The merchant underwriting process is a critical step that payment processors and financial institutions use to assess the risk associated with onboarding new businesses.
Whether you’re running a small eCommerce shop or managing a high-risk industry venture, understanding merchant underwriting can help you navigate the approval process and maintain a strong partnership with your payment service provider.
TL;DR
- Merchant underwriting is the process of evaluating a business’s risk level before approving it for credit card processing for any kind of payments from electronic payments to in-person payments.
- The merchant underwriting process helps reduce fraud (including chargeback volume), ensures compliance with regulations, and protects financial stability in the payment processing space.
- Key steps include application review, risk assessment, credit checks, and compliance verification.
What is Merchant Account Underwriting?
Merchant account underwriting is the evaluation process payment processors use to assess whether a business meets the criteria for accepting credit card payments.
This process involves reviewing the business’s structure, financial health, industry type, and compliance with regulations. Payment processors need to ensure they are working with reliable merchants who won’t expose them to undue risks, such as fraud, chargebacks, or regulatory violations.
What is the Purpose of Merchant Underwriting?
The primary purpose of merchant account underwriting is to mitigate risks for payment processors and credit card networks. By thoroughly assessing merchants, processors can:
- Reduce fraud and chargebacks by identifying potentially fraudulent or non-compliant merchants before onboarding them.
- Ensure regulatory compliance by adhering to anti-money laundering (AML) laws and Know Your Customer (KYC) requirements.
- Protect financial stability by avoiding potential financial losses from high-risk businesses.
- Safeguard reputation by maintaining trust with customers and partners by onboarding reliable businesses.
Implementing a robust underwriting process enables payment providers create a secure environment for all parties involved in the payment ecosystem.
How Merchant Underwriting Works
The merchant underwriting process typically follows a few steps carried out by the payment facilitators or acquiring bank to develop an underwriting risk profile.
They focus on a variety of key factors and it generally takes at least a few days. Each step is crucial in ensuring the merchant’s reliability and compliance:
Step 1: Application Review
Compliance or onboarding teams at the payment facilitator or acquiring bank gather all the required documents and essential merchant information such as business address, bank statements, income statements, chargeback histories, ownership information, industry type, and transaction volume through submitted merchant account applications or online platforms.
This step ensures the merchant provides accurate and complete information about their operations.
Step 2: Risk Assessment
Risk management departments or specialized underwriting teams at the payments company evaluate the business’s model, industry risks, and potential sales volume. High-risk industries, such as gaming or adult entertainment, undergo more stringent scrutiny due to their higher likelihood of fraud or chargebacks.
This step helps payment facilitators determine the overall risk profile of the merchant.
Step 3: Credit Checks
Financial analysts within the underwriting team or third-party credit reporting agencies review the merchant’s financial stability and credit history. This process involves pulling credit reports and analyzing financial statements to assess the merchant’s ability to handle refunds, chargebacks, and other financial obligations.
The goal is to ensure the business has a solid financial foundation.
Step 4: KYC and AML Checks
Compliance officers or automated systems integrated with KYC and AML verification services verify the identity of business owners and ensure compliance with anti-money laundering regulations.
- Know Your Customer (KYC): This check involves verifying government-issued IDs, business licenses, and ownership structures to confirm the merchant’s legitimacy and authenticity.
- Anti-Money Laundering (AML): AML checks prevent the use of payment systems for illegal activities, such as money laundering or financing terrorism. This involves analyzing transaction patterns and cross-referencing merchant data against global sanctions lists or politically exposed persons (PEPs) databases.
Step 5: Website and Product Review
Compliance teams, product review specialists, or automated web-crawling tools inspect the merchant’s website to ensure adherence to acceptable use policies. This review checks the terms of service, refund policies, product listings, and whether any prohibited items are being sold.
This step is especially critical for e-commerce businesses.
Keep in mind:
Modern underwriting increasingly leverages technology to streamline processes and improve accuracy.
Tools like AI and data analytics enable faster evaluations by analyzing vast amounts of data and identifying patterns.
Automated underwriting systems can flag potential risks and reduce the need for manual effort, allowing underwriters to focus on complex cases. Many payment providers also collaborate with third-party services to perform KYC and AML checks more efficiently.
Why Merchant Underwriting is Important
Merchant underwriting benefits both payment providers and businesses by creating a safe and reliable payment ecosystem. Key advantages include:
- Minimizing fraud and chargebacks. Credit card chargebacks, which occur when customers dispute a transaction, can be costly for both merchants and payment facilitators.
