Digital payments are increasingly becoming the norm. According to Forrester’s data, digital payments are the most used payment method today, with 69% of American adults using them to make payments online. Businesses must therefore adapt and be able to accept such payments.
However, setting up and managing a payment system can be complex and overwhelming. That’s why many often turn to third-party providers for help. Two of the most popular payment solution providers for businesses looking to accept digital payments are payment processors and payment facilitators (PayFacs).
In this article, we’ll discuss what SaaS companies looking to become payment facilitators need to know about risk management strategies.
TL;DR
- Payment facilitators remove the need for businesses to open merchant accounts of their own to accept payments. PayFacs handle risk assessment, underwriting, settling of funds, compliance, and chargebacks which exposes them to greater potential risks.
- Major risk factors for PayFacs include fraudulent transactions, merchant credit risk, regulatory compliance, and operational risks. Understanding, addressing, and managing them is crucial for maintaining business operations while ensuring safe payment processing for clients.
- Thorough due diligence, technology, and adherence to regulatory guidelines are essential in a PayFac’s risk management strategy. Implementing an effective risk management framework can help you minimize the impact of potential threats, ensure business continuity, and recover quickly in the face of adversity.
Why PayFacs Need an Effective Risk Management Strategy
Payment facilitators remove the need for businesses to open merchant accounts of their own to accept payments like those from credit cards, debit cards, mobile wallets, etc. Think of them as service providers that rent their master merchant accounts to their clients.
This makes it much easier and quicker for businesses to start accepting payments. PayFacs also handle risk assessment, underwriting, settling of funds, compliance, and chargebacks. On the other hand, this exposes PayFacs to greater potential risks.
This is why an effective risk management process is crucial for PayFacs to safeguard themselves against fraud, maintain compliance, and thereby protect themselves and their clients.
Let’s dive deeper into risk management practices for PayFacs.
Key Risk Factors for PayFacs
Understanding, addressing, and managing risk factors that PayFacs might encounter is crucial for maintaining business operations while ensuring safe payment processing for clients. You need thorough due diligence, technology, and adherence to regulatory guidelines in your risk management strategy. Before we get to your risk management plan, let’s look at the major risk factors for PayFacs.
Fraudulent transactions
Malicious parties are always on the lookout to exploit vulnerabilities online to steal information and money. They always seem to adapt and evolve their techniques even when security measures are in place.
Identity theft, data breaches, and chargeback fraud are some of the most common types of risks. Such events can lead to significant financial losses and reputation damage for a PayFac.
This is why you need robust fraud detection mechanisms and ensure that they are up-to-date. Some of these mechanisms include advanced machine learning algorithms, real-time transaction monitoring, and multi-factor authentication.
Once these mechanisms are in place, you also need to educate your sub-merchants about fraud and keep them informed about the latest trends in fraudulent activity. It can also help to teach them about best practices they can follow to prevent fraudulent transactions.
Merchant credit risk
Merchant credit risk occurs when a merchant (or a PayFac’s client) is unable to fulfill its financial obligations. This is another major risk factor as it can result in PayFacs losing money.
Merchant credit risk is much higher with high-risk merchants. PayFacs need to be careful when onboarding merchants from industries that are volatile or have high chargeback rates. Some PayFacs completely avoid working with merchants from such industries.
It is up to a PayFac to conduct detailed risk analysis on every client or sub-merchant when they are being onboarded. You must assess their creditworthiness and take into account how much risk you can realistically handle before onboarding merchants.
The due diligence doesn’t stop at onboarding. PayFacs need to continuously track the financial health, chargebacks, transactions, and compliance activities of all their sub-merchants. To mitigate some of the financial risks, you can look into retaining a portion of the funds and creating reverse accounts.
Regulatory compliance risk
To maintain the integrity of financial transactions and to protect cardholder data, any company dealing with payments must strictly adhere to laws and regulations. Regulatory compliance failure can have a negative impact on reputation, large fines, and even legal action.
It can be quite hard for PayFacs to manage compliance with all these regulations in the industry but it is a necessity. You need to adhere to KYC (Know Your Customer) requirements, GDPR (General Data Protection Regulation), and AML (Anti-Money Laundering) regulations among others.
Payfacs need to have regular AML screenings and strictly implement KYC procedures. They also need to have strong data security protocols in place. Additionally, you need to conduct regular compliance training for your staff and internal audits. Stay updated about the latest regulations, compliance, and industry standards to prevent regulatory compliance from becoming overwhelming for your business.
Operational risk
This type of risk includes a wide range of issues that can hamper the payment processing capabilities of a PayFac. Cyberattacks, human errors, third-party service provider failures, and system disruptions all come under operations risk.
These risk events can occur suddenly and are hard to foresee but PayFacs can still set up systems to lower the chances of operational risks. You need firewalls, encryptions, intrusion detection, and other security measures in your technology stack. Maintain a comprehensive disaster recovery program and undertake contingency planning so that you can resume operations quickly.
Risk Management Strategies
Let’s now look at four types of risk management strategies that can better prepare PayFacs to safeguard themselves—and their customers—against specific risks while boosting retention, profits, and improving their bottom line.
Fraud prevention and detection
The first step is to install advanced fraud detection systems in your overall technology infrastructure. We now have fraud detection systems that use machine learning and AI to identify and prevent fraud and cyberattacks.
