5.7. Authorization vs Clearing vs Settlement

Each transaction is processed by International Payment Systems (IPS, e.g. Visa, Mastercard, etc.) using 3 hardware and software components:

1. authorization platform;
2. global clearing management system (for example, MasterCard GCMS);
3. settlement account management system (for example, MasterCard S.A.M.).

Any card transaction goes through at least 3 stages:

1. Authorization;
2. Clearing;
3. Settlement.

There are 2 different types of payment systems operated by the IPS that process card transactions:

1. Dual Message System is a system that was originally designed for credit cards only, but today it is also used for debit card transactions. This system uses the cardholder`s signature to authenticate transactions, rather than the card number with an authorization code.
2. Single Message System is a system designed for transactions made at ATMs or POS terminals. This system will not be discussed in this section.

DMS transactions usually require a physical or virtual signature to be verified. This category includes credit card transactions (except for cases when credit cards are used to dispense cash at ATMs) and debit card transactions with signature authentication. When the acquirer`s card processing system receives an authorization message, it creates an authorization record through Electronic Draft Capture (EDC). The EDC record is then stored in the batch until Merchant initiates batch processing (at least once a day).

Merchants with large volumes can process their batches several times a day, however, regardless of the frequency, write-offs are made not one-by-one, but in batch write-off requests.

The IPS rules establish a specific time frame for providing transaction information, during which transactions must be sent to acquiring banks. Acquiring banks also have their own time period for entering the required information into the Clearing network. If these periods are met, issuers are required to complete the transaction. In addition, issuers are required to conduct transactions outside the specified time period if the cardholder`s account is still available for debiting, i.e. it still has money on it.

Using all this data, IPS calculates the total amount owed by each issuer and each acquirer. This function of Clearing process is crucial for the final stage of the Settlement process, as reconciliation files are generated on this basis. If the transaction was not received at the Clearing stage, it is not added to batch with all following consequences.

The result of authorization is funds blocking on the customer’s card for up to 7 days for debit cards and 28 days for credit cards. This gives time to make sure that the customer’s card is valid and that the customer is not a fraud. This operation is free of charge and can be cancelled at any time for free. It is impossible to create a chargeback for this operation, since there was neither the Clearing fact, nor the Settlement fact, and the funds did not actually move. However, this operation can receive a fraud mark.

After Clearing, all transactions have already been successfully registered for all participants in the process, but no funds transfer flow has been made yet. This usually happens in 1-2 banking days.

Once the Clearing is done, a dispute flow can be initiated.