Payment Clearing vs. Settlement Explained

Fast and reliable payments are crucial for the financial system. To understand the movement of funds between different banks, it is important to understand the concepts of clearing and settlement. Let's not waste any time, and Icon.Partners will explain in more detail!

Understanding Clearing and Settlement

What does “clearing” mean in payments?

Let's answer the question “what does clearing mean”. In payments, clearing is the stage between making a payment and completing it. At this stage, the bank verifies the accuracy of the payment details, determines the transfer amount, and prepares the transaction for completion. 

Settlement in finance defined

Settlement in finance is the final step, when the sender's bank withdraws funds from the account, transfers them to the recipient's bank, and the recipient's bank credits the funds. At this stage, the funds are directly transferred to the new owner. 

Why both processes are essential in banking

Clearance and settlement are key stages of transactions, working together to ensure the reliability, accuracy, and security of banking operations. The absence of these stages would lead to errors, double payments, loss of funds, etc. 

The Clearing Process

What is clearing?

As we mentioned earlier, clearing means the process of checking, matching, and preparing payment transfers before they're finally credited. The main task is to ensure that the amount to be paid by one party exactly matches the amount to be received by the other. 

How the clearing system works

So, in practice, when you transfer funds, the clearing system receives and verifies the information, in particular, whether there are funds in the account, whether the details are correct, and so on. This information is then transferred between banks via special internal networks (such as SWIFT or SEPA). Clearing creates transparency and trust between banks.

Role of intermediaries and clearinghouses

When answering the question “what is a clearing”, it is also important to mention the functions of intermediaries. Intermediaries and clearinghouses act as guarantors that the transfer will be made even if one of the banks fails. 

The Settlement Process

Payment settlement process explained

The payment settlement process is the final stage of payment during which money is transferred from the payer to the recipient. When clearing is complete, the payer's bank transfers funds to the recipient's bank using a payment system or central bank. 

How funds are transferred and finalized

Funds are transferred via bank accounts or payment networks. Banks may use so-called gross systems, where each payment is executed separately, or net systems, where the total liability is calculated. 

Risks and timeframes in settlement

It is great when settlements are instantaneous, but sometimes international transactions take from several hours to even several days. Human and technical risks may arise in the process of processing payments, as well as external interference aimed at stealing funds. 

Clearing vs Settlement: Key Differences

Timing and purpose

Clearing is a preparatory stage, when the system checks the data, and prepares the payment for execution. Settlement is the final stage, when the funds are actually transferred from one account to another. 

Clearing vs settlement in payments workflow

Let's consider clearing vs settlement in payments. The main thing is that clearing precedes settlement. Only after clearing the funds transferred between accounts. 

Example of clearance and settlement in practice

So, let's look at the clearing and settlement process. When your company makes a payment, for example, to a seller of goods, all payment information is first checked, and if the bank has no objections, the money is credited to the recipient. 

Importance in Financial Systems

Ensuring accuracy and security in transactions

Clearing and settlement as elements of fund transfers are aimed at ensuring data processing accuracy, helping to avoid errors, prevent fraud, and generally promote user confidence. 

Clearing and settlement in international payments

For international transfers, the clearing and settlement process is extremely important, as by definition several banking institutions are involved, possibly different currencies, different transfer times, and this increases the risks. 

FAQ on Clearing and Settlement

What is the difference between clearing and settlement?

The main purpose of clearing is to verify transfer data, prevent errors, and only if everything is in order, proceed with settlement.

What does clearing mean in banking?

The stage at which payment details are verified to ensure the transaction is correct. 

Why are clearing and settlement important in finance?

These steps prevent mistakes and reduce the risk of losing money.