Introduction
A merchant’s cash flow means everything for their business. It is needed to pay salaries to your workers and buy input resources from your vendors. Your ability to make these payments in a timely manner depends on how quickly your funds from customers are settled into your account.
On a given business day, you might be in the middle of making a payment to your vendor when you get the notification for insufficient funds. But your bank has already authorized your customer payments. So, why did your T+1 settlement become T+3? That’s because your bank’s payment gateway settlement is slow and at times unreliable.
Continue reading the article to understand payment gateway settlements and their various nuances in detail.
What is payment gateway settlement?
Payment gateway settlement is the transfer of funds from a customer’s bank account to the merchant's bank account. Payment settlement is the last step in a financial transaction in which your acquiring bank settles the authorized and captured funds to the merchant’s bank account.
Payment settlement is immediately preceded by payment authorization and capture.
Payment authorization occurs when the issuing financial institution has verified its account holder’s details and authorized the payment to proceed.
Payment capture, on the other hand, is the process by which the merchant’s acquirer initiates the process of transferring authorized funds from the issuing bank to the acquiring bank.
Only once both of these steps are successfully completed does the settlement process begin, resulting in the funds being deposited into the merchant's account.
How does the payment gateway settlement cycle work?
The payment gateway settlement cycle begins when the customer makes a payment to the merchant at their point of sale and ends when the payment is settled in the merchant's account. Below is a detailed explanation of this cycle:
1. Payment initiation
The customer makes the payment for goods or services at the merchant’s POS using their debit card, credit card issued by their bank or through a digital wallet (PayPal, Apple Pay). For an online transaction, it involves giving their payment information to a payment gateway such as Razorpay.
2. Authorization request
The payment gateway encrypts payment information and sends it to payment processors. Some payment gateways, such as Stripe, offer the ability to process payments as well.
The payment processor verifies the information and passes it to the acquiring bank. The acquiring bank makes an authorization request to the issuing bank and forwards transaction information through the card network (Mastercard, Visa).
3. Payment approval
The issuing bank verifies if the customer’s account has enough funds and whether the card details are valid. It then sends an approval or decline message back through the card network to the acquiring bank. If approved, the transaction goes through. If declined, the merchant asks the customer to try a different payment method.
4. Batch processing
The fund transfer is yet to be processed. It starts with the merchant making a batch of the transactions that had taken place that day and asking its payment processor or acquiring bank for settlement.
5. Settlement
The acquiring bank processes this request and initiates payment capture from the issuing bank. The funds are routed via card network from the issuing bank to the acquiring bank. They are reflected in the merchant account in T+1 to T+7 days, where T is the day of the transaction.
What is the settlement cycle?
A settlement cycle is the time taken for funds to transfer from a customer’s account to a merchant’s bank account. The settlement timing can range from the same day to up to a week, depending on the industry and the risks involved in the business. It also depends on whether the transaction is domestic or international.
Merchants from industries with low-fraud or chargeback risks are able to get faster approvals for payment settlement, typically on the next business day (T+1). Payment gateway instant settlement or same-day settlement (T+0) is also possible but is less common and usually requires a special arrangement with the payment processor. These include industries like retail, clothing or household goods.
Domestic businesses with medium risk engage in batch processing. The acquiring bank processes this batch and captures funds from the issuing bank. These funds are deposited in the merchant account on the next or T+1 day. This is the standard domestic settlement.
High-risk or cross-border businesses have the longest settlement cycle. Their payment processors withhold a percentage of funds, known as rolling reserves, as a precaution against chargebacks, fraud, and other financial liabilities. It is reserved for a set period and released to the merchant account after that, thus leading to delayed settlement.
In international transactions, currency exchange, time zone, and compliance with the bank regulations of the countries involved also play an important role in deciding the payment settlement time. It typically takes 2-7 days for the funds to reflect in the merchant account.
| Settlement type | Meaning | Typical use case |
|---|---|---|
| T+0 | Same day | Low-risk merchant |
| T+1 | Next day | Standard domestic |
| T+2 - T+7 | Delayed | Cross-border or high-risk |
Cross-border payment gateway settlement
Cross-border payment gateway settlement is a transaction between a customer and a merchant in two different countries. Compared to the domestic transaction, the time taken by these payment settlements can be anywhere between T+2 and T+7 days.
