Risk Factors in Underwriting

Last Updated: 2025-12-26 Status: Complete

Quick Reference

Purpose: Identify and quantify merchant risk to determine approval decisions and appropriate terms.

Key Insight: Risk is additive - multiple medium-risk factors can create a high-risk profile.

Critical Fact: Individual risk factors matter less than their combination and context.

Decision Impact: Risk factors determine:

• Approval vs. decline
• Reserve requirements (0-50%)
• Volume limits
• Pricing tier
• Monitoring intensity

PayFac Context: Portfolio-level risk aggregation requires managing concentration across all sub-merchants.

Overview

Risk factors are measurable characteristics of a merchant's business, processing history, ownership, and operations that indicate the likelihood of:

• Fraud: Stolen card usage, identity theft, fake businesses
• Chargebacks: Customer disputes exceeding acceptable thresholds
• Regulatory Violations: AML, sanctions, licensing non-compliance
• Merchant Failure: Business collapse leading to unfulfilled obligations
• Reputational Damage: Association with controversial or illegal activities

Effective underwriting evaluates multiple dimensions of risk simultaneously. A merchant may be low-risk in one dimension (established business) but high-risk in another (delivery timeframe), requiring nuanced evaluation.

Risk is Contextual

The same business characteristic can be low-risk in one context and high-risk in another. For example:

• $50,000 monthly volume = low risk for an established restaurant
• $50,000 monthly volume = high risk for a 1-month-old online business

Why Multiple Factors Matter

Risk rarely comes from a single factor. Instead, combinations of factors create risk profiles:

Example Combination:

• New business (< 6 months) = Medium risk
• High-risk MCC (nutraceuticals) = Medium risk
• No processing history = Medium risk
• Poor owner credit score = Medium risk

Individual Assessment: Each factor alone might be acceptable

Combined Assessment: Together they indicate very high risk - likely decline or heavy restrictions

Risk vs. Pricing Relationship

Higher risk doesn't always mean rejection. It often means adjusted terms:

Risk Level	Typical Outcome	Reserve Requirement	Volume Limits	Funding Schedule	Pricing
Low	Auto-approve	0-5% (0-90 days)	Standard	T+1 or T+2	Best rates
Medium	Conditional approval	5-10% (90-180 days)	Capped initially	T+3 to T+7	Mid-tier rates
High	Manual review + restrictions	10-20% (180-365 days)	Strict caps	T+7 to T+14	Higher rates
Very High	Decline or specialized program	20-50% (365+ days)	Very limited	T+30+	Premium rates

Business Risk Indicators

Business-level characteristics that affect overall risk assessment.

Business Type Risk by Industry

Different industries have inherent risk levels based on historical performance data:

Industry Category	Examples	Typical Chargeback Rate	Risk Level	Reasoning
Retail - Card Present	Grocery, hardware stores, clothing boutiques	0.10-0.30%	Low	Customer present, immediate delivery, tangible goods
Restaurants & Food Service	Restaurants, cafes, food trucks	0.15-0.40%	Low	Card present, immediate consumption, low ticket
Professional Services	Law firms, accounting, consulting	0.20-0.50%	Low-Medium	Established relationship, B2B transactions
Retail - E-commerce	General online retail	0.50-1.00%	Medium	CNP, shipping delays possible, returns common
Digital Goods	Software, e-books, online courses	0.80-2.00%	Medium-High	Intangible, easy chargebacks ("didn't work")
Subscription Services	SaaS, membership sites, streaming	1.00-2.50%	Medium-High	Recurring billing disputes, "forgot to cancel"
Travel & Hospitality	Hotels, airlines, tour operators	0.70-1.50%	Medium-High	Future delivery, cancellations, weather/health events
Nutraceuticals	Supplements, vitamins, weight loss	2.00-5.00%	High	Health claims, negative options, regulatory scrutiny
Telemarketing	Outbound sales, free trial offers	3.00-8.00%	High	Aggressive sales, buyer's remorse, elderly targeting
Dating Services	Online dating, matchmaking	2.00-6.00%	High	Intangible results, emotional purchases, fake profiles
Adult Content	Adult entertainment, webcams	3.00-10.00%	Very High	Fraud, family member disputes, regulatory issues
Gambling	Online casinos, sports betting	2.00-8.00%	Very High	Addictive behavior, losses disputes, regulatory

Industry Benchmarks (2025)

Overall US Average: 0.65% across all industries

By Transaction Type:

• Card-Present: 0.10-0.50%
• Card-Not-Present: 0.93% (15x higher fraud rate than CP)

Acceptable Range: <0.5% is considered "safe zone"

Warning Thresholds:

• Visa VAMP (April 2025): >2.2% merchant excessive (drops to >1.5% April 2026)
• Visa VAMP (April 2026): >0.9% early warning (drops from current >1.5%)
• Mastercard ECP: 1.5-2.99% = ECM program, ≥3.0% = HECM program

Card Environment Risk

The method of card presentation dramatically affects fraud and chargeback risk:

Environment	Description	Fraud Rate (2025)	Chargeback Risk	Authentication	Risk Level
Card Present (CP)	Physical card swiped/inserted/tapped at point of sale	0.06%	Very Low	EMV chip, PIN	Low
Card Not Present (CNP)	Card details entered manually (online, phone, mail)	0.93% (15x higher)	High	CVV, AVS, 3DS	Medium-High
E-commerce	Online shopping with shipping	1.20%	High	3DS2, device fingerprinting	High
MOTO	Mail Order / Telephone Order	0.80%	Medium-High	Limited (CVV, address)	Medium-High
Recurring/Subscription	Saved card on file, automatic billing	1.50%	Very High	Initial verification only	High
Mobile In-App	Purchases within mobile applications	0.70%	Medium	App store protections vary	Medium

Why Card-Not-Present is Higher Risk:

ACH vs. Card Risk Comparison

Many PayFacs process both card and ACH transactions. Each has distinct risk characteristics:

Risk Dimension	Card Transactions	ACH Transactions	Key Difference
Dispute Window	60-120 days (max 540 for fraud)	Up to 60 days (unauthorized)	Similar timeframe
Dispute Rate	0.65% average (CNP: 0.93%)	0.5-2.0% (returns/NSF)	ACH can be higher for some models
Fraud Detection	Real-time (milliseconds)	Batch processing (1-3 days)	Card = immediate feedback
Return Codes	Decline codes (insufficient funds immediate)	NSF returns 2-3 days later	ACH = delayed failure
Liability	Card networks arbitrate	Direct merchant liability (Nacha rules)	ACH = less protection
Identity Verification	Card issuer validates	Merchant validates account ownership	ACH = higher fraud if not verified
Authorization	Real-time approval/decline	No pre-authorization (debits process blind)	ACH = "push and pray"

