How Does Credit Card Settlement Work?

Credit card transactions involve a series of steps to move funds from a customer to a business. While swiping or tapping a card may seem instantaneous, a process unfolds behind the scenes. Understanding this process, particularly the final stage known as credit card settlement, is valuable for anyone who uses or accepts credit card payments. Settlement ensures businesses ultimately receive their earned revenue.

Understanding Credit Card Settlement

Credit card settlement refers to the final stage in a credit card transaction where funds transfer from the cardholder’s bank to the merchant’s bank. It ensures a business receives payment for goods or services sold via credit card. It completes the financial cycle initiated by a purchase, moving the payment from a pending status to a finalized transfer.

The core purpose of settlement is to reconcile and verify transactions, allowing for the accurate and secure movement of money. Settlement is a distinct step that follows the initial approval of a transaction, solidifying the financial exchange.

The Key Participants

Several distinct entities collaborate to facilitate a credit card transaction, each with a specialized role in the settlement process.
Cardholder: The individual consumer who initiates a purchase using their credit card. Their account is the source of funds for the transaction.
Merchant: The business that sells goods or services and accepts credit card payments. This entity is the ultimate recipient of the funds.
Acquiring bank: Also known as the merchant’s bank, it processes credit card transactions on behalf of the merchant. This financial institution facilitates the merchant’s ability to accept card payments.
Issuing bank: The financial institution that provides the credit card to the cardholder. This bank is responsible for approving or declining transactions and holds the cardholder’s account.
Card networks: Such as Visa or Mastercard, they act as intermediaries, providing the infrastructure to facilitate communication and fund transfers between acquiring and issuing banks. They manage the flow of information and set the rules for transactions.
Payment processor: A technology provider handling transaction data and communication between the merchant, banks, and card networks. They streamline the process of getting payments authorized and settled.

The Settlement Process

The credit card settlement process involves a sequence of steps, from a customer initiating a transaction to the merchant receiving funds.

Authorization

The initial phase is authorization, where the merchant’s system sends a request to the cardholder’s issuing bank. This verifies the card’s validity, sufficient funds, and that it is not reported lost or stolen. If approved, a temporary hold is placed on the funds, but no money is yet transferred.

Batching

Following authorization, merchants group all approved transactions from a specific period, often a business day. Merchants compile these authorized sales into a single batch. This batch is submitted to their acquiring bank, usually at the close of business.

Clearing

The acquiring bank sends the batched transactions to the appropriate card networks. The card networks then route these transactions to the respective issuing banks for verification and to debit the cardholder accounts. During clearing, transaction data is checked for anomalies, and if correct, the issuing bank confirms the details and converts the hold into a charge on the cardholder’s statement.

Funding

The final step is funding, the actual transfer of money. Once clearing is complete, the issuing bank transfers the funds, minus applicable interchange fees, to the card network. The network then sends these funds to the acquiring bank. The acquiring bank then deposits the net amount, after deducting its processing fees, into the merchant’s account. This entire funding process typically takes between one to three business days for the merchant to receive the funds.

Settlement vs. Authorization

Authorization and settlement are distinct yet sequential phases in a credit card transaction. Authorization is the preliminary step at the point of sale, confirming the cardholder’s account is active and has enough available credit or funds. During authorization, the issuing bank places a temporary hold on the specified amount, reserving funds. No actual money transfer occurs; it is merely a verification.

In contrast, settlement is the conclusive process where the actual transfer of funds occurs. It moves money from the cardholder’s issuing bank to the merchant’s acquiring bank, completing the transaction. Authorization ensures the funds are available, while settlement ensures the merchant is paid.