Day 2: How a Credit Card Transaction Works – Authorization, Clearing, and Settlement

When you swipe, tap, or enter your credit card details online, the process behind the scenes is far more complex than it looks. A single transaction can involve multiple steps and several key players — all happening within seconds.

🔹 Step 1: Authorization

• What happens: The merchant requests approval from the cardholder’s bank (issuer) to ensure the card is valid and has sufficient credit.
• Flow:
  • The cardholder presents their card to the merchant.
  • The merchant sends the transaction details to the acquirer via a payment processor.
  • The card network (Visa, MasterCard, etc.) routes the request to the issuer.
  • The issuer approves or declines the transaction.
• Outcome: If approved, the transaction amount is held (reserved) on the cardholder’s account.

🔹 Step 2: Clearing

• What happens: Transaction details are shared between the acquirer, card network, and issuer for record-keeping and reconciliation.
• Flow:
  • Merchants batch transactions at the end of the day and send them to the acquirer.
  • The acquirer passes them to the card network, which forwards them to the issuer.
• Outcome: The issuer prepares to transfer funds to the acquirer.

🔹 Step 3: Settlement

• What happens: Funds move between the issuer and acquirer, minus applicable fees.
• Flow:
  • The issuer sends the payment to the card network.
  • The card network passes it to the acquirer.
  • The acquirer deposits the amount into the merchant’s account.
• Outcome: The merchant receives their payment, and the cardholder sees the charge on their statement.

📝 Quick Example

• Customer: Buys a $100 shirt using a credit card.
• Authorization: Bank confirms $100 is available and reserves it.
• Clearing: Transaction details are sent to the bank for processing.
• Settlement: Merchant gets $97 (after fees), customer owes $100 to their bank.

✅ Summary

Understanding authorization, clearing, and settlement is key to grasping the full payment lifecycle. Tomorrow, we’ll dive into Interchange Fees & Other Costs in Credit Card Transactions — because knowing the money flow is just as important as the technology behind it.