ACH-Specific Risk Factors:

High-Risk ACH Scenario	Risk Level	Why It's Risky
Subscription Debits	High	Customer claims unauthorized, high return rates
Large First Transaction	High	No account validation, $5k+ initial debit = high NSF risk
Consumer Accounts	Medium-High	Higher return rates than business accounts
Manual Entry	Medium	Typed account numbers prone to typos
No Account Verification	Very High	Proceeding without confirming account ownership

ACH Underwriting Requirements:

• Nacha Third-Party Sender (TPS) registration required for PayFacs
• ACH-specific reserves (often higher than card: 10-15% baseline)
• Account ownership verification (micro-deposits or instant verification via Plaid)
• Return rate monitoring (<1% acceptable, >2% = Nacha violation risk)
• OFAC screening for all ACH transactions

PayFac Consideration

Most modern PayFacs support both card and ACH, requiring dual risk frameworks. A merchant might be low-risk for cards (established, good history) but high-risk for ACH (new to bank transfers, large ticket debits).

Business Model Risk

How a merchant makes money affects delivery disputes and chargebacks:

Business Model	Description	Primary Risk	Chargeback Rate	Mitigation Required
One-Time Purchase	Single transaction, no recurring	Low	0.30-0.80%	Standard
Subscription - Physical	Monthly box, magazine delivery	Medium	1.00-2.00%	Clear cancellation policy, reminder emails
Subscription - Digital	SaaS, streaming services	Medium-High	1.50-3.00%	Easy cancellation, usage monitoring
Free Trial → Paid	Trial converts to subscription	High	2.50-6.00%	Clear disclosure, reminder before charge
Negative Option	Auto-ship unless canceled	Very High	4.00-10.00%	Heavy scrutiny, explicit consent required
High Ticket	Luxury goods, jewelry, electronics >$500	Medium-High	1.00-3.00%	Enhanced verification, shipping insurance
Crowdfunding	Pre-orders, project funding	Very High	5.00-15.00%	Escrow, milestone delivery, project insurance
Marketplace/Platform	Third-party sellers	High	2.00-5.00%	Seller vetting, holdbacks, buyer protection

Negative Option Billing

Definition: Automatically shipping and charging customers unless they actively cancel.

Why High Risk:

• FTC scrutiny and enforcement actions
• High complaint rates (Better Business Bureau)
• "Didn't know I was being charged" disputes
• Regulatory violations common
• Many processors prohibit entirely

If Allowed: Requires explicit consent, clear disclosure, easy cancellation

Time in Business

Operating history is one of the strongest predictors of merchant stability:

Time Operating	Risk Level	Reasoning	Typical Treatment
5+ years	Low	Proven business model, survived economic cycles, established customer base	Standard terms, lower reserves
2-5 years	Low-Medium	Established but less proven, fewer economic cycles weathered	Standard to slightly elevated reserves
1-2 years	Medium	Still establishing, vulnerable to market changes	Moderate reserves (5-10%), enhanced monitoring
6-12 months	Medium-High	Early stage, higher failure rate, unproven model	Higher reserves (10-15%), volume caps
< 6 months	High	Startup, highest failure rate, no track record	Significant reserves (15-20%), strict limits, gradual ramp
Pre-launch	Very High	No operations yet, purely speculative	Often decline, or very restricted approval

Statistical Reality (SBA/BLS 2024 Data):

• ~20% of small businesses fail in first year
• ~50% fail within five years
• ~70% fail within 10 years
• Established businesses (5+ years) have <5% annual failure rate

Industry-Specific Failure Rates (First Year):

Business Type	First-Year Failure Rate	Underwriting Impact
E-commerce/Online	~30%	Higher reserves, stricter caps
Brick-and-Mortar Retail	~15%	Standard underwriting
Professional Services	~10%	Lower risk tier
Restaurants	~25%	Moderate caution

Why This Matters: An e-commerce startup (<6 months) has ~30% probability of failure in year one, making reserves and volume caps critical protections.

New Business Exception

A "new" business may actually have experienced ownership. Consider:

• Owner's industry experience (10 years in restaurant industry)
• Previous business ownership (sold last company)
• Management team credentials
• Capitalization level

These factors can offset lack of business operating history.

Processing History

Prior payment processing experience is the best predictor of future performance:

Processing History	Chargeback History	Risk Level	Typical Action
Clean Record	<0.3% chargebacks	Low	Standard approval, best terms
Good Record	0.3-0.5% chargebacks	Low-Medium	Standard approval, normal monitoring
Acceptable Record	0.5-0.65% chargebacks	Medium	Approval with monitoring, possible reserves
Warning Level	0.65-1.0% chargebacks	Medium-High	Enhanced monitoring, reserves required
High Level	1.0-1.5% chargebacks	High	Heavy reserves, volume caps, may decline
Excessive	>1.5% chargebacks	Very High	Likely decline (network monitoring threshold)
Violations	Network fines, monitoring programs	Very High	Decline or specialized high-risk program
MATCH List	Terminated for cause	Prohibited	Auto-decline (5-year blacklist)

Verification Methods:

• Request 3-6 months of processing statements
• Contact previous processor (with merchant authorization)
• Check MATCH list (Member Alert to Control High-risk merchants)
• Review chargeback ratio trends (improving vs. worsening)
• Verify volume claims match statements

MATCH List

What It Is: Database of merchants terminated by processors for fraud, excessive chargebacks, or violations.

Impact: Merchants remain on MATCH for 5 years, making it extremely difficult to get approved anywhere.

Common Reason Codes:

• Code 01: Account Data Compromise
• Code 04: Excessive Chargebacks (most common)
• Code 05: Excessive Fraud
• Code 10: Violation of Standards
• Code 11: Merchant Collusion

Underwriting Action: MATCH list hit = automatic decline for most processors

Credit History of Principals

Personal and business credit scores indicate financial responsibility:

Personal Credit (FICO Score)

FICO Range	Risk Level	Typical Impact	Considerations
750-850	Low	Best terms, minimal reserves	Strong financial management
700-749	Low-Medium	Standard terms	Generally acceptable
650-699	Medium	May require reserves or guarantees	Some concerns, manageable
600-649	Medium-High	Higher reserves, possible co-signer	Increased scrutiny
550-599	High	Significant reserves, limited volume	Major concerns
< 550	Very High	Often decline or specialized program	Severe financial distress

Special Considerations:

• Bankruptcy: Recent (<3 years) = very high risk; Discharged >5 years = less impact
• Judgments/Liens: Unresolved = high risk; Resolved/paid = medium risk
• Payment History: Pattern matters more than single late payment

Business Credit (Dun & Bradstreet, Experian Business)

Score	Risk Level	Typical Impact
80-100	Low	Strong business credit, best terms
60-79	Medium	Acceptable, may require some reserves
40-59	Medium-High	Concerning, enhanced monitoring required
< 40	High	Significant reserves or decline

FCRA Compliance

Fair Credit Reporting Act requires:

• Merchant consent before pulling credit report
• Adverse action notice if declined based on credit
• Disclosure of credit bureau used
• Merchant's right to dispute inaccuracies

Example Adverse Action:

"Your application was declined based in part on information from Experian (credit score 580). You have the right to obtain a free copy of your credit report from Experian within 60 days by calling 1-888-397-3742."

