How Does the Payment Card Settlement Process Work?
Accepting credit card payments is so simple today that you can be forgiven for not understanding the ins and outs of the process. A customer taps, swipes, or enters their card details, et voila, the payment is accepted or declined.
It’s really no more complicated than that. If everything is running smoothly, there’s no reason to contemplate the inner workings of those transactions. But when calculating costs or trying to troubleshoot payment issues, it’s helpful to understand the settlement process.
This article will explain how the payment card settlement process works—from the point of sale to your account.
Credit Card Settlement vs. Payment Card Settlement
Before we outline what credit card settlement is, let’s first clarify what it’s not.
You may have heard of the United States government MDL class action lawsuit against Mastercard, Visa, Wells Fargo, Capital One, Bank of America, and various others who issue payment cards. A.k.a. card issuers. The lawsuit, known as the “In Re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation,” resulted in a settlement agreement. This is now known as the payment card settlement.
Payment card settlement is an unfortunate name, as payment cards are all the credit, debit, and gift cards used to make payments. Hence, the term is important when discussing the intricacies of the day-to-day card settlement process.
You can find FAQs at the end of this article detailing the legal case of the payment card settlement. For now, though, our focus is on the transaction settlement process: what happens between the tap and the money reaching your account?
What Is a Credit Card Settlement?
Credit card (or payment card) settlements are the process that takes place between merchants and financial institutions after a credit card or debit card transaction. After each transaction, the money from the cardholder is transferred to the merchant minus any fees their processor has applied.
The settlement process begins when the customer’s card is accepted at the point of sale and ends with the money being sent from the financial institution to the merchant’s bank account. Each transaction goes through a series of steps—authorization, clearing, and settlement—before the merchant receives their funds.
How Does Credit Card Processing Work?
Before you can understand how the settlement process works, you have to know the basics of credit card processing. As mentioned above, a series of steps are involved in each transaction (authorization, clearing, and settlement).
Within these steps, a few key players are involved: the customer, the merchant, the financial institution (or card issuer), and the payment processing company. Let’s take a closer look at each one.
Customer
The person using their Visa or Mastercard credit card to pay for goods and services.
Merchant (You)
The store owner or business accepting payment from customers via credit or debit cards.
Financial institution (Visa, Mastercard, etc.)
The bank or organization that has issued the customer’s credit or debit card.
Payment processing company
A third-party service provider (like Payment Depot) responsible for connecting merchants and financial institutions. We provide the technology and infrastructure to securely authorize, process, and settle transactions.
Acquiring bank
The bank or financial institution that handles the payment processing activities and receives your money.
It’s worth noting that the acquiring bank and card issuer usually aren’t the same—they are separate entities. The card issuer may or may not be a bank. For example, Visa and Mastercard are credit card companies, not banks. Acquiring banks are always banks or credit unions.
Now let’s explore the steps.
Authorization
When a customer swipes or inputs their card information, the merchant’s point-of-sale (POS) system sends an authorization request to the customer’s bank or financial institution. This is usually done through the merchant’s payment processor. The institution then responds with an authorization code, giving the merchant permission to proceed with the transaction.
Clearing
Once the merchant receives an authorization code, their processor sends a clearing request to the customer’s financial institution. This request contains all the details associated with that particular transaction—including the amount, customer account number, and point-of-sale data.
Once the financial institution receives and validates this information, they’ll send back a clearing response confirming the transaction details. At this point, the customer’s available balance is adjusted to reflect the purchase amount. And the funds are now ready for settlement.
The Credit Card Settlement Process Explained
Now that all the key players have given the green light to make it to the final stage—the settlement—merchants have to think about when and how to utilize this step.
The settlement process transfers the funds from the customer’s financial institution to the merchant’s bank account. These funds are transferred bank-to-bank using EFT (electronic funds transfer).
This process is usually run daily, but some businesses may need longer to initiate the settlement. Let’s look at some examples.
Settlement Strategies for Merchants: Examples
Settle immediately
If you’re a brick-and-mortar retailer, your customers always leave with their items, having paid in full. In this case, you can set up your processing to initiate settlement immediately after the authorization.
Settle same day
If you own a restaurant and a customer comes to pay for their meal, the initial swipe of their card begins the authorization process. But you want it to go to settlement later. The customer has to add their tip. Once the tip has been added, you’re ready to initiate the settlement. If you do it before the tip is added, this will process as two transactions.
Settle within the week
When shipping goods to customers, the protocol is typically to authorize the payment at the point of purchase and to settle once the shipping is confirmed. This is an authorization hold. In this case, you should set up your settlement process to wait until the item is shipped before moving to the settlement step.
The situation is similar for hoteliers, who often have bookings held weeks or months in advance. The settlement should only be processed after checkout.
Settlement Processing Fees
Processing fees come from three parties: the card issuer (i.e., the customer’s bank), the merchant’s acquiring bank, and the payment processor.
The card issuer typically charges an interchange fee to both the merchant and the acquiring bank to compensate them for the risk of carrying out the transaction.
The merchant’s acquiring bank may also charge markup and interchange fees. Then there are additional fees charged by the payment processor to facilitate the back-end services connecting all the institutions.
Gross Settlement vs. Net Settlement
There are two types of settlements that merchants should understand: gross and net.
A gross settlement is when the full payment amount for that day is transferred into the merchant’s account. The processing fees would then be taken out separately after the money is in the account. It’s a two-step process. Money goes in. Then the fee comes out.
Conversely, the net settlement is when the merchant receives the amount (minus the credit card processing fees). This is done in one step, with the processor taking out the fees and sending them directly to the card issuer before sending the final amount to the merchant.
The net settlement is typically faster and more efficient than the gross settlement process.
The Bottom Line
The settlement process is an integral part of any payment transaction. It is the final step that allows all parties to obtain the funds they are owed, and it needs to be done quickly, securely, and efficiently. You can ensure a smooth transition from authorization to settlement with the right setup and understanding of key players, their functions, and their capabilities.
Payment Card Class Action Settlement FAQs
Why were they sued?
The credit card brands were being sued by more than 7 million class members for allegedly violating antitrust laws. They were accused of rigging the rules to limit competition, resulting in control of interchange fees. The subsequent settlement is also known as the interchange fee settlement.
They tried to stop merchants from being able to charge surcharge fees, passing on credit card transaction fees to customers.
What are the details of the settlement?
In 2013, at the United States District Court in the Eastern District of New York, judge, John Gleeson, ruled that: over a class period of eight months, the final approval of the settlement would provide a cash equivalent of a 0.1% reduction in swipe fees, totaling a settlement amount of $7.25 billion to merchants in the settlement class.
Who is opposed to the settlement?
Among 1200 class plaintiffs, Wal-Mart, Target, Neiman Marcus, Home Depot, and Saks were in opposition.
What happened in the appeals?
The case has been to the Court of Appeals for the Second Circuit on two occasions. On the first occasion, it was ruled that the appeals with preliminary approval would not be heard until objections were filed. The second overturned the settlement stating that class counsel couldn’t adequately represent the merchants.
How did merchants claim?
Those affected were able to file claims to join the claims process. Those who needed an attorney or claims administrator struck deals to exchange an agreed-upon amount of their class action settlement which came from the larger class action settlement fund. Everything was done through claim forms.
One scandal to come from this process was around attorneys’ fees. Various firms, including Berger Montague; and Robbins Geller Rudman & Dowd LLP, requested an amount that was significantly larger than would typically be requested in such a case.
Visit the settlement website for more information: www.paymentcardsettlement.com.