Processing Reserves Explained
Merchants sign many agreements when setting up a new business. While establishing a merchant account with a payment processor, it’s necessary to read through all the agreement terms and conditions so you thoroughly understand any policies that determine if your account is deemed high-risk and will be subject to a processing reserve. So, what is a processing reserve and why does my payment processor require one?
Every payment processor and financial institution has policies regarding transaction processing reserves. You can think of a processing reserve as a security deposit for your bank or payment processor to ensure that the funds they are fronting to you for each credit card transaction don’t turn into a financial loss for them.
The processing reserve is a specific dollar amount or percentage of the funds processed for your merchant account that is held separately in a reserve account. When a financial institution or payment processor takes you on as a client they’ve run a risk analysis to determine how much risk your business poses. Based on this risk analysis they establish a financial cushion in the case of excessive chargebacks or refunds, or to cover any fraudulent transactions.
Is there anything you can do as a merchant to keep a reserve off your account? The answer is no, a payment processor has the sole discretion via the policy terms in their processing contract to implement a reserve on any merchant account they agree to cover. If you do some research you’ll find processing reserve language in various forms with every payment processing company, whether large or small.
A processing reserve is more likely to apply to your merchant account if your business is considered high-risk versus a standard risk account. So why might your business end up in the high-risk category? There are many different types of merchants that are classified as high-risk based on the type of product that they serve or due to the clientele they serve.
Some obvious examples of high-risk merchants include:
- Online Casinos
- Sellers of Adult Products or Services
- Cannabis and CBD Businesses
- Dating Websites
- Bitcoin Trading
- Lotteries and Sweepstakes
If your business or industry isn’t on this list, it’s possible your business may still fall under the high-risk umbrella. The high-risk label can also apply to businesses that tend to have large transaction amounts, such as travel agencies, timeshare sellers, and retailers that sell luxury items. Transactions for large dollar amounts are riskier for a payment processor to handle, as these transactions tend to have a higher default rate.
Some businesses that might appear more stable like a merchant who sells reasonably priced fashion items could still be considered high-risk if the merchant has a less than stellar credit history, or they’re a ‘terminated merchant’ meaning they lost their last payment processor due to excessive chargebacks and refunds.
A start-up travel company would be designated high-risk, especially if the merchant has never previously applied for a payment processing account. The reason that travel companies tend to be high-risk is that they sell travel bookings and trips with relatively high price tags – consider a cruise to the Mediterranean or a luxury excursion on the Orient Express. Travel businesses tend to be at the mercy of the whims of customers who easily change their minds and cancel or change bookings unexpectedly. When you consider these factors, a start-up travel business would definitely be subject to a payment processing reserve.
Processing Reserve Terms
As previously mentioned, every payment processor has processing reserve terms outlined in their service contract, but there are 3 basic types of processing reserves; an up-front reserve, an accrual reserve, and a rolling reserve.
Up-Front Hold or Reserve
An up-front hold or reserve refers to the funds that a payment processor withholds from the merchant ‘up-front’ in a separate account from the merchant’s payment account. An up-front reserve is similar to the security deposit that’s required when you rent or lease an apartment. The landlord or management company will request funds that are held separately to minimize their financial risk, and/or risk to their property.
An accrual reserve is a fixed percentage of each sales transaction that is ‘accrued’ by the payment processor until the pre-established reserve amount is satisfied. As an example, a payment processor may subject your merchant account to a $5,000 reserve at 10%. When doing so, they will withhold 10% from each payment transaction until the $5,000 reserve is fulfilled. These funds will be kept in a reserve account to cover processing chargebacks, issuing refunds or managing any fraudulent payment transactions.
A rolling reserve is the most common type of reserve account. A typical term for a rolling reserve is 6 months. As an example, let’s say your payment processor institutes a rolling reserve of 5% per transaction for a 6- month term. For the next 6 months, your processor will take 5% of each payment they process and place those funds in a separate reserve account. At the end of 6 months, as your account reaches the 7th month processing period, the reserve funds from the first month will be released. In month 8, the reserve funds from the second month will be released, and so on and so forth. By establishing this rolling reserve, your processor can rest assured that there is always a fund balance available to cover charges, chargebacks, refund requests, and any other fees that might come up. The rolling reserve guarantees the payment processor peace of mind in covering your payment transactions.
Can I have a Processing Reserve Removed?
Having a merchant account with a processing reserve may seem daunting, especially if you have a fledgling business or if you are struggling with liquidity. You may be wondering if there is any way to free your account from a processing reserve once a financial institution or payment processor has mandated one. The answer is to stay optimistic, as there are a few things that will help improve your chances of having a processing reserve reduced or lifted.
When presenting information to a payment processor regarding the type of business you’re engaged in, including descriptions of items or services that you intend to sell it’s important to be honest. It might seem like no big deal to exclude information on your application to protect your account from being thrown into the high-risk category, but if your payment processor’s Fraud Department notices suspicious sales activity it could trigger an account freeze or even a merchant termination.
Some payment processors have more aggressive reserve policies. For instance, if you choose to sign up with Stripe as a payment processor the processing reserve language in their Standard User Agreement allows them to confiscate the “entire amount of charges” processed until the reserve is met. And they can enforce this clause at will (with notice), especially if they suspect that you “have violated or are likely to violate” their processing terms. So if you’ve been engaging in business activities that you didn’t fully disclose, or you’re unable to meet their processing reserve requirements then they have the option to terminate your merchant account.
Along these same lines, don’t mix business accounts. If you choose to branch out into new retail territory or if you decide to dabble in a side business, it’s important to notify your payment processor and maintain separate merchant accounts for each business.
Consistent Processing Activity
Before approving you for an account, a payment processor will require information regarding your anticipated monthly transaction volumes and average transaction size. Once your business opens, it’s important to demonstrate payment processing consistency that matches the business model you provided when you applied for your account. If you can show 6 to 12 months of steady, successful processing history you can ask to have your account’s risk profile reviewed.
Monitor and Reduce Chargeback and Refund Activity
A low incidence of chargebacks and refunds speaks to your business acumen as a merchant. In the long term, stable business operations should result in more favorable business terms with your payment processor and a better chance at reducing or removing a processing reserve. Keeping chargeback activity to a minimum requires diligence on your part and it makes sense to invest in chargeback management tools. You should also monitor and maintain a low refund-to-sales ratio. Ensuring that the products and services you offer are of great quality and in high-demand should reduce the likelihood of excessive refund requests.
Communication and Accurate Record Keeping
A good business owner monitors payment activity closely. If you see any transactions that are larger than normal or appear suspect for other reasons, contact your payment processor’s Fraud Department immediately. It’s beneficial to both of you to work together to stop fraud before it detrimentally impacts your merchant account and their bottom line.
When contacting your processor, be sure to provide detailed information regarding the transaction, including the payment form, receipts, batch data, and any other history related to the sale. Remember, chargeback activity can happen up to 180 days after payment has been processed so it’s a good rule of thumb to keep records for 6 to 12 months.
Finally, if you’re a high-risk merchant or you’re starting a new business with no payment processing history, it makes sense to choose a payment processor that has an outstanding reputation for working with high-risk accounts.