Transaction Risk Factors

Transaction characteristics that affect fraud and chargeback likelihood.

Average Ticket Size

Transaction amount significantly affects fraud targeting and chargeback exposure:

Average Ticket	Risk Level	Reasoning	Examples
< $25	Low	Low fraud appeal, disputes unlikely	Fast food, coffee shops, convenience stores
$25-$100	Low-Medium	Moderate appeal, standard retail	Casual dining, retail clothing, groceries
$100-$500	Medium	Attractive to fraudsters, meaningful chargebacks	Electronics, services, home goods
$500-$2,000	High	High fraud target, significant chargeback exposure	Jewelry, luxury goods, home repairs
> $2,000	Very High	Major fraud target, large losses per incident	High-end jewelry, electronics, B2B equipment

High-Ticket Underwriting Requirements:

• Enhanced identity verification (3DS2, manual review)
• Shipping address verification
• Signature required delivery
• Insurance requirements
• Lower volume limits initially
• Higher reserves (proportional to exposure)

Ticket Size Variance Red Flags:

• Sudden spike in average ticket (fraud pattern)
• Inconsistent with industry norms
• Mismatched to stated business model

Monthly Volume Projections

Projected processing volume must align with business capacity and history:

Scenario	Projected Volume	Time in Business	Risk Assessment
Conservative	$10k/month	3 years, retail shop	Low - realistic
Moderate	$50k/month	1 year, e-commerce	Medium - monitor growth
Aggressive	$200k/month	6 months, subscription	High - verify capacity
Unrealistic	$500k/month	New, no history	Very High - likely fraud or ignorance

Variance Monitoring:

Major Variance Triggers:

• Merchant processing 3x-10x projected volume = potential fraud, money laundering, or BIN attack
• Merchant processing <25% projected volume = business failure risk, application fraud

Velocity Monitoring and Fraud Detection

Velocity refers to transaction speed and pattern changes that indicate fraud or BIN attacks:

Velocity Metrics Monitored:

Metric	Normal Range	Warning Threshold	Critical Threshold	Action
Transactions per Hour	Consistent with business type	3x normal rate	5x+ normal rate	Auto-suspend for review
Daily Volume Spike	±20% variance	2x projected daily	5x+ projected daily	Manual review required
Card Testing Pattern	Random amounts	Multiple $1-$5 transactions	10+ small transactions in <1 hour	Block + fraud alert
AVS Mismatch Rate	<5% for e-commerce	10-15%	>20%	Flag for fraud review
Decline Rate Spike	2-5% baseline	15-20%	>30%	Potential BIN attack

Automated Velocity Response:

Real-World Example - BIN Attack Detection:

• Day 1-30: Merchant processes $30k/month (1,000 transactions)
• Day 31: Suddenly processes 500 transactions in 2 hours
• Velocity Alert: 500 transactions = 50% of monthly volume in 2 hours
• Pattern: Multiple cards, sequential numbers, different ZIP codes
• Immediate Action: Auto-suspend, freeze payouts, review for stolen card testing

Why Velocity Monitoring Matters

Fraudsters use compromised merchant accounts to test stolen card numbers rapidly. Without velocity monitoring, a single merchant could process thousands of fraudulent transactions before detection. The processor bears liability for all approved fraudulent transactions.

Delivery Timeframe Risk

Time between payment and product/service delivery is critical:

Delivery Window	Examples	Chargeback Rate	Risk Level	Mitigation Required
Immediate (Same Day)	Restaurants, retail stores, gas stations	0.10-0.40%	Low	Standard procedures
1-7 Days	E-commerce, food delivery, local services	0.50-1.50%	Medium	Tracking numbers, delivery confirmation
1-4 Weeks	Custom goods, made-to-order, pre-orders	1.50-3.00%	Medium-High	Clear timelines, progress updates, reserves
1-3 Months	Major custom work, special orders	2.00-5.00%	High	Milestone payments, escrow, insurance
3+ Months	Travel (cruises, vacations), events, crowdfunding	5.00-15.00%	Very High	Major reserves (10-20%), delayed funding, guarantees

Why Delivery Timeframe Matters:

1. Merchant Failure Risk: Longer delivery window = more time for merchant to go out of business before fulfilling
2. Buyer's Remorse: Customer circumstances change (cancel vacation, don't need product)
3. Chargebacks Concentrated: If merchant fails, ALL customers chargeback simultaneously
4. Customer Forgetting: Long gap between charge and delivery = "I didn't authorize this"

Future Delivery Disaster Scenario

Real-World Example:

A travel agency collects $800,000 for cruises departing 6-12 months in the future. At month 4, the agency:

• Faces cash flow problems (spent customer funds on operations)
• Cannot secure cruise bookings (supplier issues)
• Declares bankruptcy

Chargeback Impact:

• ALL 400 customers file chargebacks
• Processor must return $800,000 to cardholders
• If reserve was only 5% ($40,000), processor eats $760,000 loss
• This is why travel merchants need 10-20% rolling reserves

Reserve Requirements by Delivery Timeframe:

Delivery Window	Typical Reserve	Duration	Funding Schedule
Immediate	0-5%	0-90 days	T+1 to T+2
1-7 days	5-10%	90-180 days	T+2 to T+3
1-4 weeks	10-15%	180-365 days	T+7 to T+14
1-3 months	15-20%	365+ days	T+14 to T+30
3+ months	20-50%	Until delivery + 90 days	T+30+

Refund Policy Analysis

Merchant refund policies affect customer disputes and chargebacks:

Refund Policy	Risk Level	Reasoning	Impact
Full refund, 30+ days, no questions asked	Low	Customer-friendly, fewer disputes escalate to chargebacks	Lower chargeback rates
Full refund, 14-30 days, reasonable conditions	Low-Medium	Standard retail policy, fair to both parties	Normal chargeback rates
Partial refund or store credit only	Medium	Customer dissatisfaction may lead to chargebacks	Higher dispute rates
No refunds, all sales final	Medium-High	Customers forced to chargeback for recourse	Significantly higher chargebacks
No refunds + high-pressure sales	Very High	Buyer's remorse + no legitimate recourse = chargebacks	Very high chargeback rates
Unclear or hidden refund policy	High	Violates card network rules, customer confusion	Disputes + regulatory issues

