Understanding Credit Card Payment Processing: Authorization, Clearing, and Settlement

Table of Contents

1. Introduction
2. Understanding the Payment Processing System
3. Key Terms and Definitions
   1. Issuer
   2. Acquirer
   3. Credit Card Networks
4. The Authorization Process
5. The Clearing Process
6. The Settlement Process
7. MasterCard's Explanation of the Payment Process
8. Interchange and Service Fees
9. The Role of the Settlement Bank
10. Conclusion

Understanding the Payment Processing System

In this article, we will explore the payment processing system for credit and debit cards, with a specific focus on credit cards. To fully understand the flows involved in this system, it is important to familiarize ourselves with key terms and definitions related to the process. We will begin by discussing the roles of issuers, acquirers, and credit card networks.

Key Terms and Definitions

Before delving into the intricacies of the payment processing system, it is crucial to grasp the meaning of certain terms that will be frequently mentioned throughout this article.

Issuer

The issuer refers to the bank or financial institution that issues credit or debit cards to individuals. When applying for a credit card, the financial institution assesses various factors such as credit history, income, and debt-to-income ratio. Based on this evaluation, they determine the credit limit and decide whether to approve or deny the credit card application.

Acquirer

The acquirer acts as the backbone of merchant processing. These companies provide point-of-sale devices to merchants and facilitate the payment processing process. They serve as intermediaries between merchants and credit card networks, enabling the authorization, capture, and settlement of transactions.

Credit Card Networks

Credit card networks, such as Visa, Mastercard, Maestro, RuPay, Discover, and American Express, function as intermediaries between the issuing bank and the acquiring bank. When a cardholder makes a purchase using their credit or debit card, the transaction information is transmitted through the credit card network from the acquirer to the issuer bank. These networks ensure smooth connectivity and secure data transmission between the involved parties.

The Authorization Process

The payment process begins with the authorization step, which determines the eligibility of the cardholder to make a purchase. Whether the transaction occurs through a card swipe or an online payment, the information is sent to the acquirer, and then the credit card network transmits it to the issuer bank. The issuer bank reviews the transaction details and approves or declines the request based on various parameters.

During the authorization process, the issuer bank assesses the genuineness of the card, verifies the identity of the cardholder, checks for sufficient funds, ensures the transaction amount is within the credit limit, and verifies if the card is not blocklisted. Once the authorization is approved, the funds in the card are temporarily blocked for the transaction.

The Clearing Process

After the authorization, the next step in the payment process is the clearing process. Clearing serves as a precursor to settlement, where the final funds transfer to the merchant takes place. In the clearing process, the involved parties share transaction details to agree on the payment details.

The merchant initiates the clearing process by sending a clearing file containing all the transaction details to the acquirer. The acquirer, in turn, notifies the issuer through the credit card network about the transaction information. It is important to note that during the clearing process, no actual funds transfer occurs. The parties involved are primarily exchanging data and agreeing on payment details.

The Settlement Process

The settlement process, the final stage of the payment process, involves the actual transfer of funds from the issuer to the settlement bank and ultimately to the acquirer. Settlement occurs in batches, with daily exchanges between acquirers and issuers. The settlement process is facilitated by the credit card networks, which transfer the funds according to the clearing and reconciliation files.

The issuer transfers the funds to the settlement bank based on the clearing file received earlier. Subsequently, the credit card network transfers the funds from the settlement bank to the acquirer. Finally, the acquirer credits the funds to the merchant's account. It is important to note that settlement occurs for the net value of clear transactions, meaning multiple transactions are settled together in a batch.

MasterCard's Explanation of the Payment Process

As illustrated by MasterCard, one of the major credit card networks, the payment process involves several steps. Firstly, the cardholder initiates the purchase by swiping their MasterCard at the merchant's point of sale. The transaction then flows through the acquirer, the MasterCard network, and finally reaches the issuer. The issuer verifies the transaction and responds to the merchant regarding its approval or denial.

The clearing process occurs as a batch process, with six cycles per day. During the clearing process, transaction data, currency conversion information, interchange, and service fee calculations are exchanged. However, no actual funds transfer takes place at this stage.

The settlement process entails the final transfer of funds. Settlement advertisements are sent to inform the parties involved about the settlement details. An intermediary bank, known as the settlement bank, facilitates the transfer of funds from the issuer to the settlement bank, and ultimately to the acquirer. The merchant receives the funds during the settlement process, while the cardholder's account is debited accordingly.

Interchange and Service Fees

Interchange and service fees are integral components of the payment processing system. These fees are charged by acquirers and credit card networks for their services. To gain a comprehensive understanding of the fee structure and calculation methods, please refer to the linked video provided at the end of this article.

The Role of the Settlement Bank

The settlement bank plays a crucial role in the payment process as an intermediary between the issuer and the acquirer. It facilitates the transfer of funds from the issuer to the acquirer during the settlement process. The settlement bank ensures the secure and efficient exchange of funds between the involved parties.

Conclusion

In conclusion, the payment processing system for credit and debit cards involves multiple steps, including authorization, clearing, and settlement. Issuers, acquirers, and credit card networks play distinct roles in facilitating the smooth flow of transactions. Understanding this payment process enables a better grasp of the intricacies and behind-the-scenes operations of the credit card industry.

Highlights:

• The payment processing system for credit and debit cards
• Roles of issuers, acquirers, and credit card networks
• Authorization, clearing, and settlement processes explained
• MasterCard's explanation of the payment process
• Interchange and service fees in the payment processing system
• The role of the settlement bank in fund transfer

FAQ:

Q: How does the authorization process work? A: The authorization process determines the eligibility of a cardholder to make a purchase, verifying factors such as genuineness of the card, identity of the cardholder, sufficient funds, credit limit, and card blocklisting.

Q: What is the clearing process? A: The clearing process involves exchanging transaction details to agree on the payment details. It occurs before the settlement process and does not involve actual funds transfer.

Q: How does the settlement process work? A: The settlement process is the final stage of the payment process, where funds are transferred from the issuer to the settlement bank and then to the acquirer. Settlement occurs in batches, and the net value of clear transactions is settled together.

Q: What are interchange and service fees? A: Interchange and service fees are charged by acquirers and credit card networks for their services in the payment processing system.

Q: What role does the settlement bank play? A: The settlement bank acts as an intermediary, facilitating the transfer of funds between the issuer and acquirer during the settlement process.