In order for businesses to accept credit card, debit card, and related forms of payments, a merchant account is required. Some merchants attempt to arrange merchant accounts for their organizations with little knowledge of the process and issues addressed in obtaining them. This can be very frustrating for merchants because of terminology used within the payments industry and because of the thorough underwriting process initiated to determine if a merchant account application is to be approved or denied.
The purpose of this article is to clarify the need to underwrite merchant accounts and to explain underwriting in enough depth so that merchants can effectively prepare as knowledgeable, willing participants in a process designed to protect all parties involved.
To better understand merchant account underwriting, it is helpful to understand some terms used within the payments industry:
- Businesses that accept credit card and debit card payments in all forms are known as merchants
- Merchant accounts are bank accounts specifically arranged to process funds vis-à-vis payments accepted by merchants
- An acquiring bank originates and maintains merchant accounts
- Financial institutions that process credit card and debit card transactions for merchants are known as acquirers
- Financial institutions that issue credit cards and debit cards to customers are known as issuers
- Customers are those who purchase goods and services from merchants
- A chargeback is a demand by an issuer for a merchant to refund money to a customer for an allegedly fraudulent or otherwise disputed transaction
- Underwriting, as related to merchant accounts, is assumption of ultimate risk by an acquirer on behalf of its merchants, which guarantees payments to issuers for claims against merchants that merchants fail to satisfy
- Familiar card brands include Visa, MasterCard, American Express, Discover, UnionPay, and JCB
Merchant account underwriting involves careful analysis and rigorous evaluation of merchant account applicants by acquirers to ensure that businesses that wish to accept electronic payments from customers are honest, viable, and meet certain basic standards.
Firstly, there is the well-founded risk that some merchants will use a merchant account for fraudulent purposes; merchant fraud is common and costly. Secondly, merchants accepting electronic payments must have the capacity to fulfill financial obligations. Engaging with merchants may present unacceptable risks of loss for the acquirer, which is ultimately financially liable for charges against the merchant’s account if the merchant fails to meet its commitments; for instance, for charges that might result from excessive refund and chargeback transactions. Thirdly, merchants must also meet certain basic requirements established by the card brands for financial and ethical conduct. The merchant account underwriting process addresses these concerns with due diligence.
PHOTO BY: CreditDebitPro
According to Ron Teicher of EverCompliant, a fraud-prevention firm, “merchant fraud is still one of the most common and costly causes of financial loss for acquirers.”1 So reasonable questions arise during the underwriting process: Is it possible that this merchant is going to process fraudulent transactions? Is this merchant applying for a merchant account just to obtain an ill-gotten line of credit? Is the merchant using a stolen identity or a fake on-line presence? Will it allow other unacceptable businesses to launder actual or fictitious transactions through its merchant account? Mr. Teicher’s firm has estimated that money laundering is a substantial problem and that, of on-line sales, “$6 billion involves illegal goods sold on-line by an estimated 335,000 unregistered merchants.”2
According to David Steinberg of Merchant E Solutions, his firm rejects from five to ten percent of all applications it receives, to protect itself. In one scheme affecting the firm, fraudsters registered numerous domain names, set up fictitious web-sites as believable businesses, and arranged merchant accounts with several different processors. Then stolen credit card numbers were used to make fraudulent purchases on the web-sites and the money flowed unimpeded into the fraudsters’ bank accounts. “If you don’t catch it you could lose hundreds of thousands of dollars over a weekend,” said Steinberg.3
An important aspect of merchant account underwriting, therefore, is to verify that payments represent valid business transactions between merchants and cardholders.
PHOTO BY: Ken Teegardin
Can the merchant generate income to cover operating expenses and debt commitments? Does income allow for growth and continuing quality service? The acquirer, of course, wants the merchant to be successful, because then both will benefit from their ongoing relationship. That said, because the acquirer is ultimately responsible to the merchant’s customers, it therefore needs to measure the degree of risk involved. If the level of risk is acceptable and the merchant account application is approved, then the acquirer 1) accepts the risk of loss and 2) guarantees the merchant’s funding of charges against the account.
