Understanding clearing in payments

In the intricate space of payments, the term “clearing” plays a pivotal role in making sure that financial transactions are performed seamlessly and securely among parties involved. This process is integral in the transaction cycle, as it is responsible for transmitting the credit/debit card information across parties, while enabling the verification of transaction data to mitigate the risk of chargebacks or fraud and facilitating the settlement of funds to the merchant's bank account.

In this article, we dig deeper into the concept of clearing. We also explore how clearing works, its distinction from payment settlements, and the benefits it can offer to merchants and various players participating in card transactions.

What is clearing and why is it important?

In the context of financial payments, clearing describes the post-transaction process of exchanging payment information and reconciling funds between the parties involved in a card transaction. In fact, to facilitate the transfer of payment data during transaction processing, card schemes carry out “clearing” of each card transaction every processing day. This interaction is interbank, as it takes place between the merchant’s acquiring bank (or else, acquirer) and the customer’s issuing bank (or issuer for short) via the card schemes.

It should also be noted that the term clearing refers to the procedures related to the processing of card-based payment transactions (be it online or in-store) in accordance with the regulations of each card scheme.

Essentially, clearing is the intermediary between the initiation of the transaction by the consumer and the final payment settlement (more of this below). The transaction details exchanged during the clearing stage are crucial for issuers in matching their authorisation records to the clearing data – with authorisation being the first step of payment processing when the cardholder’s transaction details are verified, and other checks are conducted by the issuer – and appropriately debiting cardholder accounts. Clearing is equally significant for acquirers in making credits and settling the funds to merchant’s bank accounts.

How clearing works

When a customer completes the payment at the merchant's POS terminal (for card present transactions) or online checkout (for card not present transactions) using their payment card, the merchant submits a request to the card schemes for transaction authorisation. This request is imparted to the issuer who validates the transaction data, confirms funds availability and conducts anti-fraud and other checks. When the issuer approves the transaction, the merchant receives an authorisation code via the card scheme that allows them to finalise the sale.

Clearing encompasses all the activities that happen behind the scenes and the time period during which the transaction details are transferred from the merchant’s POS terminal or online payment system to the acquirer in batches. A batch file contains a collection of payment transactions that are consolidated and processed together as a group at the end of the day. Such files help streamline payment processing in situations where multiple transactions need to be handled simultaneously.

Then, the acquirer sends the transaction information to the card schemes. Card schemes are somewhat a central hub for clearing a payment. When card schemes receive information related to the transaction from the acquirer, they route it to the issuer. Next, the issuer confirms that the clearing files align with the authorisation codes generated and relays the funds to the acquirer who then deposits the funds to the merchant’s bank account – a stage known as settlement and which we'll further explore in the following section.

Clearing vs settlement – what’s the difference

While the clearing and settlement process are associated, they account for different phases in financial transaction processing.

The main difference between settlement and clearing is that the latter occurs before the settlement and includes the exchange, validation, and reconciliation of transaction information across the payment network. It encompasses the matching of transactional data and assessing risk, among others. On the other hand, settlement is the actual transfer of funds between the customer and the merchant's bank account through the consumer’s issuer and merchant’s acquirer, respectively, in order to finalise the card payment.

Precisely, once the transaction is authorised and clearing is completed, settlement takes place. During this process, the acquirer sends a settlement request to the card scheme, in which additional details are provided about the authorised transaction(s). Then, the card schemes enable the transmission of funds from the acquirer to the issuer. When the issuer receives the settlement request, it deducts the appropriate amount from the customer's account, and passes it to the acquirer via the card scheme. The acquirer relays the funds for the purchased goods and services to the merchant’s business bank account.

Settlement happens one, two or three business days after the transaction date. The settlement time is determined based on the merchant’s agreement with the acquirer. Yet, settlements are also dependent on the region and payment type (whether domestic or cross-border), the card scheme, the merchant’s business type, and other factors. Despite the differences between clearing and settlement, both processes are crucial for the smooth functioning of card schemes. This allows customers to make purchases seamlessly and merchants to effectively receive payments for their products or services.

Benefits of clearing

The clearing process serves a series of critical purposes in financial payments, including the following benefits:

Risk mitigation

One of the key benefits of clearing is its role in risk mitigation. During the clearing stage, transaction data is thoroughly verified while risk checks are made to ensure the validity of the payment. These checks can help further detect and deter any threats of fraudulent behaviour, thereby minimising the risk of financial losses for all parties involved.

Maximised efficiency

Clearing streamlines the payment flow by automating the verification and reconciliation of transaction information. This means that it partly lessens the manual intervention and paperwork, which can result in increased operational efficiency and speedier payment processing times.

Simplified settlement

By consolidating multiple transactions into a batch file, as explored above, clearing also simplifies the settlement process. This is because it reduces the number of individual transactions that need to be settled, making the settlement process faster and more seamless.

Reducing of payment disputes

The acts of validating and authenticating transaction data during the clearing process reduces the likelihood of chargebacks (If you want to delve more into chargebacks, read our article here). This, in turn, can help effectively prevent payment disputes and the need for costly and time-consuming dispute resolution procedures.

How emerchantpay can help

Clearing is a critical component of financial transactions, ensuring the safe and frictionless transfer of transaction information and reconciliation across parties within the payment flow. In effect, it acts as a bridge from when a customer completes a payment at checkout to the final settlement of funds to the merchant's bank account.

As a Level 1 PCI compliant payment service provider and acquirer, emerchantpay is committed to supporting businesses of all sizes smooth and reliable payment experiences to their customers. Our experienced payment experts will utilise our advanced fraud prevention tools and reporting to pinpoint inefficiencies in your payment flow that, in turn, can allow you to accept more transactions across the globe. We will also team up with you to help you build your risk and chargebacks management strategy to safeguard your revenue and customers.