- Ensuring adherence to legal and regulatory standards, such as PCI DSS (Payment Card Industry Data Security Standard) requirements.
- Reducing potential losses from high-risk merchants. This is particularly important for processors that operate on slim margins.
- Building trust by partnering with compliant businesses. A single high-profile fraud case can damage a processor’s reputation significantly.
Common Challenges in Merchant Underwriting
Underwriting isn’t without its difficulties. Both processors and merchants face significant challenges:
Challenges for Payment Processors
Underwriting teams can have their work cut out for them. Here are the challenges they face throughout the merchant underwriting process.
- Identifying high-risk merchants: High-risk merchants often present a higher chance of fraud or chargebacks but can also be lucrative clients for processors.
- Managing false positives: Another challenge? Avoiding the rejection of legitimate businesses due to overly stringent criteria. False positives can result in lost revenue opportunities and damage the processor’s reputation among potential clients.
- Evolving fraud tactics: Keeping up with increasingly sophisticated fraud methods, such as synthetic identities and complex money laundering schemes.
- Speed vs. accuracy: Streamlining processes without compromising due diligence. Merchants expect quick approvals, but processors must balance this with the need for comprehensive reviews.
Challenges for Merchants
On the merchant side, businesses can also face underwriting challenges. These include the following.
- Complex documentation requirements: Providing extensive and detailed documentation can be daunting, particularly for small businesses unfamiliar with the process.
- Industry bias: Businesses operating in high-risk industries may face additional scrutiny or rejection, even if they operate legitimately.
- Delayed approvals: Lengthy underwriting processes can delay the ability to start accepting payments, impacting cash flow and operations.
- Understanding compliance requirements: Navigating complex regulations, such as AML and PCI DSS standards, can be challenging for merchants without prior experience.
- Addressing historical issues: Merchants with past chargebacks, disputes, or poor credit histories may struggle to gain approval and need to demonstrate improvements.
By recognizing and addressing these challenges, both processors and merchants can work towards a smoother underwriting experience.
Best Practices for Effective Merchant Underwriting
To optimize underwriting processes, payment providers should:
Leverage data analytics and AI
Use advanced tools to detect risk patterns and improve decision-making. Predictive models can help identify potential red flags early in the process.
Update criteria regularly
Adapt to new industry trends and emerging risks. For example, the rise of cryptocurrencies has introduced unique challenges in evaluating merchants operating in this space.
Collaborate with third-party tools
Utilize specialized risk management platforms to enhance underwriting capabilities. These tools can provide detailed insights into merchant behavior and risk levels.
Monitor merchants continuously
Reassess merchant risk periodically to address evolving business dynamics. Ongoing monitoring can help detect changes in transaction patterns or compliance issues.
Merchant Underwriting for High-Risk Businesses
Some industries, such as CBD, adult services, and travel, are considered high-risk. For these businesses, underwriting involves additional scrutiny:
- Defining high-risk industries: Identifying sectors prone to chargebacks, fraud, or regulatory complexities. High-risk businesses often operate in areas with legal ambiguities or heightened customer disputes.
- Additional checks: Conducting deeper financial and compliance reviews. This may include reviewing prior processing history, industry-specific licenses, and detailed product descriptions.
- Risk management: Implementing safeguards, such as rolling reserves, for high-risk accounts. Rolling reserves involve holding a percentage of the merchant’s revenue in reserve to cover potential chargebacks or disputes.
Despite the challenges, high-risk merchants can be profitable clients for payment processors when managed effectively.
How Merchants Can Prepare for Underwriting
Need to go through an underwriting process? As the merchant, here are steps you can take to prepare.
- Provide complete documentation: Ensure all required business and financial records are accurate and up to date. Missing or inconsistent information can delay the approval process.
- Maintain transparency: Operate with a clear and honest business model. Payment processors value transparency, especially for high-risk industries.
- Address potential red flags: Proactively resolve issues that could raise concerns during the review process. For example, businesses with a history of chargebacks should implement strategies to reduce disputes.
- Invest in compliance: Stay informed about relevant regulations and ensure the business adheres to them. Compliance with PCI DSS and other standards can strengthen a merchant’s application.
Conclusion
Merchant underwriting plays a pivotal role in creating a secure and stable payments space.
Understanding its importance and preparing accordingly is a must, especially for businesses that need to accept payments online and in-person. Compliance, transparency, and proactive risk management are the keys to a smooth underwriting experience.
Explore how Stax simplifies merchant underwriting and helps your business accept payments seamlessly. Contact us today.
Request a Quote
