What is Net Settlement?

Net settlement is a payment settlement system between banks, where a large number of transactions are accumulated and offset against each other, with only the net differential being transferred between banks. Payments handled through a net settlement system usually wait until the end of the day, when all transactions between the banks are summarized and offset against each other by a clearing institution; the clearing institution then sends the net transfer information to the settlement institution, which executes the transfer of funds between banks. The clearing institution normally completes its daily summarization process and transmits net transfer information to the settlement institution after the cut-off time of the settlement institution. This means that the transfer of funds to the account of the beneficiary bank will be delayed by one business day. A few clearing institutions compile net transfer information to settlement institutions not only before their cut-off times, but several times per day, which allows for settlement speeds similar to those of gross settlement systems. The cost of net settlement transactions is low, so lower value transactions are usually settled through these systems.

Advantages of Net Settlement

There are several advantages associated with a net settlement system, which are as follows:

Better funds management. The main advantage of a net settlement system for a bank is that the least possible amount of cash is needed to settle its accounts with other parties on a day-to-day basis.
Fewer transactions. There are fewer total transactions for a bank to deal with, since all transactions to be settled are aggregated.