High Risk Merchants - Do the Banks Want You?

A merchant is considered high risk if the bank believes acceptance of a merchant will lead to a higher than usual risk of financial loss. Increasingly, banks are refusing to establish accounts for merchants that are high risk.

Some banks will accept a high risk merchant but impose limits on how much the merchant can process per month. Classification as a high risk merchant can translate into higher discount rates for the merchant. Additionally, a bank may insist that the merchant post a reserve. A reserve means the bank holds a percentage of the dollars processed through the account in order to protect itself from potential loss.

Why do banks worry about high risk merchants? The answer is simple. Banks fear chargebacks.

A chargeback occurs when a consumer calls the issuing bank and disputes a charge. The consumer has the right to dispute a charge up to 180 days after buying a product or service. Therefore, the bank is ultimately responsible for contingent liabilities of 6 months on every purchase made using a card.

There are many reasons for chargebacks. Some are valid. For instance, a consumer may not have received merchandise or a merchant may refuse to refund money to an unhappy consumer. Sometimes a consumer calls the bank rather than calling the merchant resulting in a chargeback being issued.

Sometimes, neither the merchant nor the consumer is to blame for chargebacks. Chargebacks may be caused by identity theft, fraud and cybercrime.

Millions of people are affected by identity theft each year. The American television show "Dateline" reports that a stolen identity, including all credit card and banking information, can sell for as little as $5 on the internet.

Within minutes, merchants can be targeted by fraudsters around the world buying items using stolen credit card information. Chargebacks ensue. The merchants and the banks lose money. And consumers are angry and frightened by the loss of their identity.

Merchants can dispute chargebacks. The merchant may even win the dispute. But, the bank sees a record of dissatisfaction on the part of consumers. And, for the most part, the chargebacks still remain on the merchant's processing statements.

The credit card companies insist that the merchant account portfolio of the banks remain under 1%. If a merchant consistently exceeds the 1% threshold, the bank is fined. The longer the merchant stays over the threshold, the higher the fines become. If a bank continuously has a high percentage of chargebacks from merchants, the bank risks losing its ability to issue merchant accounts.

Card company fines are passed on to the merchant who may or may not be able to pay. If chargebacks do not decrease to below 1%, the bank will terminate the merchant account. As a result, the merchant may go out of business or declare bankruptcy. Leaving the bank financially responsible for the chargebacks.

Certain industries are automatically considered high risk by banks because they carry a higher risk of consumer chargebacks or fraud. For example, ecommerce stores selling electronics are a particularly favorite target for fraudsters. Examples of other high risk ecommerce industries include travel, adult entertainment, subscription sales, digital downloads, herbal supplements, cellular and satellite services, infomercials, telemarketing, collectibles, international charities, and auction sites.

Surprisingly, a merchant with a high sales volume in any industry can be considered high risk by banks. More sales mean more potential chargebacks. Naturally, well-known established companies with strong financials processing high volumes are not considered high risk. Similarly, ecommerce merchants that also have retail locations are rarely classified as high risk.

Online merchants selling high ticket items such as furniture or jewelry are may considered high risk. The reason? A chargeback on a higher ticket item impacts chargeback ratios much more than a lower ticket item.

What about merchants with rapidly growing sales volumes? Do you think the banks are happy? The answer is no. Fast growth makes the banks nervous. The banks prefer to see a slow, steady rise in credit card processing. A steep growth curve can throw a merchant into a high risk classification because of chargeback fears