Understanding your risk exposure
The credit card processing industry is a complex network of financial institutions, middlemen, and businesses that all play a part in the few seconds it takes to complete a credit card transaction. Understanding where these unique risks lie can help you better understand the fees you pay as a merchant, the processes — both apparent and hidden — you're involved in each time you process a credit card, and your business' general place in how it all works.
When you accept credit card payments it can be helpful to understand the different kinds of risks that each entity in a given credit card transaction is exposed to when you're looking at how to accept credit card payments.
Risks for Issuing Banks
For a customer to be able to visit your business and make a credit card purchase, they first need to be issued a credit card by their bank. When the bank issues a credit card to a consumer, they are essentially extending credit to them and trusting that the cardholder will be able to repay their credit card balance. If a cardholder is unable to pay their credit card and defaults on their debt, the issuing bank will be taking a loss on that account and the balance owed. Issuing banks will mitigate their risk by doing personal credit checks on credit card applicants and setting card balance limits to define the amount of credit that a consumer is able to access based on their individual circumstances.
As a business accepting credit cards, the base fee you pay for each transaction is called the interchange fee. The interchange fee, while set by the card brands, goes to the issuing bank to help pay for the cost of mitigating their risk, among other costs associated with its part in facilitating the transaction.
Risks for Acquiring Banks / Processors
When if you sign up for a merchant account with a traditional processor, you can expect to be required to submit adequate documentation and to wait while they ensure that you aren't a high-risk business. High-risk businesses are considered more likely to incur excessive chargebacks, which can be very costly to businesses. Some measures processors take to ensure your business isn't high risk can include credit checks, referencing the Mastercard MATCH (Member Alert to Control High-Risk Merchants) List, and reviewing your business' financials. This can take anywhere from a few days to a few weeks, but it is an important step for processors to adhere to before approving your business for a merchant account in order to mitigate their risk. Credit card processors need to evaluate these risks when approving merchant accounts and determining processing rates.
Even if a processor offers instant approval, they will often mitigate their higher exposure to risk by placing holds while they review your initial transaction period, and slowly release the holds as you build rapport and history with them. You will likely also be charged much higher processing rates with these types of processors.
If your business is deemed high risk, then your application may be denied or you may have to try signing up with a high-risk credit card processor who specializes in serving high-risk businesses. There is a price to pay with these processors, however, as they will likely require even more documentation, they will charge much higher fees, will lock you into long contracts with less flexibility, and will often place what are called "reserves" on your account. Again, there is often a heavy price to pay for elevated risk.
Risks for Merchants
As a merchant, the primary risk you are exposed to is the risk of incurring chargebacks. Chargebacks are essentially a customer dispute about a charge that they either don't recognize, was charged by mistake, or if it was fraudulent. As a merchant, you carry the financial responsibility of any potential reversals for transactions that you process. To mitigate this risk, you should monitor your transactions for suspicious activity and beware of fraudulent activity.
With the rise of ecommerce transactions, there has been an unfortunate trend of rising chargeback fraud and friendly fraud. It's important that your business is aware of these types of activities, and how to lower your risk of processing fraudulent transactions because chargebacks can be very costly to businesses.
There is also the very important issue of security. With all the recent data breaches and privacy violations in the news over the past few years, security will continue to be a crucial consideration for any business accepting credit cards. In recent years, data breaches have been most prevalent with smaller businesses, probably because larger companies are more likely to have more robust security measures in place to combat cyber attacks. Data breaches can compromise your business' reputation literally overnight, and the fines incurred can be crippling to small businesses. All merchants (as well as processors and anyone else who handles sensitive credit card information) are required to be PCI compliant, and even though it can sometimes be confusing for merchants, it's certainly worth working with your payments provider to understand your risk exposure.
Risks for Consumers
Consumers are exposed to risk as well, as their credit cards can be stolen or compromised and used fraudulently. However, your customers are provided fairly comprehensive protections against the abusive use of their credit card by the card brands and their issuing banks. For example, if their credit card is stolen and used at your store, they can call their issuing bank and have the charges reversed. They can also dispute charges for purchases that are not recognized, were never received (if ordered online), or where the goods or services received were not as described.
The advantages of these broad cardholder protections are that they promote the use of credit cards and give customers the confidence to make purchases at locations they might otherwise not know or trust "“ essentially, promoting the easy flow of commerce. However, as a merchant, you need to understand that by accepting credit cards as a form of payment, you are putting yourself and your business on the other end of these cardholder protections. If a stolen credit card is used at your location, or a shipment fails to reach a customer, then you are liable for refunding the original transaction.
What Does it All Mean?
Ultimately, everyone who is involved in credit card processing faces risks unique to their relative position in the chain of players involved with processing a transaction. However, by working closely with your credit card processor to understand your risk profile and having a full understanding of the cardholder protections your customers are entitled to, you can effectively manage risk while continuing to process transactions safely and securely.