Card Network Requirements

Visa and Mastercard Mandate:

• Refund policy must be clearly disclosed before purchase
• Policy must be displayed on website, checkout, receipt
• Cannot be more restrictive than disclosed
• "No refunds" policy requires explicit customer acknowledgment

Violation = Merchant Liability for chargebacks even if policy states "no refunds"

Refund Policy Red Flags:

• Hidden or hard to find policy
• Policy contradicts customer service statements
• Overly restrictive for the product type (digital goods with no refunds)
• Changed after disputes arise
• Inconsistent application

Chargeback History

Historical chargeback performance is the single best predictor of future chargebacks:

Chargeback Ratio	Industry Benchmark (2025)	Risk Level	Action Required
< 0.3%	Excellent	Low	Standard monitoring
0.3-0.5%	Good (safe zone)	Low-Medium	Normal monitoring
0.5-0.65%	Average (overall US avg)	Medium	Increased monitoring
0.65-1.0%	Warning level	Medium-High	Enhanced monitoring, corrective action plan
1.0-1.5%	Elevated	High	Significant reserves, volume caps, urgent remediation
1.5-2.2%	Excessive (network threshold)	Very High	Pre-arbitration holds, may need to exit merchant
> 2.2%	Visa VAMP Excessive (April 2025)	Critical	Terminate or extraordinary measures

Network Monitoring Thresholds (2025/2026)

Visa VAMP (Visa Acquirer Monitoring Program):

Period	Merchant Excessive	Early Warning	Acquirer Excessive	Safe Zone
Current (Apr 2025 - Mar 2026)	>2.2%	>1.5%	>0.7% portfolio	<0.5%
April 2026 Forward	>1.5%	>0.9%	>0.7% portfolio	<0.5%

Impact of April 2026 Changes:

• Thresholds tightening by 32-40%
• Merchants currently at 1.5-2.2% will move from "monitoring" to "excessive"
• Start remediation NOW if above 1.0%

Mastercard ECP (Excessive Chargeback Program):

• ECM (Excessive Chargeback Merchant): ≥100 chargebacks/month AND 1.5-2.99% ratio
• HECM (High Excessive Chargeback Merchant): ≥300 chargebacks/month AND ≥3.0% ratio

Consequences:

• Monthly monitoring fees ($5,000-$25,000)
• Required action plans and monthly reporting
• Potential fines up to $100,000+
• Possible termination and MATCH listing
• Acquirer portfolio penalties

Chargeback Calculation:

Chargeback Ratio = (Total Chargebacks in Month) / (Total Transactions in Month) × 100

Important: Card networks use count-based ratios (number of transactions), not dollar-based.

Example:

• 1,000 transactions in March
• 8 chargebacks in March
• Chargeback Ratio = 8 / 1,000 × 100 = 0.8%

Risk Factor Matrix

Comprehensive matrix showing how individual factors map to risk levels:

Risk Factor	Low Risk	Medium Risk	High Risk	Very High Risk
Time in Business	5+ years	2-5 years	6mo-2yr	<6 months
Processing History	<0.3% chargebacks	0.3-0.65% chargebacks	0.65-1.5% chargebacks	>1.5% or MATCH list
Credit Score (Personal)	720+	660-719	600-659	<600
Industry/MCC	Retail CP, restaurants	E-commerce, professional services	Travel, digital goods, subscriptions	Nutraceuticals, telemarketing, adult
Card Environment	Card-present (EMV)	Card-present (mag stripe)	CNP with 3DS	CNP without 3DS
Delivery Timeframe	Immediate (same day)	1-7 days	1-4 weeks	30+ days
Average Ticket	<$50	$50-$200	$200-$1,000	>$1,000
Monthly Volume	<$50k (established)	$50k-$200k	$200k-$500k	>$500k (new business)
Business Model	One-time purchase	Subscription (clear)	Free trial → paid	Negative option
Refund Policy	Full refund 30+ days	Refund 14-30 days	Store credit only	No refunds
Documentation	Complete, verified	Complete, minor gaps	Incomplete, some verification issues	Falsified or missing
Web Presence	Professional, transparent	Basic but functional	Minimal or unclear	No website or suspicious
Geographic Location	US-based, established area	US-based, newer area	International (low-risk country)	High-risk country
Ownership Structure	Single owner, transparent	Partnership, clear structure	Multiple entities, complex	Opaque, shell companies
Cross-Border Processing	Domestic only	International (low-risk countries)	International (medium-risk)	Sanctioned/high-risk countries
Currency Risk	USD only	Major currencies (EUR, GBP, CAD)	Emerging market currencies	Crypto/high volatility

Cross-Border and Multi-Currency Risk

International processing introduces additional risk layers that require enhanced underwriting:

Geographic Risk Factors:

Merchant/Customer Location	Risk Level	Primary Concerns	Mitigation Required
US Merchant → US Customer	Low	Standard domestic risk	Standard underwriting
US Merchant → International Customer	Medium	Cross-border chargebacks, FX disputes, delivery confirmation	3DS, tracking, FX disclosure
International Merchant → US Customer	High	Jurisdiction issues, regulatory gaps, collection difficulty	Enhanced KYB, local entity verification, higher reserves
High-Risk Country Involvement	Very High	OFAC sanctions, fraud networks, compliance violations	Decline or specialized program

Currency Exchange Risk:

• FX Rate Disputes: "I was charged more than expected due to conversion"
• Multi-Currency Pricing: Customer confusion about final charge amount
• Settlement Currency: If merchant settled in different currency than cardholder, disputes more complex
• Volatility: Emerging market currencies can swing 5-10%+ causing chargeback timing issues

OFAC Sanctions Screening (Required for ALL International):

• Beneficial owners must clear SDN (Specially Designated Nationals) list
• Countries/regions with restrictions: Cuba, Iran, North Korea, Syria, Crimea, Donetsk, Luhansk
• Violation = Federal crime (civil penalties up to $250,000+ per violation)
• Ongoing monitoring required (sanctions lists updated frequently)

Cross-Border Underwriting Requirements:

1. Local business registration verification in merchant's country
2. Tax identification in merchant's jurisdiction
3. Sanctions screening (OFAC, EU, UN lists)
4. Higher reserves (15-20% baseline for international)
5. Delayed funding (T+7 to T+14 minimum)
6. Legal jurisdiction agreements for collections
7. Currency disclosure requirements at checkout

International Merchant Caution

International merchants are inherently higher risk due to:

• Difficulty verifying business legitimacy remotely
• Limited recourse if merchant defaults (jurisdiction issues)
• Higher fraud rates in certain regions
• Regulatory compliance complexity
• Currency fluctuation exposure

Most PayFacs limit international merchants to <10-15% of portfolio volume.

