Why do High Risk Merchant Accounts Require Reserves?
From the perspective of a credit card processing bank, each transaction processed for a merchant represents a measure of financial risk. Chargebacks and other issues can result in losses for the processing bank; in order to insulate themselves from such losses, many credit card processing banks may require a reserve on your merchant account.
A reserve is similar to an escrow account, and allows the processing bank to establish a cash reserve in relation to the merchant’s monthly processing volume. These funds are used to cover losses from chargebacks, uncollected fees and merchant fines if the merchant is unable to cover these expenses from their own checking account. Since customers have six months to file a chargeback, the reality for the processing bank is that each cleared transaction is essentially a loan to the merchant for the six-month period during which the transaction is vulnerable to being chargedback; the reserve acts as a cushion for the processing company in case that “loan” ends up going unpaid. The funds in the reserve still belong to the merchant, but are inaccessible for the period of time during which they are held in reserve. A processing bank will often require reserves from clients it approves for high risk merchant accounts.
Reserves can take a number of different forms, depending on the type of business and the individual situation of the high risk merchant in question.
- A rolling reserve is one of the most commonly used reserve models for high risk merchant accounts. For every deposit made to the merchant’s account resulting from a cleared transaction, a fixed percentage of that deposit (typically 5-10 percent) will be held back for a period of six months. Funds that were held back in the first month will be released to the merchant account in the seventh month, and so on.
- A capped reserve holds back a percentage of each deposit resulting from a cleared transaction (usually 5-15 percent of the transaction) until a fixed “goal” amount is reached. The amount of that goal is typically one-half the merchant’s monthly processing volume, up to one full month’s processing volume. After that goal is reached, that money remains in reserve but nothing further is held from future transactions.
- An upfront reserve is also based on a percentage of a merchant’s expected monthly volume (though not necessarily the same goal amount as a capped reserve), but that reserve is required upfront, at the beginning of the merchant’s relationship with the credit card processing bank. This upfront reserve can be collected in one of three ways: either 100 percent of transaction deposits will be held in reserve until the target goal is met, the merchant will be asked to wire the requisite amount from their checking account, or a letter of credit will be required from the merchant’s own bank.
Certain industries entail a greater degree of built-in risk for credit card transactions. Any merchant that operates in an environment involving transactions that are not primarily conducted face-to-face is at greater risk for chargebacks and other payment issues, like eCommerce and direct marketing businesses. Merchants that typically process large volumes or have large average tickets are also often considered high risk merchants (these risks are magnified for new businesses that operate solely online). A merchant’s personal credit history will also be considered during the underwriting process; having bad credit can lead to a reserve being required for the merchant account approval. If your business was previously placed on the TMF or MATCH list by a previous credit card processor, a reserve is likely going to be required on a new account. Further, offshore processing providers will typically require a reserve from high risk merchants applying with them, as well as charging higher processing rates.
Because high risk merchants are evaluated on an individual basis, and different processing banks will have different criteria for setting reserves and processing rates, it is best to speak with an account manager at D