Examination Preparation Materials - Chapter 02

Fintech General Practices and High Level Understanding

Sessions and Settlements in the Financial Ecosystem:

Sessions: In the financial ecosystem, sessions refer to the period during which financial transactions or activities are conducted. For example, a trading session in the stock market refers to the time when trading occurs, typically during specific hours of the day.

It can also be a window of time (eg. 10 AM to 1PM), which can later be accumulated, processed to perform transaction reconciliations, fee and commission calculations etc.

Settlements: Settlements involve the process of transferring funds or securities to complete a financial transaction. It includes the reconciliation of transactions, confirmation of payment, and transfer of ownership or funds between parties. Settlements ensure that all parties involved in a transaction fulfill their obligations and that the transaction is finalized. Disbursement is a movement of fund. Settlement is everything required to be done before deciding the disbursement, and then running the disbursement.

Four Party Model in Fintech Ecosystem:

The four-party model, also known as the four-corner model, is a common framework in the payment card industry that involves four key entities or parties collaborating to facilitate electronic payments. These parties include:

  1. Cardholder: The individual or entity who owns and uses the payment card (e.g., credit card, debit card) to make purchases or transactions. The cardholder is typically the customer or consumer.

  2. Merchant: The business or entity that sells goods or services and accepts payment cards as a form of payment. Merchants require payment processing services to authorize and process card transactions.

  3. Acquirer (Merchant Bank): The financial institution or bank that establishes and maintains relationships with merchants to enable them to accept payment cards. Acquirers provide merchants with the necessary equipment, software, and services for processing card transactions. They also settle funds from card transactions into the merchant's bank account.

  4. Issuer (Card Issuing Bank): The financial institution or bank that issues payment cards to cardholders. Issuers are responsible for managing cardholder accounts, issuing cards, setting credit limits, processing transactions, and providing customer support to cardholders.

In the four-party model, transactions involve interactions between these four key entities:

  • Authorization: When a cardholder makes a purchase at a merchant, the merchant sends the transaction details to the acquirer for authorization. The acquirer forwards the transaction to the issuer, which approves or declines the transaction based on the cardholder's account status and available funds.

  • Clearing: After authorization, the transaction data is transmitted from the merchant's acquirer to the card network (e.g., Visa, Mastercard), which facilitates the clearing process. The card network routes the transaction data to the issuer for payment settlement.

  • Settlement: The issuer transfers funds to the acquirer for the authorized transactions, and the acquirer deposits the funds into the merchant's bank account. Settlement typically occurs within a specified time frame, such as one to two business days after the transaction.

The four-party model provides a standardized framework for processing card transactions, ensuring interoperability and cooperation among card networks, issuers, acquirers, and merchants in the payment ecosystem.

Tokenization in the Fintech Ecosystem:

Tokenization is the process of replacing sensitive data, such as credit card numbers, with unique tokens that have no intrinsic value and are meaningless outside of the system that generated them. These tokens are used to represent the original data securely.

Example: In a mobile payment app, when a user adds their credit card to make purchases, the app may tokenize the card number. Instead of storing the actual card number, the app generates a token linked to that card. When the user makes a payment, the token is sent to the payment processor instead of the card number, enhancing security by reducing the risk of exposing sensitive data in transit.

The payment processor or processing application like mobile wallets can reuse the token for future usage if required.

MDR (Merchant Discount Rate) and MSF (Merchant Service Fee):

MDR (Merchant Discount Rate): MDR is the fee charged by a payment acquirer to a merchant for processing debit and credit card transactions. It is usually a percentage of the transaction amount and covers the costs associated with processing payments, including interchange fees and network fees.

MSF (Merchant Service Fee): MSF is similar to MDR and represents the fee charged by payment processors to merchants for processing card transactions. It may include other fees in addition to the interchange fees, such as gateway fees and assessment fees.

Idempotency in Payment:

Idempotency ensures that performing the same operation multiple times has the same effect as performing it once. In the context of payments, idempotency ensures that duplicate requests for the same transaction do not result in duplicate charges or actions.

Example: Suppose a customer submits a payment request to purchase a product online. Due to network issues or timeouts, the customer's device doesn't receive an immediate response confirming the payment. As a result, the customer resubmits the payment request. If the system is designed to be idempotent, it will recognize that the second payment request is a duplicate and will not process it again, preventing the customer from being charged multiple times for the same transaction.