Combining Risk Factors

Risk assessment is about combinations, not individual factors in isolation.

Additive Risk Model

Risk scores typically use weighted factors that add together:

How Risk Weights Are Determined

Risk scoring weights are derived from historical loss data and predictive analytics:

Weight Determination Methodology:

1. Historical Loss Analysis: Analyze 3-5 years of chargeback/fraud losses; correlate to specific factors
2. Statistical Significance: Only factors with proven correlation are weighted
3. Industry Benchmarks: Compare internal data to card network benchmarks; adjust for risk appetite

Example Weight Derivation - Time in Business:

Time in Business	Historical Loss Rate	Risk Points	Justification
5+ years	0.05% average loss	5 points	Baseline (proven track record)
2-5 years	0.12% average loss	10 points	2.4x baseline loss
6mo-2yr	0.35% average loss	20 points	7x baseline loss
<6 months	0.75% average loss	35 points	15x baseline loss

Example Weight Derivation - Industry/MCC:

Industry	Chargeback Rate	Fraud Rate	Combined Loss	Risk Points
Restaurant (CP)	0.18%	0.06%	0.24%	5 points
E-commerce	0.65%	0.93%	1.58%	20 points
Nutraceuticals	3.50%	2.00%	5.50%	50 points

Why Industry Receives Highest Weight:

• Nutraceuticals have 23x higher combined loss than restaurants
• Industry is the strongest single predictor of risk
• This is why MCC classification is critical in underwriting

Combining Weighted Factors - Full Example:

Factor	Coffee Shop	Points	Nutraceutical Startup	Points
Time in Business	8 years	5	4 months	35
Industry/MCC	Restaurant	5	Nutraceuticals	50
Card Environment	CP	5	CNP	20
Credit Score	750	5	620	20
Processing History	0.2% CB	0	New	15
Total Score		20		140

Decision:

• Coffee Shop (20 points): Auto-approve, best terms
• Nutraceutical Startup (140 points, capped at 100): Decline or specialized high-risk program

Model Calibration Targets:

• True Positive Rate: % of high-score merchants who had losses (should be high)
• False Positive Rate: % of high-score merchants who were fine (should be low)
• False Negative Rate: % of low-score merchants with unexpected losses (target: <1%)

Example Scenarios

Scenario 1: Low-Risk Approval

Merchant Profile:

• Coffee shop, 8 years in business
• MCC 5814 (restaurant)
• Card-present transactions
• Immediate delivery
• Average ticket $12
• $30k/month projected volume
• Owner FICO 750
• Clean processing history (0.2% chargebacks)

Risk Assessment:

• Time in business: Low (5 points)
• Industry: Low (5 points)
• Card environment: Low (5 points)
• Delivery: Low (5 points)
• Credit: Low (5 points)
• Processing history: Low (0 points)

Total Score: 25/100 = Low Risk

Decision: Auto-approve, standard terms, 0% reserve, T+2 funding

---

Scenario 2: Medium-Risk Conditional Approval

Merchant Profile:

• E-commerce clothing retailer, 18 months in business
• MCC 5651 (family clothing)
• Card-not-present, 3-5 day shipping
• Average ticket $85
• $75k/month projected volume
• Owner FICO 680
• Prior processor showed 0.6% chargebacks

Risk Assessment:

• Time in business: Medium (20 points)
• Industry: Medium (15 points)
• Card environment: Medium (15 points)
• Delivery: Medium (10 points)
• Credit: Medium (10 points)
• Processing history: Medium (10 points)

Total Score: 80/100 = Medium Risk

Decision: Conditional approval

• 8% rolling reserve for 180 days
• $100k/month volume cap initially
• T+5 funding schedule
• Enhanced monitoring (weekly reviews)
• Re-underwrite at 6 months

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Scenario 3: High-Risk Manual Review

Merchant Profile:

• Online supplement seller (weight loss), 4 months in business
• MCC 5499 (miscellaneous food stores - nutraceuticals)
• Card-not-present, subscription model
• Average ticket $120/month
• $200k/month projected volume
• Owner FICO 620
• No prior processing history (new to cards)

Risk Assessment:

• Time in business: High (30 points)
• Industry: Very High (35 points - nutraceuticals)
• Card environment: High (20 points - CNP + subscription)
• Delivery: Medium (10 points - ships within week)
• Credit: Medium-High (15 points)
• Processing history: Medium (15 points - new to processing)

Total Score: 125/100 (capped at 100) = Very High Risk

Decision: Manual review required, likely outcomes:

• Option A (Decline): Risk too high for standard program
• Option B (Specialized Program):
  • 20% rolling reserve for 365 days
  • $50k/month initial volume cap
  • T+14 funding (2-week delay)
  • Daily monitoring
  • Higher pricing tier
  • Proof of FDA compliance
  • Supplier agreements required
  • Personal guarantee from owner

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Scenario 4: Combination Creates High Risk

Merchant Profile:

• Travel agency selling cruise packages
• 12 years in business (established!)
• MCC 4722 (travel agency)
• Card-not-present bookings
• Average ticket $3,500
• Cruises depart 6-12 months after booking
• $400k/month projected volume
• Owner FICO 740 (excellent!)
• Prior processor: 0.4% chargebacks (good!)

Individual Factors:

• Time in business: Low (established 12 years)
• Credit score: Low (FICO 740)
• Processing history: Low (0.4% ratio)

BUT Combination Risk:

• High average ticket ($3,500) = High (25 points)
• Future delivery (6-12 months) = Very High (35 points)
• High monthly volume = High (25 points)
• Total exposure = $400k/month × $3,500 avg = massive

Total Score: 85/100 = High Risk

Decision: Approve BUT with heavy protections:

• 20% rolling reserve (held until 90 days post-cruise departure)
• Delayed funding: T+30 (hold funds for 30 days)
• Financial review: Quarterly financial statements required
• Volume cap: $500k/month maximum
• Supplier verification: Confirm cruise line contracts
• Travel insurance: Require or recommend to customers

Key Insight

Even "good" individual factors (established business, good credit, clean history) don't eliminate risk when business model creates structural vulnerability (future delivery, high ticket, concentrated exposure).

