Acquirers and card processors are pulling the trigger on reserve requirements for merchants. Here’s what you need to know.
The role of payment card purchases and the associated unsecured indebtedness in the American economy is often understated. Credit card purchases are the most common borrowing tool for American consumers and businesses. It is estimated that there are 180 million cardholders, more than 500 million credit accounts, and $995 billion in outstanding card balances as of May 2020. In 2018, credit card transactions totaled almost $3.98 trillion, an increase of $930 billion from 2015, according to the U.S. Federal Reserve System.
CFOs often do not fully understand, nor do they challenge, the acceptance fees that organizations incur with payment card payments. The fees merchants pay can vary depending on many factors, such as the industry, the size of the merchant, the acceptance environment, and the technology.
Fees can range from 1% to 4% of every card transaction. However, almost all merchants are more than happy to accept payment cards for three reasons: 1) cards are a universal form of payment, 2) cards make it easy for customers to make payments, and 3) cards have a positive impact on cash flow.
Increased risk to acquirers
The deteriorating economy has impacted the cash flow and balance sheets of merchants in almost every industry. As a result, acquiring banks are concerned that some businesses may not be able to cover their obligations to provide the goods or services for which funds were received. Acquirers and card processors (also called merchant acquirers) are pulling the trigger on reserve requirements for merchants and holding back funds due to merchants until the reserve requirements are satisfied.
In addition, card issuers are setting large loan loss reserves. American Express recently announced a $1.6 billion reserve for credit losses. The country’s largest banks – JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., and Wells Fargo & Co. – increased their allowance for credit losses by more than $28 billion in the first six months of 2020. To reduce their financial risks, acquiring banks across America are reviewing their underwriting policies, fee structure, and reserve requirements. It is important to note that many of the largest issuers are also acquirers.
Merchants experiencing the following events are likely to be hit with new or increased reserve requirements:
- Rising levels of chargebacks
- Excessive customer refunds
- Deteriorating financial conditions
- Extended times between purchase and delivery of goods or services
Many banks have reevaluated their underwriting standards or have decided not to take on new merchants from certain sectors at this time.
Account reserve requirements
A typical Merchant Services Agreement is complex, with a multitude of clauses to protect acquirers, not merchants. To the surprise of many CFOs, card processors typically have the right to implement or raise reserve requirements on short notice. Banks and merchant acquirers apply reserves to reduce their risk and shift it to the merchant.
Reserves can take several different styles and structures:
- Rolling Reserve Allowance: the merchant acquirer withholds a predetermined percentage of each transaction for six to 12 months (i.e., when the dispute rights of the cardholder have elapsed).
- Accrual Reserve Balance (sometimes referred to as an “upfront balance”): the merchant acquirer requires a fixed dollar amount, typically equal to a percentage of monthly processing volume, to be deposited or captured from payments as they are processed until the reserve is fully funded.
- Capped Reserve Balance: like a rolling reserve allowance, the acquirer withholds a predetermined percentage of each transaction until meeting the defined reserve. The withheld funds are held by the acquirer indefinitely unless contractual changes are accepted.
Recently, Square Inc. – a merchant acquirer and processor – sent shockwaves through the small business community after merchants complained that it was instituting a hold of 20%-40% of processed credit card transaction funds.
Even though withheld funds (the reserve) remain an asset on merchants’ books, merchants do not have access to the cash and working capital the reserve provides. While reserves protect acquirers from potential losses, the implementation of a 30% reserve effectively and temporarily increases merchants’ real costs for accepting card payments by more than 40% ($4,000/$100,000 = 4%; $4,000/$70,000 = 5.7%). The impact on cash flow is even more onerous.
Proactive steps to avoid or minimize payment card reserve requirements
The negative impact of increased reserve requirements is not limited to small and medium-sized companies. Even large corporates are experiencing many of the same challenges. Fortunately, with the aid of an experienced partner who is active in the payments industry, there are steps you can take today to minimize the impact of increased reserve requirements. Unlike interchange fees and card assessments, reserve terms and conditions can be restructured, modified, mitigated and negotiated.
- Level of reserve amount. The amount of a reserve required varies according to the nature of the merchant’s business; their financial strength; the type of credit transactions (large ticket, small ticket); chargeback experience; diversity, amount, and profitability of related business between merchant and bank; and competitive industry conditions.
- Length of withholding period. The requirements of a reserve, especially the term of the withholding period, can range from 75 days up to a year. From the merchant’s perspective, the shorter the time, the better.
Before negotiating with your processor or acquirer over a reserve requirement, make sure you have:
- Thorough knowledge of your payment card acceptance environment and the roles of the principal players
- A realistic perspective of the acquiring bank and their desired relationship with the merchant
- An awareness of terms and conditions detailed in the Merchant Processing Agreement
- A recognition of what is practically possible and what is not
The bottom line
To succeed in negotiations about reserve requirements, the merchant’s representatives need to understand what is a good deal or what is feasible.
Your organization must also have the team, process, technology, and tools in place to ensure you are proactive in managing your environment and costs. If you do not have the necessary team or resources, let Redbridge’s payment card experts manage this for you. We do all the work for you.