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The card brands have defined basic requirements for merchants accepting payment cards from customers. Additionally, acquirers prohibit or restrict certain specific products and services offered by merchants that are considered to be illegal or that may be prone to high levels of financial risk and liability.4 High-risk merchants are subject to additional underwriting requirements.5
Many new businesses qualify and present acceptable risks; given that they have provided any requested business documents, financial information, or guarantees.
The Merchant Account Underwriting Process6
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The underwriting process requires the same due care that a reasonable person would take to avoid harm. Due-diligence methodically researches areas of potential risk to establish that facts presented by a merchant have not been misrepresented. Overall underwriting objectives include assessment of an applicant’s financial viability and integrity, and detection of potential fraud, bribery, and corruption.7 The process includes review of an applicant’s business background, operations, locations, and principals. The underwriter may seek information from credit reports, financial statements, income tax returns, and other lawfully available sources of information during the course of its investigation.
A background check, among other things:
- Verifies that a merchant is a bona fide business and that applicants are indeed the principal business owners
- Considers how long a merchant has been in business
- Determines if the business form is corporation, partnership, or sole proprietorship
- Verifies legal and fictitious (dba) business names to ensure that the business is legitimate
Credit checks are an important indicator of the merchant’s financial stability and are used vis-à-vis all applicants; excepting publicly listed and non-profit corporations. Bankruptcy filings and other credit difficulties are taken into account, and merchants previously associated with merchant account risk programs are identified. A low credit score isn’t necessarily a disqualifier for merchant account approval, because acquirers may have tools available to mitigate particular risk cases.
Prior merchant account relationships are reviewed to assess transaction history vis-à-vis customers, and will also determine if a merchant account previously held by an applicant has been terminated by an acquirer. If so, the nature of the termination will be investigated.
When large processing volumes are involved, merchants may be asked to provide information about other owned or operated businesses.
A review of business operations can entail:
- Data security
- Operating statistics
- Orders and shipments
- Chargeback handing
- Credit, refund, and exchange transactions
- Guarantees and warrantees
The underwriter will verify that the merchant has sufficient safeguards in place to protect account data from unauthorized access, disclosure, or use.
Operating statistics will help the underwriter determine expected business revenue and indications of customer service issues. The estimated dollar amounts of total sales and electronic payments to be accepted, as well as available chargeback data, are useful indicators.
The underwriter will want to know how merchants who receive orders and ship merchandise handle these transactions. For instance, the underwriter will want to make sure that the merchant charges customers on or after the merchandise shipment date, that applicable deposits are charged separately when taken, and that the duration of time between an order and its shipment is not excessive. These procedures decrease the risk of cancellations and chargebacks from dis-satisfied customers.
Does the business have a history of formal customer disputes resulting in charges to the merchant account? The underwriter will evaluate an existing firm’s chargeback history to make sure that frequency, quantity, and reasons for the disputes are within acceptable limits. A merchant with a significant number of chargebacks may be subject to reserved funds, held funds, or potential merchant account termination when chargebacks exceed certain thresholds.
The underwriter will look at an applicant’s billing terms and procedures, as may be applicable, and will look closely at long service terms such as annual subscriptions, for which subscribers are more apt to cancel and request refunds.
Are credits, refunds, or exchanges allowed? Flexible policies can reduce the risk of chargebacks. The underwriter can be expected to review terms and conditions of a merchant’s standard sales contract to determine if credits, refunds, and exchange transactions are appropriately processed.
If the merchant sells ongoing services such as guarantees and extended warranties, service contracts will be reviewed; if third parties provide these services on behalf of the merchant, they will be identified.
A review of the merchant’s inventory will assess issues affecting the merchant’s ability to meet its financial obligations. It will seek assurance that stated inventory reflects the sales volume disclosed by the merchant, will determine if the owner owns or finances the inventory, and will identify such things as contractual relationships that might affect financial stability if terminated.