Red Flag Combinations

Certain combinations should trigger immediate scrutiny or decline:

Automatic Decline Triggers:

1. MATCH list presence + any other application
2. Sanctions screening hit (OFAC SDN list)
3. Prohibited industry (illegal goods/services)
4. Fraudulent documentation detected
5. Prior termination by same processor

Immediate Manual Review Triggers:

1. New business (<6 months) + high-risk MCC + high volume projection
2. Poor credit (<600) + no processing history + CNP business
3. Volume spike (3x+ projection) within first 90 days
4. Multiple failed businesses under same ownership
5. Opaque ownership structure + high-risk industry
6. Inconsistent information across application and verification

Enhanced Due Diligence Triggers:

1. High-risk country operations + large volume
2. Multiple related entities with same ownership
3. Sudden business model change
4. Cash-intensive business + high CNP volume
5. Unusual transaction patterns vs. stated business

Industry Benchmarks and Standards

Understanding where merchants fall relative to industry norms:

Chargeback Rates by Industry (2025 Data)

Industry Vertical	Median Chargeback Rate	75th Percentile	90th Percentile	Network Threshold Risk
Grocery & Supermarkets	0.12%	0.20%	0.35%	Very Low
Restaurants (QSR/Casual)	0.18%	0.30%	0.50%	Very Low
Retail Apparel (CP)	0.25%	0.40%	0.65%	Low
Professional Services	0.30%	0.50%	0.80%	Low
General E-commerce	0.65%	1.00%	1.50%	Medium
Travel & Hospitality	0.89%	1.30%	2.00%	Medium-High
Digital Goods/Software	1.20%	1.80%	2.50%	High
Subscription Services	1.50%	2.20%	3.50%	High
Nutraceuticals	2.50%	4.00%	6.00%	Very High
Dating/Adult	3.50%	6.00%	10.00%	Very High

Source: Card network data, payment processor benchmarks, 2025

Fraud Rates by Transaction Type (2025)

Transaction Type	Fraud Rate (% of transactions)	Fraud Rate vs. Card-Present
Card-Present (EMV Chip)	0.06%	Baseline (1x)
Card-Present (Mag Stripe)	0.15%	2.5x higher
Card-Not-Present (no 3DS)	0.93%	15.5x higher
Card-Not-Present (with 3DS2)	0.45%	7.5x higher
Mobile In-App	0.70%	11.7x higher
Recurring/Subscription (initial)	1.20%	20x higher
Recurring/Subscription (subsequent)	0.40%	6.7x higher

Key Insight: EMV chip adoption has dramatically reduced CP fraud, pushing fraud to CNP channels.

Reserve Requirements by Risk Tier (Industry Standards)

Risk Tier	Reserve %	Hold Duration	Funding Delay	Typical Merchants
Tier 1 (Low)	0-5%	0-90 days	T+1 to T+2	CP retail, restaurants, established e-commerce
Tier 2 (Medium)	5-10%	90-180 days	T+3 to T+7	New e-commerce, services, moderate risk MCC
Tier 3 (High)	10-20%	180-365 days	T+7 to T+14	Travel, high-ticket, future delivery, subscriptions
Tier 4 (Very High)	20-50%	365+ days	T+14 to T+30+	Nutraceuticals, crowdfunding, high-risk specialized

Reserve Types:

• Rolling Reserve: % of each transaction held for specified period, then released on rolling basis
• Fixed Reserve: Upfront amount held for duration (e.g., $50,000 held for 1 year)
• Capped Reserve: Rolling reserve until cap reached (e.g., 10% up to $100k maximum)

PayFac Portfolio Risk Aggregation

Payment Facilitators must manage risk across their entire sub-merchant portfolio, not just individual merchants.

Portfolio-Level Considerations

Concentration Risk Management

PayFacs must avoid over-concentration in any single dimension:

Concentration Type	Risk	Mitigation Strategy
Industry	If 60% of portfolio is travel, one industry crisis (COVID-19) devastates entire book	Limit any single industry to <30% of portfolio volume
Geographic	All merchants in one state = state regulatory risk, natural disaster impact	Diversify across states/regions
Volume	Top 10 merchants = 80% of volume; if they leave, portfolio collapses	Balance large and small merchants
High-Risk MCC	Too many high-risk merchants = network scrutiny, sponsor bank concern	Cap high-risk at <20% of total volume
Ownership	Same owner controls multiple sub-merchant accounts	Aggregate limits across related entities

Aggregate Reserve Requirements

PayFacs maintain reserves at two levels:

Sub-Merchant Level:

• Individual reserves based on each merchant's risk
• Protects against that specific merchant's chargebacks

Platform Level (PayFac's Master Reserve):

• Separate reserve required by sponsor bank
• Protects against aggregate portfolio risk
• Typically 1-5% of total monthly volume
• Replenished if depleted by losses

Example:

• PayFac processes $10M/month across 500 sub-merchants
• Individual sub-merchant reserves total $800k
• PayFac master reserve requirement: 3% × $10M = $300k
• Total reserves: $1.1M

Network Threshold Monitoring

PayFacs must monitor both:

1. Individual sub-merchant thresholds

   • Any sub-merchant exceeding 1.5% = network excessive
   • Action required: Remediate or terminate

2. Acquirer (PayFac) aggregate threshold

   • Visa VAMP Acquirer Excessive: >0.7% across entire portfolio
   • All sub-merchant chargebacks count toward PayFac's aggregate ratio

Calculation:

PayFac Aggregate Ratio = (All Sub-Merchant Chargebacks) / (All Sub-Merchant Transactions)

Example:

• 500 sub-merchants
• 480 have <0.5% chargeback rate (good)
• 20 have 2-3% chargeback rate (bad)
• Aggregate ratio = 0.85% (EXCEEDS 0.7% threshold)
• Result: PayFac enters VAMP program, faces fines, must remediate

PayFac Portfolio Risk

A PayFac can have 95% low-risk merchants and still face network penalties if the remaining 5% high-risk merchants generate excessive chargebacks.

This is why PayFac underwriting must be STRICTER than traditional acquirer underwriting - the PayFac bears ALL risk.

Sponsor Bank Risk Requirements

PayFacs operate under sponsor bank partnerships. Understanding why sponsor banks impose strict requirements helps underwriters make better decisions:

Sponsor Bank Liability:

The sponsor bank (e.g., Wells Fargo Bank, Fifth Third Bank, Esquire Bank) is the actual registered acquirer with Visa/Mastercard. The PayFac operates under the bank's BIN (Bank Identification Number).

