Net Settlement vs Gross Settlement

Net settlement and gross settlement refer to the two main types of settlement methods used in electronic payment transfers.

In the payments world, there are two commonly used settlement methods when it comes to transactions: net settlement and gross settlement.

Nearly all digital transactions go through the process of clearing and settlement, which is where transactions are verified and settled on behalf of each financial institution by a governing body.

Net settlement and gross settlement differ in their approach to the clearing and settlement process, and each has its pros and cons.

What Is Net Settlement?

In its simplest form, net settlement calculates and consolidates multiple transactions from two financial institutions, then the net amount owed is settled to one of the parties. It is the most common settlement method used for the majority of transactions.

Instead of processing transactions individually and settling them separately, payments and collections are aggregated and settled at the end of specific windows, such as daily or hourly.

This is then scaled across many Financial Institutions, which can be millions of transactions daily.

Net Settlement Example

Financial Institution A sends Financial Institution B 100 transactions.
Financial Institution A receives 50 transactions from Financial Institution B.

Instead of sending and receiving the 150 transactions individually, the amount owed is settled in a single transfer at the end of the day.

This is the process of net settlement, which is then multiplied across hundreds of other Financial Institutions.

Advantages of Net Settlement

• Reduces transaction costs which would be high for millions of daily transactions
• Reduced operational burden of having to manage individual transaction settlement
• Minimizes liquidity by requiring only the net balance to be settled
• Ability to process high-volume transactions with ease

Disadvantages of Net Settlement

• Delayed settlement means that funds are not available immediately
• Counterparty risk since multiple transactions are settled in bulk

What Is Gross Settlement?

Gross settlement is fundamentally the opposite of net settlement. With gross settlement, each transaction is processed individually in real-time, meaning that every payment is settled immediately between each Financial Institution.

Because transactions are sent and cleared right away, gross settlement is typically used in much lower volumes for higher-value transactions.

Gross Settlement Example

Financial Institution A transfers $1 million to Financial Institution B.

The full amount is transferred instantly and in isolation.

Other transactions do not affect the balance that is settled.

Advantages Of Gross Settlement

• Ideal for high-value payments where confirmation is crucial
• Ideal for time-sensitive transactions where access to funds are required instantly
• Immediate settlement reduces counterparty risk

Disadvantages Of Gross Settlement

• Requires higher liquidity since every transaction must be funded in real-time
• Usually more expensive due to higher processing costs of single transactions

Summary

In general, net settlement is best for everyday transactions such as bill payments, payroll, and transferring money to friends and family.

Gross settlement is typically reserved for high-value payments and is utilized by governments and enterprises for large or urgent payments.