Authorization and Settlement in Payment Services
In the domain of payment services within money services businesses, particularly concerning money transfers and cross-border payments, it is imperative to understand the distinction between authorization and settlement. These concepts are pivotal and primarily rely on two foundational elements:
- Trust
- Network
These elements can be conjoined to form what can be referred to as a “trusted network”.
Understanding Authorization
When a transaction takes place, such as a payment made through cheque, electronic transfer, card payment, money transfer, Point of Sale (POS), ATM, wallet-to-wallet transfer, or cross-border transactions, the authorization process comprises three critical steps:
- Validation of Funds: The system checks the feasibility of the transaction against a certain balance. This balance could be in the form of pre-funding, source funding, or an escrow fund.
- Execution of Payment or Exchange of Services/Products: At this stage, an actual payment is made, or, in most instances, a product or service is delivered against the authorized amount.
- Agreement on Settlement Timeline: There is a consensus on a specific timeframe within which the amount will be settled. This agreement includes a definitive date and time.
Essentially, authorization is a request within a trusted network to pay a particular amount to an individual or entity, with an assurance to settle the amount at a later specified date. This agreement is feasible only within a network that relies on established trust and structured arrangements.
To illustrate authorization, consider this scenario: A company requests a network partner to pay a certain amount to a supplier and promises to settle the amount in three days. This can be articulated as, “Can you please pay person X, and I will settle with you in 3 days from now” or “Can you please provide this product or service to the customer for X amount of money, and I will settle with you in 3 days from now”.
The Concept of Settlement
Settlement, on the other hand, involves the actual process of clearing and reconciling the transactions that were authorized. Taking an example mentioned earlier, a T+3 transaction signifies that the settlement will occur three days after the trade or transaction date (‘T’ stands for Trade or Transaction date, while ‘+3’ indicates three days later).
During the settlement process, IOUs (I Owe Yous) are accumulated for the day when the settlement is scheduled, and a singular bulk payment is dispatched for the comprehensive settlement of these IOUs within the trusted network.
Conclusion
Authorization and settlement are integral components in the execution of financial transactions. While authorization involves validating the availability of funds, executing the payment, and agreeing on a future date for settlement, the settlement process involves the actual transfer of funds to reconcile the transaction. Both processes are underpinned by the principles of trust and structured networking arrangements. Through understanding these concepts, one can better comprehend the mechanics of transactions within money services businesses.
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This page was last updated on June 20, 2023.
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