What Is a Settlement Bank? Definition, Functions, and Process

What Is a Settlement Bank?

A settlement bank is the last bank to receive and report the settlement of a transaction between two entities. It is the bank that partners with an entity being paid, most often a merchant. As the merchant’s primary bank for receiving payment, it can also be referred to as the acquiring bank or the acquirer.

Key Takeaways

  • A settlement bank refers to a customer's bank where payments or transactions finally settle and clear for customer use.
  • Often times, the payer of a transaction will be a customer of a different bank from the receiver, and so an interbank settlement process must occur.
  • A settlement bank also provides merchant services to businesses such as transaction processing.

How Settlement Banks Work

Settlement banks are a primary component of the transaction process, helping to make electronic transaction processing available for merchants. With a significant majority of customers seeking to make electronic payments, it is important that merchants have good relationships with processing entities including settlement banks to ensure a fast and efficient payments system for their business and their clients.

Transaction Processing

When processing an electronic payment transaction, there are typically three main entities involved: the cardholder’s bank, the settlement bank and a payment processor. The settlement bank, also known as the acquiring bank is the lead facilitator of communication on the transaction.

Merchants partner with a settlement bank to ensure efficient settlement of transactions in electronic payment processing. To facilitate electronic transactions, the merchant must first open a merchant account and sign an agreement with an acquiring bank detailing terms for processing and settlement of transactions for the merchant. Acquiring settlement banks usually charge merchants a per transaction fee and a monthly fee for their services.

When a customer chooses to purchase with a merchant using electronic payment, the customer’s card must be in compliance with the settlement bank which means it must be acceptable for processing through the settlement bank’s processing network. Settlement banks typically have relationships with all of the major processing networks, including Visa, Mastercard, Discover, and American Express. However, they may be restricted to only a single processor based on the terms of the agreement.

Once the acquiring settlement bank accepts a cardholder's payment card, the settlement bank then contacts its network to process the transaction. The payment brand network contacts the cardholder’s bank, also known as the issuing bank to ensure that funds are available. If available funds are deducted and sent through the processing network to the settlement bank which settles the transaction for the merchant.

The settlement bank will typically deposit funds into the merchant’s account immediately. In some cases, settlement may take 24 to 48 hours. The settlement bank provides settlement confirmation to the merchant when a transaction has cleared. This notifies the merchant that funds will be deposited in their account.