What This Means:

• Regulatory Liability: Bank faces OCC/FDIC/Fed scrutiny for PayFac's merchants
• Network Liability: Bank's BIN is on every transaction; network fines hit the bank first
• Financial Liability: Bank may be required to cover PayFac losses if PayFac fails
• Reputational Liability: Merchant fraud/violations reflect on bank's brand

Sponsor Bank Risk Requirements:

Requirement	Purpose	Impact on PayFac Underwriting
Master Reserve (1-5% of portfolio)	Cover aggregate portfolio losses	PayFac must maintain $100k-$5M+ in reserves
Portfolio Chargeback Limits (<0.7%)	Avoid Visa VAMP Acquirer Excessive	PayFac must terminate merchants approaching 1.5%
Prohibited Industry Lists	Bank risk appetite	PayFac cannot onboard even if willing to take risk
Quarterly Financial Reviews	Monitor PayFac solvency	PayFac must show capital adequacy, loss ratios
Audit Rights	Ensure compliance	Bank can review ANY merchant file, demand changes
Immediate Termination Rights	Exit bad merchants quickly	PayFac must have rapid offboarding processes

Why Sponsor Banks Care About Individual Sub-Merchants:

Even though the PayFac manages the direct relationship, sponsor banks review:

• High-volume sub-merchants (>$1M/month typically)
• High-risk industries (travel, nutraceuticals, etc.)
• Merchants with excessive chargebacks
• Any merchant generating network violations

Real-World Consequence:

If a PayFac onboards too many high-risk merchants:

1. Sponsor bank receives network notifications (VAMP warnings)
2. Bank demands PayFac remediate or exit specific merchants
3. If not resolved, bank can terminate the entire PayFac relationship
4. PayFac loses ability to process for ALL sub-merchants (catastrophic)

Why This Matters for Underwriters

When evaluating a borderline merchant, remember: the sponsor bank relationship is the foundation of the entire PayFac business. One bad merchant isn't worth risking the whole platform.

Common Sponsor Bank Restrictions:

• Adult content: Usually prohibited entirely
• Gambling/cannabis: Only licensed, heavily restricted
• Crypto: Often prohibited or requires specialized approval
• High-risk MCC cap: <20-30% of portfolio volume
• Individual merchant volume caps: $5M-$10M/month maximum
• Geographic restrictions: May exclude certain countries

Self-Assessment Questions

Test your understanding of risk factors in underwriting:

Question 14: Why is a nutraceuticals merchant higher risk than a coffee shop?

Click to reveal answer

Nutraceuticals (Very High Risk):

• Card environment: Card-not-present (online sales) = 15x higher fraud rate
• Delivery timeframe: Future delivery (ships days later) = more disputes
• Business model: Often subscription-based = "forgot to cancel" chargebacks
• Product claims: Health claims ("lose weight fast") = regulatory scrutiny (FDA/FTC)
• Chargeback rate: Industry average 2-5% (vs. <0.5% goal)
• Regulatory risk: FDA warning letters, FTC enforcement actions common
• Customer disputes: "Didn't work," "false advertising," "negative option billing"

Coffee Shop (Low Risk):

• Card environment: Card-present (EMV chip) = 0.06% fraud rate
• Delivery timeframe: Immediate (consumed on-site) = virtually no delivery disputes
• Business model: One-time purchase = no subscription disputes
• Product: Tangible, straightforward goods = no health claims or regulatory issues
• Chargeback rate: Industry average <0.2%
• Regulatory risk: Minimal (health permits only)
• Customer disputes: Rare (customer present, immediate satisfaction/dissatisfaction)

Key Difference: The combination of CNP, future delivery, subscriptions, health claims, and regulatory scrutiny makes nutraceuticals 10-25x riskier than card-present retail with immediate delivery.

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Question 15: How does delivery timeframe affect chargeback risk? Give examples

Click to reveal answer

Delivery timeframe directly correlates with chargeback risk:

Immediate Delivery (Same Day):

• Example: Restaurant meal
• Chargeback Rate: 0.1-0.4%
• Why Low Risk: Customer receives product before leaving, sees quality, disputes resolved immediately
• Common Disputes: Virtually none (stolen card fraud only)

Short Delivery (1-7 Days):

• Example: Amazon order
• Chargeback Rate: 0.5-1.5%
• Why Medium Risk: Small window for merchant failure, tracking reduces disputes
• Common Disputes: "Never arrived," "wrong item," "damaged in shipping"

Medium Delivery (1-4 Weeks):

• Example: Custom furniture
• Chargeback Rate: 1.5-3%
• Why Higher Risk: Greater opportunity for merchant failure, buyer's remorse period
• Common Disputes: "Took too long," "not as described," "changed mind"

Future Delivery (3+ Months):

• Example: Cruise booked 8 months in advance
• Chargeback Rate: 5-15% (if merchant fails)
• Why Highest Risk:
  • Merchant may go out of business before delivery
  • Customer circumstances change (illness, job loss, pandemic)
  • Buyer's remorse over long period
  • If merchant fails, ALL customers chargeback simultaneously
• Common Disputes: "Merchant didn't deliver," "canceled but not refunded," "business closed"

Risk Mitigation by Timeframe:

• Immediate: No special mitigation needed
• 1-7 days: Tracking numbers, delivery confirmation
• 1-4 weeks: Progress updates, 5-10% reserve
• 3+ months: 15-20% reserve, delayed funding (T+30), delivery guarantees

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Question 16: What additional risk factors should be considered for a merchant with no processing history?

Click to reveal answer

New-to-processing merchants lack the primary risk indicator (chargeback history), requiring evaluation of alternative factors:

Mandatory Additional Checks:

1. Credit History (Always Required)

   • Personal credit for sole proprietors (FICO score)
   • Business credit if available (D&B, Experian Business)
   • Cannot waive for new merchants (no processing history to offset)

2. Business Capitalization

   • Bank statements showing adequate working capital
   • Ability to fulfill orders without using customer funds
   • 3-6 months operating expenses in reserve

3. Time in Business (Even if Not Processing)

   • How long has business operated (with other payment methods)?
   • Cash-only for years? Check business licenses, tax returns
   • Startup (<6 months) = highest risk tier

4. Owner Experience

   • Industry experience (10 years in restaurant industry)
   • Prior business ownership (successful exit from previous company)
   • Professional background and education
   • Payment processing experience in previous roles

5. Online Reputation

   • Website quality, professionalism, SSL certificate
   • Social media presence and customer engagement
   • Google reviews, Yelp ratings
   • Better Business Bureau rating
   • No negative regulatory actions or complaints

6. Business Legitimacy Verification

   • Physical location vs. virtual/home-based
   • Operating licenses and permits
   • Supplier relationships and contracts
   • Inventory or service delivery capability

Underwriting Adjustments:

• Higher Reserves: 10-15% minimum (vs. 0-5% for established)
• Volume Caps: Conservative initial limits
• Enhanced Monitoring: Daily/weekly reviews for first 90 days
• Gradual Ramp: Increase limits over time as history builds
• Delayed Funding: T+5 to T+7 vs. T+2

Gradual Ramp Example:

• Month 1: $25k cap, 15% reserve, daily monitoring
• Month 2-3: $50k cap if clean (no chargebacks, no fraud)
• Month 4-6: $100k cap, reduce reserve to 10%
• Month 7+: Standard limits and monitoring if performance good

Red Flags for New Merchants:

• Projecting unrealistic volume for business size/age
• Poor credit with no offsetting factors
• No web presence or unprofessional website
• Vague business description or inconsistent information
• Reluctance to provide documentation
• High-risk MCC + new business + no experience

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Question 17: What is the purpose of a reserve, and when should one be required?

