Issuing and acquiring banks need to maintain cash accounts to clear the payment obligations associated with their daily transactions.
In some instances, acquirers and issuers can settle their payments directly; these are referred to as interbank settlements. However, issuing and acquiring banks depend on settlement bank services in the absence of bilateral agreements.
In the following we describe what interbank settlements and settlement bank services are.
Interbank settlements. They occur when acquiring and issuing banks come to a bilateral agreement. These direct agreements permit fund transfers that are almost as inexpensive as balance transfers within a single bank.
Settlement bank services. Designated by credit card unions to facilitate transaction settlements, they receive funds from the issuer, which debits the account of the credit card holder, and transfer those funds back to the acquirer, which credits the merchant’s account.
Though, note that the term “settlement bank” is misleading because institutions providing such settlement services are not necessarily banks; for example, Visa and MasterCard both provide such a service.