ayment settlement is the critical process in payments which ensures the smooth transfer of funds between banks after a transaction is Autherized.

For example you are paying 100 Rs. to your friend through an online method like UPI or internet banking, when you initiate the transaction your bank processes the request and checks for sufficient funds and once the transaction is authorized by you, the payment details will be share with your friend’s bank.

Now The settlement process ensures that the funds are transferred from your account to your friend’s account. This involves the exchange of payment instructions and funds between the banks. payment network like NPCI for UPI facilitated the settlement between the banks. In essence the payment settlement ensures that both parties in the transaction — whether it’s you paying your friend or to the merchant

This is the third chapter of the UPI blog series. You can find links of the other chapters at the end of this blog. In this blog we will take a deep dive into the technical part of payment settlement for UPI

Stages of Settlement

The settlement process in financial transaction involves several stages to ensure that funds are transferred accurately and securely between the banks. Here is the overview of the major stages involved in the settlement process:

The Bank of Banks — The Reserve Bank of India

RBI is often referred to as the “Bank of Banks” because it serves as the central financial institution that governs and oversees the functioning of all other banks in India ( particularly in the context of the UPI payments).

Regulation and Oversight: RBI sets the regulations for UPI operations, ensuring compliance, security and efficiency across the banks. Settlement of Funds: RBI facilitates the settlement of funds between banks by maintaining settlement accounts for all banks (who provides UPI to customers) and ensure smooth interbank transactions through systems like RTGS and NEFT Liquidity Management: RBI manages the liquidity of Banks to ensure there are enough funds available for settlement. Interbank Coordination: RBI coordinates between banks involved in UPI transactions, resolving issues and maintaining the integrity of the payment system.

Settlement in UPI

UPI Settlement is managed by the National Payments Corporation of India and play important role in multiple stages. the NPCI process the reconciling and transferring fund request between Banks to finalize the transactions. the System ensures that the money debited from the payer’s account reaches the payee’s account accurately.

Let’s take an example: Raj has an account with ICICI, and Priya has an account with Axis Bank.

Raj initiates a UPI transaction to send Rs. 50 to Priya. As a result, ICICI Bank debits Raj’s account and Axis Bank credits Priya’s account.

Even Priya receives the money in real-time but the banks don’t exchange funds immediately. To settle the transaction the banks must go through a settlement process.

Since all banks participating in UPI transactions must have an account with the RBI. The NPCI aggregates all transactions every few hours and sends settlement reports to each bank. The banks then perform internal calculations to determine how much they owe or are owed by other banks.

Once each banks verifies the settlement report the bank that owes the amount authorizes the payment with the RBI and the RBI initiates the fund transfer between the banks.

Steps in UPI Payment Settlement

1. Transaction Logging: For every UPI transaction, the UPI Switch records the details, such as payer and payee information, transaction amount, timestamps, and status.
2. Interim Fund Hold: Once the payer’s account is debited, the payer’s bank temporarily holds the funds until the transaction is settled.
3. Batch Processing: All transactions are aggregated into batches by NPCI. This happens multiple times a day (typically in predefined settlement cycles).
4. Net Settlement Calculation: NPCI calculates the net payable or receivable amount for each participating bank. This ensures that funds are transferred based on the net difference rather than individual transactions, optimizing efficiency.
5. Settlement Clearing: NPCI coordinates with the Reserve Bank of India (RBI) to clear the funds. The RBI acts as the settlement bank, ensuring accurate fund movement between banks.
6. Fund Transfer: After clearance, the payer’s bank transfers the funds to the payee’s bank, completing the transaction.
7. Notification: Both the payer and payee receive confirmation of the transaction status (success or failure) through their respective PSPs.

Settlement cycle in UPI

The UPI settlement cycle operates in near real-time with multiple settlement cycles throughout the day. Unlike some payment systems that settle at fixed intervals, UPI facilitates continuous settlement, ensuring that funds are transferred promptly between banks. This real-time or near real-time settlement system enhances the efficiency and speed of digital transactions.

As per the latest notification from NPCI below is the current settlement cycle is followed

We have now explored UPI settlement and the important role RBI plays in the settlement process. In the next chapter, we will cover VPA (Virtual Payment Address) and PIN management, which will give us a deeper understanding of the UPI system.

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Chapters

Chapter 1 : A Seamless Payment Revolution architecture and its core components, understanding the mechanisms that enable millions of transactions to happen in real time. Chapter 2 : Payment Types Peer-to-Peer Transfers and Recurring Mandates. Chapter 3: Payment Settlement the Settlement processes, and UPI’s inner workings.