Cross-border payments are like regular transactions, but they involve a few extra steps. It includes exchanging currency and processing the payment through intermediary banks, connected via the SWIFT network, before reaching the acquiring bank, and then into the merchant account. Each intermediary bank along the way can add to the processing time.
When a customer makes a payment in their currency, it is converted to the native currency of the merchant. Because of the forex spread, the conversion happens at a rate higher than the actual foreign exchange rate.
After the payment reaches the acquiring bank, compliance checks further delay the settlement. In India, RBI and FEMA guidelines require banks to complete Know Your Customer (KYC) to verify transaction details. They also have to issue a Foreign Inward Remittance Certificate (FIRC) to the merchants as proof of the incoming foreign payment.
Cross-border payment gateway settlement takes many days to finally reflect in the merchant account, as it is repeatedly delayed by corresponding banks and compliance checks. This disrupts the finances of merchants and their business operations.
Common settlement delays and why they happen
Delays in settlement happen for many reasons. These are:
1. Intermediary banks
If there is no direct connection between the acquiring and issuing banks, the funds pass through intermediary banks. The time zone and review process of these banks vary, further delaying settlement.
2. Compliance checks
International bank regulatory checks, such as Know Your Customer (KYC), Anti-Money Laundering (AML) and other screenings must be cleared for the transaction to proceed. Until these are cleared, the funds don't move.
3. Chargebacks and refunds
The risk of chargebacks or refunds leads payment processors to adopt a rolling reserves policy, which slows the settlement of funds in the merchant account.
4. Weekend and bank holiday
Payments cannot be processed on weekends and bank holidays. If a payment is made immediately before a holiday, it will not be processed until the next working day in banks. Payment processing through intermediary banks often faces further delays due to country-specific bank holidays.
5. Incorrect merchant documentation
Errors or mismatches in account numbers, SWIFT codes, or names can lead to rejection or returns. Fixing these issues ends up consuming time.
6. Currency conversion
Currency exchange at banks can take up many hours or sometimes a whole business day. Especially in the case of a less common currency.
Is there a payment gateway settlement fee?
Yes, there are multiple fees involved at different levels in payment gateway settlement. There are additional fees involved in international transactions. These are:
1. Merchant Discount Rate (MDR)
Merchant discount rate, or MDR, is a combination of fees charged to the merchant on each transaction. It consists of interchange fee, network fee charged by the card network and the processor fee charged by the payment service provider. It is usually 1% to 3% of the transaction made.
2. Interchange fees
In a credit or debit card transaction, the issuing bank receives interchange fees from the acquiring bank. It is set by the card networks such as Visa or Mastercard. The acquiring bank charges this fee to the merchant. Interchange fees are actually already included within the MDR, so merchants don't pay them separately.
3. Currency conversion markup
For international payments, currency has to be converted from the customer's currency to the merchant's currency. Banks, card providers and payment processors charge a forex markup fee on top of the actual exchange rate for this service. This markup may range from 1% to 3% of the actual rate of the currency.
4. Platform fees
All platforms that merchants use to receive their payments, such as gateways, processors, SWIFT, and acquiring banks, charge a platform fee that can be 2% of the transaction amount.
5. Reserve deductions
Reserve deductions are a portion of the settlement that is kept by the payment processor or acquiring banks as a security net in case a customer makes a chargeback request. They are kept for a certain amount of time and released into the settlement account if no chargeback request is made.
Settlement reconciliation & reporting
Settlement reconciliation and reporting is the process of matching bank statements with payment records in the company’s general ledger. Its need arises because of tax audits and for staying compliant with RBI guidelines.
The type of settlement you receive can complicate the task of reconciling. You may get a Gross settlement where the whole transaction amount is transferred into your account, and the payment service provider later deducts their fee and other charges.
In the other case, you will get net settlements where funds will be transferred to your account after the gateway fees and charges have been deducted. With your business processing hundreds of transactions, it can prove difficult to have clear visibility of your balances and reconcile payment data.
