A settlement is an important part of the payment process, resulting in the transfer of funds from card payments directly into the merchant’s business account. Having a good understanding of this can help your business to streamline its operations, as different settlement timeframes and terms can impact your day to day operations. Without further ado, let’s unpack everything you need to know about settlements.
What is a payment settlement?
A settlement is the final stage of the payment process, whereby the acquiring bank collects funds from the cardholder’s issuing bank, through the payment gateway. The money is then deposited into the merchant’s business account, minus relevant processing fees.
The time it takes to receive a settlement varies based on factors such as the merchant’s agreement with their payment service provider, the region (domestic vs cross-border transaction) and merchant’s industry, among other things (this will be explained in more detail later).
What is the payment settlement process?
To wrap your head around settlements, you must first understand how they fit into the payment process, which is as follows:
1. Initiation: the customer makes an online purchase to initiate a payment request.
2. Authentication: the payment gateway encrypts the payment data and performs fraud checks, before sharing this with the acquirer. The acquirer will then send this information to the card schemes to conduct further risk analysis.
3. Authorisation: this information is then securely passed from the acquirer on to the issuing bank to:
- Verify the cardholder’s details;
- Confirm there are sufficient funds; and
- Validate that the card is legitimate and hasn’t been compromised or stolen.
If there are no issues, the issuing bank will authorise the payment and the customer will receive confirmation that the purchase has gone through. However, funds will not be transferred from the customer’s account to the merchant’s bank until the transaction has been settled.
4. Clearing: the funds now go through a reverse verification process with the relevant card schemes and issuing bank to clear.
5. Settlement: this can be separated into the following two phases:
- Card schemes (e.g. Visa and Mastercard) will debit the customer’s issuing bank account and credit the acquiring bank for the funds. They will also deduct interchange and network fees immediately or on an agreed later date, according to the settlement type.
- The acquiring bank will settle and transfer funds to the merchant’s bank account, according to the merchant’s agreement with their payment service provider (more to come on this).
Is capture the same as settlement?
The terms “capture” and “settlement” are two vital parts of card transaction processing. They relate to the transfer of funds to the merchant’s bank account but cover different aspects of this.
Following authorisation from the issuer, a capture request is sent by the merchant’s acquirer to move the required funds from the customer’s issuing bank to the acquirer’s account, in order to be settled to the merchant. This stage is known as the ‘honour period’ and the timeframe depends on the type of authorisation, such as a standard authorisation or pre-authorisation. This could be three days, a week or, in some cases, up to 30 days (this is the maximum that Visa allows). On the other hand, settlement is when the acquirer sends funds to the merchant’s bank account.
In a nutshell, a capture is basically a request from the merchant’s acquiring bank saying that the funds are ready to be sent, while a settlement involves the actual movement of funds from the cardholder’s bank account to the merchant’s business account.
Both stages are essential for ensuring that transactions are securely and accurately processed by payment systems.
Why is a transaction authorised instantly but settlement takes a few days?
Authorisation occurs almost instantly as it happens at the beginning of the payment process. Comparatively, more steps need to take place during the payment process prior to funds being settled as mentioned earlier, and this can differ in length depending on a number of factors, such as:
- Payment service provider agreements: this varies based on the agreed settlement cycle (T+1 or T+2), accepted payment methods, deductions as well as the fraud and risk mitigating procedures utilised by card schemes and issuing banks.
- Changes in regulatory compliance: from time to time, regulatory bodies may make changes to compliance legislation to help improve outcomes for customers and/or merchants. Depending on the scale of the change, this can lead to disruptions in your payment processing and settlements.
- Technical issues: this includes scheduled and unscheduled maintenance with banks, connectivity issues and/or bugs associated with any players involved in the payments ecosystem, which can result in settlement setbacks.
- Merchant industry: depending on the perceived level of industry risk, businesses will operate with different honour periods. For example, most eCommerce stores will authorise the amount for incoming orders and capture it when the goods are shipped. Whereas travel merchants will have longer honour periods as they face a higher risk of cancellations and last-minute changes.
- Type of payment: cross-border payments require more time to process and clear transactions compared to domestic payments. This is due to different international banking policies, terms of card schemes, public holidays and business hours.
What's the difference between gross vs net settlements?
The difference between the two settlement types comes down to your deduction agreement with your payment service provider. Deductions may include gateway fees, acquiring fees, card scheme fees or interchange fees, just to name a few things.
Gross settlements involve the settlement of transactions without any immediate deductions. Instead, the deductions will be taken out of the merchant’s bank account at a later date, based on their agreement with the payment service provider.
Net settlements, on the other hand, will subtract deductions straight away upon the settlement of funds.
Popular types of settlement cycles
The most common types of settlement cycles based on timeframes include:
- T+1 settlement: T+1 settlement is the practice of settling a transaction one business day after the payment date. In this instance, “T” accounts for the transaction date and “1” signals one business day after the transaction.
- T+2 settlement and more: as its name suggests, transactions following this type of settlement take two business days or more to settle after the payment.
As touched on previously, the type of settlement cycle your business adopts will depend on your agreement with your payment service provider.
How emerchantpay can help
As a PCI DSS compliant payment service provider and acquirer with over 20 years of experience in the payments industry, we’re committed to helping businesses provide a smooth and secure payment experience for their customers. Our all-in-one payment platform can help streamline your card payment process with global acquiring, alternative payment methods, customisable card issuing and in-house risk and fraud management solutions.
Learn how your business can optimise its payments performance by contacting our team of experts today.