Managing Merchant Default Risk

Impact of default risk

The payments industry in the UK is very buoyant, facilitated by an advanced and stable infrastructure, as well as strong consumer protections and regulation.  The payments system is constantly evolving and the number of acquiring banks and payments processors constantly growing, fuelled by the promise of a slice of the fees on 43bn[1] annual card transactions.

It’s a numbers game.  To be viable an acquirer or processor needs sufficient volume so it’s not surprising that the focus, particularly for a newer entrant, is on growth.  Many of these providers are funded by private equity who will want to see a fast return on their initial investment.

We discussed in a previous article [here] how acquirers and processors are exposed to the default risk of merchants, in particular from Chargebacks.  With the focus on growth, managing this default risk can take a back seat, leading acquirers and processors to adopt a sub-optimal position, for example:

Factors affecting exposure

The greater the time between order placement and delivery, the greater the chance of Chargebacks and the greater the risk that the merchant may have become insolvent.  Certain industries and transaction types present higher risk than others:

For example, holidays are typically booked up to a year in advance so there is a much greater risk that between purchase and taking the holiday that the travel agent could become insolvent.  Travel agents’ prospects are compounded by cash flow issues from the fact that commissions may only be when or shortly after a client travels, so there can be a gap of months or even years until the agent is compensated.

What can be done

Whilst it may currently be taking a back seat compared to growth, all processors and acquirers should understand the risks they are facing, and those they are avoiding, in order to maximise their bottom line.

Many larger established payments processors and acquirers have their own well-resourced in-house credit risk teams that determine merchant acceptance procedures (including appropriate mitigation measures), investigate individual large potential customers and monitor the acquirer’s merchant portfolio. 

However it can be difficult for a smaller newer entrant to justify the expense of its own credit risk team.  That is where third party consultancies such as PureDelta can help.  We can supplement an acquirer’s existing credit team by providing the additional resource and expertise to enable the following:

·         Identify areas of exposure and concentration risks

·         Safely unlock riskier industries

·         Strength acceptance frameworks and criteria

·         Remove unnecessary restrictions to support merchant retention

Overall, we aim to work with our clients to achieve an optimal risk / reward balance to support profitability.

For assistance managing merchant default risk contact PureDelta.

[1] In 2023, source PSR, Pay.UK, UK Finance