payments.

• Payment Card Industry Data Security Standard (PCI DSS): PCI DSS ensures the security of card transactions and protects against data breaches. All businesses that handle card payments must comply with PCI DSS.

• Contractual obligations: Agreements with payment processors, banks, and other financial partners often come with their own legal and compliance obligations. These contracts must align with broader regulatory requirements.

Payment settlement best practices for businesses

• Payment controls: Create a solid framework for overseeing payments. Divide responsibilities to prevent too much control resting with any one individual and ensure that every step, from initiation to reconciliation, is double-checked.

• Security measures: Use payment platforms that exceed industry benchmarks such as PCI DSS. Keep your systems up-to-date with the latest updates and iron-clad encryption to safeguard every transaction.

• Reconciliation: Make it a habit to reconcile your payment activities with your bank statements and financial records. Quick reconciliation helps spot any mismatches early, wards off fraud, and keeps your financial data accurate.

• Compliance: Continually review any local and global rules that affect your payment activities. From AML to data protection, ensure you’re aware of and fully in compliance with these regulations.

• Know Your Customer: Use KYC practices to confirm the identity of your clients and cut down on fraud risks.

• Payment terms: Spell out your payment conditions clearly in every contract, including payment timelines and penalties if deadlines are missed.

• Disputes: Develop a process for handling chargebacks or disputes that allows you to respond promptly and keep a detailed log of what occurred and how it was resolved.

• Staff training: Regularly train and update your team on the latest in payment security and compliance to outsmart new threats and stay on top of regulatory shifts.

• Data protection: Follow all applicable data protection laws and keep your customers’ data protected under strict access protocols.

• Transaction monitoring: Monitor payment transactions for anything out of the ordinary. Regular audits help you spot and fix any issues in your payment processes.

• Vendor assessment: If you’re teaming up with third-party payment processors, ensure they comply with industry standards and regulations.

• Backup plans: Have a backup plan in place so your payment processes keep working even when faced with disruptions such as tech glitches, manual errors, or natural disasters.