Accepting credit cards as payment method is a no-brainer for most e-commerce merchants. It's easy and convenient. It's also accepted globally. But credit card transactions come with a set of rules defined by the card schemes. For instance, Visa and Mastercard allow cardholders to dispute a transaction up to 180 days after the delivery of the service or product. The merchants are thus exposed to financial losses. The exposure depends on factors such as:
- The service delivery delay (SDD): The longer the delay between a transaction and the consumption of the service/product, the bigger the exposure.
- The Refund Ratio: The higher the ratio, the bigger the exposure.
- The Chargeback Ratio: The higher the ratio, the bigger the exposure.
- The Settlement cycle: The shorter the cycle, the bigger the exposure. A daily settlement cycle offers less time to Acquirers to suspend payments and build additional reserve, if need be.
- The Merchant profile: High-risk merchants such as recurring billing businesses increase the exposure.
Merchants are not the only one exposed though. What happens if a merchant goes bankrupt or couldn't face chargebacks and refunds? According to the rules, credit card acquirers are ultimately liable for unrecoverable funds. It ensures optimal protection for cardholders. In addition, card schemes impose penalties to credit card Acquirers if merchants are not compliant or involved in fraud or money laundering activities.
Consequently, Acquirers often impose specific conditions such as weekly settlement cycles, delayed settlement (aging) or reserve. The goal is to protect themselves against bad debt. In this blog post, we will focus exclusively on the Reserve and more specifically the rolling reserve merchant account which is the most used.
Rolling Reserve Merchant Account
There are 3 types of Reserves:
1. Rolling Reserve
The Acquirer withholds a part of the processing volume to build the Rolling Reserve Merchant Account. It is a sub-account of the Merchant Account. The market standard varies between 5 and 10%. The Acquirer moves the funds back to the Merchant Account after a pre-defined period of time. The funds will then be released with the next scheduled payment. For instance, 180 days. Reserve is rolling and this is why we refer to it as rolling reserve merchant account.
2.Collateral (or Capped Reserve)
The Acquirer holds the funds processed until a cap is reached. It could be a fixed amount,or a percentage of the volume processed. The Acquirer will then transfer the extra funds to the Merchant Account. Reserve is not rolling but static.
3. Up-front Reserve
The Acquirer may ask for a bank guarantee or wire transfer upfront. The option isthe least preferred because it could be a deal-breaker for the merchants, andit doesn’t take into consideration the ramp-up period where processing volume will be limited.
In conclusion, the reserve is a way to mitigate risks. See it as a forced Merchant Saving Account without interests. Reserve Account affects merchant's cashflow, but it increases its odds of getting approved. It also allows Acquirers tooffer more competitive prices. The premium paid mostly depends on theidentified risk for the Acquirer.