Brick-and-mortar merchants that have shifted to online have changed their risk profile, causing conflicts with the fintechs like Square that handle their payments. And that could be an opportunity for banks.
Square has begun withholding portions of its merchants' payments as a temporary measure designed to mitigate chargebacks, and says this doesn't apply to the vast majority of its sellers. Under normal circumstances, this practice is limited to merchants with a thin track record, such as a new onboarding merchant or a merchant in a business deemed risky. The coronavirus has upended business models in a way that throws more merchants into the higher-risk zone.
While the use of new risk management technology such as AI has enhanced payment processors’ ability to spot economic softness faster, a sudden shift in revenue channels can also change a risk profile in a way that would encourage withholding.
A rise in withholding could create an opening for banks that can refrain from withholding, giving the banks an edge over the fintechs that have been chasing small-business clients for years.
“There’s a lot in the media in terms of what’s happening, but we’re not withholding funds,” Doug Mearkle, head of U.S. merchant services sales at TD Bank, said in an interview on the bank’s overall response to the impact of the coronavirus on merchants.
The global bank, which has already closed more than 30% of its U.S. branches this year, indicated that the pandemic is prompting it to adjust its plans on the fly.
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The bank’s existing relationships with merchants, including lending and other financial services, creates a larger view of the merchant that allows the bank to avoid temporary holds on payment funds.
“As we look at small businesses, we understand cash flow is critical in today’s environment; we want to make sure that as they’re processing transactions we are funding them in an appropriate timeline,” Mearkle said.
Square's withholding policy is legal, not unprecedented and built into relationships between processors and merchants.
Payments risk mitigation includes both policy rules and risk algorithms, said Rick Oglesby, president of AZ Payments. Policies include rules for industries that are not permissible, minimum revenue requirements, maximum allowed processing limits, and others, Oglesby said. Algorithms calculate probabilities, such as a percentage probability that a certain transaction will generate a loss, he said.
“When there’s a shock to the economic system, there is a necessary shift towards using more policy rules,” Oglesby said. “The algorithms are still likely to be effective at separating high-risk versus low-risk situations, but the probability calculations are likely to be less accurate. Issuers and processors alike are required to make risk decisions based on less information, so increased conservatism is the only rational path.”
Online payments, both in-browser and in-app, have higher fraud loss and dispute rates than in-person payments, according to Javelin Strategy & Research, which is monitoring the impacts of a move to digital in a short time frame. The main challenge is many businesses that are accustomed to using brick and mortar as a primary method of sales are not ready for the changing fraud dynamic of operating as an online-only business.
Since curbside pickup is considered an e-commerce transaction, it has higher loss rates — and small businesses that have quickly moved to order online and store pickup do not have the same experience of fraud mitigation technology to reduce losses, according to Javelin.
Card-not-present fraud rates are 3.1% versus 1.2% for brick-and- mortar purchases, so the reserve funds need to reflect this difference. CNP activity also increases the risk of friendly fraud by 34%, according to Javelin. Small businesses that use delivery services also need to expect higher costs for processing and delivery — another factor that could impact reserves, Javelin said.
Another long-term impact for merchants may be accepting longer onboarding times in exchange for a lower risk that funds will be withheld. For fintechs, specifically those that aggregate card and bank transfers, there’s also an increased withholding risk for the merchant. These fintechs offer fast sign-up, but also the potential for higher withholding.
“That is the risk you take when you can get approved" by the fintech so quickly, said Austin Mac Nab, CEO and co-founder of VizyPay, which requires merchants to have an account with a bank or card association, a process that takes longer to sign up but allows VizyPay to sell merchants on a lower risk of what Mac Nab calls held money. “Payment aggregators have discretion over when a merchant receives funds … aggregators can choose to release the funds" in 24 to 48 hours "or they can withhold the funds for up to another additional 30 days.”