If a third party is to fulfill orders and ship merchandise for the merchant, then its contract with the merchant will be reviewed and its references will be checked.
Merchant’s business environment
The underwriter will assess the business environment in which the merchant is to operate by verifying that the environment and location are suitable for the type of business, and by ensuring that the geographic location isn’t known for excessive fraudulent activity.
The underwriter will also determine if the property is owned or leased and how long the business has operated at its present location, and may request identity of the mortgage holder or landlord for its records or for further research.
Merchant’s principal officers or owners
The underwriter will collect detailed information about each principal having a material interest in the business; including identification, percentage of ownership, and the duration of ownership.
Merchant qualification standards
The underwriter will ascertain whether the prospective merchant and its principals will operate under basic qualifications defined by the card brands:
- All federal and state laws must be followed
- All transactions must be legal
- The merchant must be financially responsible
- The merchant must not be involved in any activity that may harm the payments system
Special Consideration for Transactions Involving eCommerce, Mobile Payments, Mail and Telephone Orders, Recurring Payments, and Subscriptions
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Underwriting for the card-not-present environment, in which a card will not be physically presented face-to-face to the merchant during the payment transaction, requires additional care because this environment is a primary target of fraudsters. The underwriter will seek to make certain that the merchant’s business model is legitimate and, for electronic transactions, will research 1) the service provider to be used by the merchant to process, transmit, and store cardholder data; 2) associated web-sites; and 3) any mobile device applications used for payment acceptance. Businesses expecting large payment processing volumes may be asked to provide business plans, merchandise samples, the policy for handling return transactions, and relevant marketing materials.
Separate Internet Merchant Application
Merchants must apply for a separate merchant account for payments accepted via the Internet. Payments taken vis-à-vis web-site eCommerce and mobile device applications are classified as internet sales.
An independent Internet merchant account facilitates:
- The merchant’s ability to separately track sales by channel
- The merchant’s ability to monitor customer acceptance of the modes in which products and services are offered for sale
- Enhanced underwriting due diligence required for Internet merchants
- Proper representation of a merchant’s information on receipts and bank statements received by customers who have made on-line purchases
Additional Internet merchant application information
The underwriter collects and verifies additional application data for internet merchants to mitigate enhanced risk exposure. The data include:
- Relevant web-site URLs
- Web-site and domain ownership
- Customer service processes
- Marketing affiliates
- Terms and conditions of sale
- Data privacy
The underwriter will verify ownership of domains and web-sites and will review how the customer service function facilitates communications with the customer. Naturally, high customer service performance levels decrease the likelihood of customer disputes and chargebacks.
Merchant Website Disclosure
The underwriter will ensure that Internet merchants provide required disclosures for customers, which may include:
- Appropriate payment industry brand marks
- Known legal restrictions
- Return and refund policy
- Customer service contact information
- Merchant address
- Transaction currency (i.e., U.S. dollars, etc.)
- Known export restrictions
- Delivery policy
- Security capabilities and policy for transmission of payment card details
- Terms and conditions of a promotion, if restricted.
Free Trial Period Merchants
Some merchants offer free trial periods for particular products and services, after which the terms or cost of the product or service changes and customers are charged on a recurring basis. The underwriter will ensure that these merchants adhere to stringent customer disclosure.
Merchants seeking to accept credit card, debit card, and related payments from customers may pose potential risks to the payments system. These risks can affect other merchants, acquirers, issuers, and customers, alike, and deserve a comprehensive appraisal before applicants for a merchant account and acquirers enter into agreements. A thorough understanding of this process by merchants can expedite timely and efficient boarding of acceptable merchant accounts.
6The following underwriting passage largely draws on information found in Visa Global Acquirer Risk Standards: Visa Supplemental Requirements https://usa.visa.com/dam/VCOM/download/merchants/visa-global-acquirer-risk-standards.pdf