The next step is to set up real-time monitoring systems that can detect unusual patterns and anomalies and allow you to provide risk responses immediately. Don’t forget about educating your sub-merchants to recognize and avoid fraudulent activity. Also, help them set up the right risk identification, risk avoidance, and risk transfer technologies to prevent fraud from their end too.
Make sure you are compliant with all data security and fraud prevention regulations. Be aware of the latest news and trends in data, cyber security, and fraud.
Merchant underwriting and monitoring
This is an important core PayFac task that is also a great risk management process. During the onboarding process, you need to thoroughly vet any new merchant—especially those from high-risk industries.
Conducting background checks, assessing their credit, evaluating their business model, verifying their transaction history, and assessing financial stability are just some of the steps required to vet a merchant.
After onboarding, you should continuously monitor the financial activity of your merchants. To reduce your risk exposure, set volume and transaction limits to cap the amount of losses your business can undertake. These limits should be customized to each client based on their transaction and risk histories.
Regulatory compliance
As mentioned earlier, straying away from regulatory compliance can lead to hefty fines and even legal consequences. That’s why a major focus as a PayFac needs to be on maintaining regulatory compliance.
Apart from staying abreast of all compliance updates, laws, and regulations, you need to conduct regular audits within your organization to safeguard your business against internal and external risks. This will help you identify areas of non-compliance and rectify these identified risks as soon as possible.
Your staff also needs to be trained and this needs to be refreshed regularly so that everyone in your organization works towards maintaining regulatory compliance and mitigating risks.
Operational risk management
Your business operations can take a huge hit from unforeseen situations. However, there are steps you can take to protect your PayFac business and sub-merchants as much as possible from the potential impact of a risk.
Standardize initiatives for handling transactions, data security, and incident response to help prevent errors and detect issues before they escalate. Review your risk mitigation and risk acceptance policies regularly and update them. Investment in advanced cybersecurity solutions and regular assessments of these solutions are also highly recommended.
Best Practices for PayFacs
Implementing an effective risk management framework can help you minimize the impact of potential threats, ensure business continuity, and recover quickly in the face of adversity. Follow these best practices for monitoring risks and dealing with them appropriately.
Collaborating with industry experts and consultants
Managing operations as a PayFac can be complicated so why not take the help of experts and consultants in the industry who have a lot of experience and expertise with them? They can give you valuable insights and actionable solutions regarding best practices for risk management, efficiency, and compliance. They can also inform you about industry trends, technological advancements, and regulatory changes.
There’s no need to have industry professionals on your roster all year round. Set up regular connections with them to get advice on the latest changes and trends and to allow them to assess and update your strategies.
Utilizing technology and automation for efficiency
Advanced software, hardware, and automation solutions can help you simplify and improve the accuracy of your processes. Automate processes like fraud detection, transaction monitoring, and incident reporting.
Multiple automation tools in the market can take care of routine tasks like compliance checking, transaction processing, and merchant onboarding. This will free up your time to focus on other business activities like strategizing. Advanced automation tools can not only improve the reliability of your business but also make merchant experiences smoother and seamless.
Building a strong relationship with stakeholders
Look into developing collaborative relationships with acquiring banks and payment networks. You may be able to get better pricing, timely support, and enhanced services as a result. In turn, you’ll be able to improve your service quality for your merchants.
Case Studies
The risk management strategies you adopt as a PayFac will constitute a key part of your risk management lifecycle. Thankfully, partnering with Stax can relieve you from these headaches as we handle risk management on your behalf. You can hit the ground running and facilitate payments for your users within 20 minutes of getting started. The following case studies demonstrate how.
Shelterluv
Shelterluv is a SaaS company that provides software to help animal rescues and shelters manage the complete rehoming process seamlessly. Their software makes managing intakes, adoptions, and community programs easier than ever so animal shelters can focus better on animal welfare.
The company was using Stripe to manage its payment processing for adoptions and donations but the integration wasn’t meeting their expectations. They decided to switch to Stax Connect’s white-labeled API to power Shelterpay.
Within 2 weeks of launching the new integrated payments system, they achieved 50% of the goal they had set for themselves—onboarding 1000 customers to the new payment system. What’s more, they’ve raised over $15 million in donations through the new solution!
Sera
Sera is a Field Service Management (FSM) software company that helps residential home service, electrical, plumbing, and HVAC businesses grow financially by leveraging technology to identify pricing gaps and inefficiencies.
The company needed to provide its numerous and diverse group of clients with payment solutions that seamlessly integrated with their workflows. It was looking for a payment partner that could remove friction points like slow communication in support or delayed merchant approval requests.
Since integrating with Stax Connect, Sera has been able to reduce merchant approval times, resolve issues faster, and process larger volumes per merchant. Not just that. What stood out the most to Sera was Stax’s extended support outside the typical scope.
Final Words
There is no doubt that you need an effective, robust yet easy-to-follow risk mitigation strategy as a PayFac. Keep payment processing secure and reliable for all your merchants while focusing on continuous monitoring and risk reduction.
Risk management is an ongoing task so you should also continually update your risk management practices to stay ahead of new threats and challenges. All this will aid your company in maintaining strong security, fulfilling compliance requirements, and providing excellent service.
