Confessions of a Risk Analyst (Part 2)

How Processors Assess Risk

Continuing from part 1.

A processor takes a silent backseat to assessing potential risk based on what they know about the business, its owner, and the transaction information. They do this while reserving the right to request additional detailed information about a transaction, the business, the owners, and the company itself. A processor reserves the right to hold funds if they feel the potential risks warrants it. Holding back funds gives them some level of protection against loss but protects the business by not allowing those funds to get spent. If a business obtains those funds and spends them in operating the business, then they could become in debited to the processor who will then end up having to hold back funds to get repaid.

Example:
A business was selling custom hot tubs and was successful for the better part of 10 years. The manufacturer they were using changed some of their processes which created a quality issue and caused almost all the products they were selling to stop working shortly after delivery. While the agreement with the manufacturer included a money back guarantee, the process to refund the business was very slow. In the meantime the business was struggling to put a new manufacturer in place to build replacement units not to mention the new orders they had coming in. They were trying to replace and refund every customer. However, with the manufacturing issues, it was taking months to get replacement sent out or refunds processed. These refunds started to turn into chargebacks which immediately began draining the cash reserve the business had on their own. In the meantime, they began accepting new orders and using those funds to refund previous customers, while waiting for their reimbursements and their new products to arrive. After months of struggling to fix their customers issues, everything started to fall apart, they couldn’t float orders anymore, or pay their employees, or deliver whatever products they did end up acquiring.

In the end, the business collapsed leaving the business owner with more than $1.5 million owed back to card holders. The processor ended up covering all of it, and is still in the process of trying to collect from the business owner. Basically because of a change at a supply chain company entirely outside of the oversight of the processor, a thriving business imploded leaving the owner, and subsequently the processor, with millions in debt.

It’s important to have your employees trained to look out for fraud which we cover in a previous articles (link1, link2). Small changes to your business can stop would-be criminals from taking advantage of your business. It’s also important to have backup plans in place to allow your business more flexibility in times of stress. Sometimes just having a line of credit you can draw on to help in a crisis can save a business if used properly. In our next article or two we will cover why processors don’t want to hold funds and what to do if you find yourself with a risk reserve.

Processors don’t want to hold funds!

Truth is, processors don’t want to hold funds. To dispel a common myth, held funds cannot gain interest, so there is no incentive on that part for a processor to place a hold. It is very disruptive to the business, the relationship between the processor and their merchant, and requires a substantial amount of administrative work for everyone. However, holding funds is better than allowing a business to over extend itself and collapse in the worst case scenarios. Most businesses and business owners are not expert risk assessors. They don’t see all the potential pitfalls, and are understandably biased about their invulnerability. A business owner doesn’t understand sometimes that a chargeback can happen at any time and that “big sale” is actually just a chargeback waiting to happen. From time to time this entrepreneurial spirit gets businesses in over their heads and sometimes it’s what causes a business to fail, which is also bad for the processor. Another reason the processor doesn’t want to hold funds is they will have to spend time, money, and resources to internally research and handle these issues. They would rather focus on addressing serious threats and their routine operations. The faster they can get the issue cleared up and funds released, the happier their customers are, and the quicker they can move on to normal operations.