DEFINITION of ‘Settlement Bank’
The entity that facilitates the exchange of money between the banks that issue consumers’ credit and debit cards and the banks that manage merchants’ credit and debit card transactions. The settlement bank is one of the main entities involved in any payment card transaction. Companies that provide settlement services are not necessarily banks. MasterCard and Visa, for example, provide these services, and both are payments technology companies, not banks.
BREAKING DOWN ‘Settlement Bank’
A settlement bank, also called a processing bank, takes information about payment card transactions and makes sure the correct amount of money gets exchanged between the banks that issue consumers’ credit cards (called issuing banks) and the banks that merchants use (called acquiring banks). This process is called “interbank clearing and settlement.” “Interbank” refers to the fact that more than one bank is involved. The information-gathering step is called “clearing” and the money-exchange step is called “settlement.” The whole process is automated and takes only seconds.
For any payment card transaction, the settlement bank receives funds from the bank that issued the credit card (the consumer’s bank), then sends those funds to the acquirer (the merchant’s bank). The acquirer then transmits the funds to the merchant, and the transaction is posted to the cardholder’s account.
Consumers only see the first and last steps in any credit card transaction. The first step is authorization and authentication, which is what happens after a consumer enters her card details for an on-line transaction or swipes her card in-store. The purchase is approved or declined, depending on whether the customer has enough available funds and whether the card is valid. The last step is posting, when the transaction has been fully processed and shows up on the consumer’s credit card account. In between these two steps is a lot of behind-the-scenes action that accounts for the fees merchants pay on each credit card transaction.