It becomes important to establish a clear and standardized approach that defines the process and frequency of reconciling settlements. All transactions should be properly documented, and necessary forms, such as FIRA, should be obtained from banks in a timely manner. To make it more efficient, it would be beneficial to invest in a payment reconciliation platform.
Integrating a payment reconciliation platform with your ERP and accounting software can help you track all your payment gateway settlements. It reduces the burden of manual data matching, thereby reducing errors in the process. Many platforms also offer real-time visibility into your cash flow and send instant alerts if a payment goes unmatched, helping you catch discrepancies before they become bigger problems.
How Xflow improves settlement efficiency?
Xflow is an efficient cross-border payment solution that offers fast and reliable payment settlement. Its multi-currency accounts allow your customers to make payments through local banks, which are cheaper and faster than international wire transfer. It allows 1-day settlement over multiple transactions that help with liquidity for your other business operations.
Compared to banks and other payment gateways, Xflow offers lower forex rates and provides its customers with transparent fee structures. Its easy-to-use dashboard gives real-time payout visibility for reconciliation purposes. Xflow also makes compliance with RBI and FEMA regulations easier by helping you download e-FIRA within 24 hours.
Best practices to optimize the settlement cycle
By optimizing your settlement cycle, you can increase your profitability and smooth sail your business. Some best practices you can observe are:
1. Choose the right gateway
A high transaction success rate directly affects your revenue. The right payment gateway is one that gives a smooth experience to you and your customers. It should easily integrate with your platform and offer multiple payment options to the customer.
2. Negotiate settlement terms
Your settlement terms with the payment gateway and processor impact your finances. They should be negotiated transparently and structurally to help prevent margin losses and keep your business’s profitability.
3. Keep a low chargeback ratio
Customers initiate chargebacks when they believe they were fraudulently charged for goods or services, or when the goods or services are of poor quality. A high chargeback ratio results in revenue loss and reputational damage. It is important to keep it low by being transparent in your billing terms to the customer and clearly communicating refund and cancellation policies.
4. Enable instant payouts
A business’s ability to get instant payout affects its customer relations and business operations. Having money at hand for initiating refunds and paying vendors is critical for your business’s reputation, which makes it important to choose a payment service provider that allows instant payouts.
5. Automate reconciliation
Payment reconciliation is an integral step in your compliance journey. Your business needs to maintain records of all transactions for audits and filing taxes. Incomplete reports or errors result in penalties and affect your business operations. Tools for automating reconciliation not only reduce errors but also give you audit-ready reports that help you save time.
Final thoughts
Faster payment settlement gives your business working capital power. Running business operations, paying suppliers or funding growth plans; all depend on your cash flow. So, rather than waiting days for payments to get deposited in your account, incorporate Xflow for instant and secure payouts. Its reduced FX spreads and transparent fee structure help you save up to 50% on variable settlement costs and increase profitability.
Head over to Xflow’s website to learn more!
Frequently asked questions
Payment authorization is when an issuing bank verifies the customer’s bank details and allows payment to be debited from their account. Payment settlement is when the payment is credited into the merchant’s account.
Payment gateway settlements can vary from T+0 to T+7 days, where T is the day of the transaction, depending on the type of payment and business risks. For domestic payments and low-risk business, payments can be settled in T+0 or T+1 days. For international payments and high-risk businesses, the process can take up to T+2 to T+7 days.
Your settlement can be delayed for a variety of reasons, such as compliance checks, bank holidays or processing currency conversion.
T refers to the day of the transaction. T+1 settlements are those where the transaction is completed on the day after the payment is made. T+2 settlements are those where the transaction is completed two days after the payment is made. A transaction is considered complete when the merchant’s account is credited with the payment.
Cross-border settlements work like any other settlement with a few extra steps. It includes exchanging currency and processing payments through intermediary banks and the SWIFT network.
The fees deducted during settlement are MDR, interchange fee, currency conversion markup, platform fee, and reserve deductions.
It depends on your transaction volume, chargeback history, and how long you've been in business. Merchants with a strong track record are more likely to get faster settlement terms. Keep in mind that faster settlement often comes at an extra fee, so it's worth comparing the cost against the cash flow benefit.