Click to reveal answer

Purpose of Reserves:

A reserve is funds held by the processor/acquirer to cover potential future chargebacks, refunds, and merchant obligations. It protects the processor from losses if:

• Merchant receives chargebacks after account closure
• Merchant goes out of business with unfulfilled orders
• Merchant lacks funds to cover disputed transactions
• Fraud or compliance issues create liability

How Reserves Work:

Rolling Reserve (Most Common):

• X% of each transaction is held for Y days, then released
• Example: 10% reserve for 180 days
  • Today's $10,000 in sales → $1,000 held
  • 180 days from now → $1,000 released (if no chargebacks)
  • Creates a rolling balance that builds over time

Fixed Reserve:

• Upfront amount held for duration
• Example: $50,000 held for 12 months
• Typically for very high-risk merchants

Capped Reserve:

• Rolling reserve until maximum reached
• Example: 10% rolling up to $100,000 cap
• Once cap reached, new funds replace released funds

When Reserves Are Required:

Scenario	Reserve Recommendation	Reasoning
Low-risk established business	0-5% for 90 days	Minimal risk, good history
Medium-risk or new business	5-10% for 180 days	Moderate risk, building history
High-risk industry or high-ticket	10-20% for 365 days	Elevated chargeback risk
Future delivery business	15-20% until delivery + 90 days	Fulfillment risk
Prior chargeback issues	15-25% for 365+ days	Proven elevated risk
Very high risk or specialty	20-50% for 365+ days	Extreme risk mitigation

Specific Triggers for Reserves:

1. New to processing (<1 year history)
2. High-risk MCC (travel, nutraceuticals, telemarketing)
3. Future delivery (30+ days after payment)
4. High average ticket (>$500)
5. Poor credit score (<650)
6. Prior processing issues (0.65%+ chargebacks)
7. No refund policy or restrictive policy
8. High projected volume vs. business size
9. Opaque ownership or complex structure
10. Card-not-present with subscription model

Reserve Calculation Example (Simple):

Merchant: Travel agency, 20% rolling reserve for 365 days

• Day 1: Process $100,000 → Hold $20,000 (released day 366)
• Day 2: Process $100,000 → Hold $20,000 (released day 367)
• ...
• Day 365: Process $100,000 → Hold $20,000 (released day 730)
• Day 366: Process $100,000 → Hold $20,000, release day 1's $20,000

After ramp-up period, reserve balance stabilizes at ~$7.3M (365 days × $20k/day average)

Complex Reserve Scenario (Delivery-Based Release):

Merchant: Cruise travel agency Terms: 20% rolling reserve, held until 90 days after cruise departure

Transaction Date	Cruise Departs	Charge	Funded (80%)	Reserve (20%)	Release Date
January 1	August 1	$4,000	$3,200	$800	November 1
January 30	March 15	$2,500	$2,000	$500	June 15
March 1	December 1	$6,000	$4,800	$1,200	March 1 (next year)

Reserve Balance Over Time:

Month	New Sales	New Reserve	Released	Balance
January	$100,000	$20,000	$0	$20,000
March	$100,000	$20,000	$0	$60,000
June	$100,000	$20,000	$500 (March cruise)	$99,500
November	$100,000	$20,000	$800 (August cruise)	$158,700
December	$100,000	$20,000	$0	$178,700

Steady-State Reserve: ~$2.5-3M (20% × avg monthly volume × avg booking-to-departure window + 90 days)

Account Termination Scenario:

If merchant closes account:

1. Stop accepting new bookings (no new sales)
2. Continue holding ALL reserves until cruises depart + 90 days
3. If last cruise departs 12 months after closure → release 15 months after closure
4. Only then return remaining reserve (minus any chargebacks)

Why This Matters: In 2020, COVID-19 caused ALL travel merchants to face simultaneous chargebacks. Processors with only 5% reserves lost millions; those with 15-20% reserves weathered the storm.

Reserve Reduction: Reserves can be reduced or removed if merchant demonstrates:

• Consistently low chargeback rate (<0.3%)
• 6-12 months of clean history
• No fraud or compliance issues
• Business stability and growth
• Improved credit or financial position

Important: Reserves are merchant's funds (not processor's) - they must be returned when contract ends and all obligations satisfied.

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Related Topics

• Underwriting Fundamentals - Core underwriting principles and processes
• MCC Codes - Industry classification and risk tiers
• Risk Scoring Models - Quantifying and automating risk assessment
• KYC Requirements - Identity and business verification
• Beneficial Ownership - UBO identification and screening
• Ongoing Monitoring - Post-approval surveillance
• Portfolio Risk Management - PayFac aggregate risk management

References

Card Network Resources:

• Visa: "Visa Acquirer Monitoring Program (VAMP)" - Updated thresholds effective April 2025
• Visa: "VAMP 2026 Threshold Changes" - Early warning dropping to 0.9% (January 2026)
• Mastercard: "Excessive Chargeback Program (ECP)" - ECM and HECM standards
• Mastercard: "MATCH List User Guide" - Terminated merchant file criteria
• Visa/Mastercard: "MCC Directory" - Merchant category classification

Industry Benchmarking:

• Chargebacks911: "State of Chargebacks 2025" - Industry vertical analysis
• Nilson Report: "Card Fraud Losses 2025" - CP vs. CNP fraud rates
• Verifi/Visa: "2025 Chargeback Benchmark Report" - Industry comparisons
• LexisNexis: "True Cost of Fraud Study 2025" - CNP fraud trends

Regulatory Guidance:

• Federal Trade Commission (FTC): Fair Credit Reporting Act (FCRA) compliance
• Consumer Financial Protection Bureau (CFPB): Equal Credit Opportunity Act (ECOA)
• CFPB: "Adverse Action Notice Requirements" (2025)
• Financial Crimes Enforcement Network (FinCEN): Beneficial ownership rules

Payment Industry:

• Electronic Transactions Association (ETA): "Merchant Underwriting Best Practices"
• Strawhecker Group: "PayFac Reserve Requirements Study" (2025)
• Payment Facilitator Standards Council: "Portfolio Risk Management Guidelines"

Risk Management:

• Nacha: "ACH Risk Management Guidelines" (cross-reference to payment risk)
• PCI Security Standards Council: "Payment Risk and Data Security"

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Next Steps:

• Review Risk Scoring Models to learn how these factors are quantified
• Study MCC Codes for detailed industry classification
• Complete the Underwriting Quiz to test your knowledge