Why Merchant Underwriting Guidelines Sometimes Make PFs Look Like Traditional Lenders – and Why That’s OK

By Dan Spalinger, Head of Global Advisory Services, Infinicept

Some people say that a payment facilitator often functions like a traditional bank. This comparison might strike fear in the hearts of PF founders and leaders. After all, PFs pride themselves on their differences from the “way things used to be done.”

But this shouldn’t necessarily be thought of as a negative thing. A PF’s methods may be different – more streamlined or automated than a bank merchant service provider, for example. But the two entities likely seek the same result: successfully mitigating risk.

Taking a risk-based approach

Submerchant underwriting is a prime example. Underwriting is not always simply a matter of collecting only the information required by card brands or regulators. The information to be collected can be extensive, particularly for submerchants processing higher volumes or those operating in certain verticals.

These more intensive requirements may be where PFs begin asking why: “Why do I need to collect financial statements?” or “Why should I review the owner’s personal credit history?”

The truth is, it’s relatively easy to justify collecting mandated items (legal name, physical address, website address, etc.). Rules and regulations can be pointed to for support. Items outside these mandates may feel harder to justify in a segment that prizes its merchant-friendly reputation.

But using a risk-based approach allows payment facilitators to focus their underwriting resources on the areas of highest risk. It enables them to create a quicker and more seamless onboarding process for smaller, less risky submerchants. At the same time, they can control the risk to themselves and their acquirer and provide a satisfactory ROI on clients of all sizes.

It can help to think of the PF as a provider of unsecured loans. Every payment facilitator is liable for the actions (or inactions) of its submerchants. This liability can be seen as an extension of credit – based on a merchant’s creditworthiness and unsecured by any collateral.

So, a payment facilitator could do worse than thinking that, by enabling payment processing, it is essentially handing each submerchant a credit card. The PF will need to pay off that credit card if the submerchant cannot cover its balance. Viewed this way, it may be easier to see why PFs and their sponsors might choose to use practices much like those of a traditional bank for large or higher-risk merchants.

Deciding what information to collect

Beyond mandated information, just what information a PF collects during underwriting is mostly up to that PF to decide. An underwriting policy is not meant to be one-size-fits-all, and no two PFs are likely to have the same requirements. Collecting documents and doing deep financial analysis on an individual selling $50 worth of homemade socks at the local flea-market each year, for example, does not result in an acceptable ROI.

However, ensuring that a custom furniture manufacturer has the working capital it needs to operate long enough to deliver the goods it has promised simply makes good business sense. With long-term delivery cycles, prepayments, and deposits, the non-delivery exposure of these types of merchants can be substantial. It may even be material to the operating viability of the PF itself. So, the PF focused on custom furniture manufacturers will want to gain insight into the financial standing of its clients.

With such clients, it’s a good idea to collect financial statements (company-prepared and CPA-audited documents, tax returns, etc.) covering prior periods as well as documents that show their current standing. Those documents provide information like basic working capital, liquidity, cash flow, debt ratios, available lines of credit and ownership withdrawals. This can be used to either provide comfort about the submerchant’s financial condition or identify red flags for further review. And certainly, if the submerchant has prior transaction history, a PF can request recent processing statements to look for indications of consumer dissatisfaction or other issues.

And if a submerchant refuses to provide such documents? That hesitation itself may be a red flag. The PF may ultimately choose not to onboard that submerchant. At least, they may want to reach out to educate them on why such items are needed.

Looking more closely at the business model

The underwriting parallels between PFs and lenders don’t stop at financials and prior processing history. Both may also need to reduce any risk specific to their client’s business model. When assessing customers for commercial or construction loans, for example, banks may ask for documentation about the business itself. Before a bank signs off on a loan to build a new car dealership, it might ask for evidence that the dealer has secured the manufacturer’s franchise rights for that region.

So it is with payment facilitators supporting larger or higher-risk submerchants. If a PF is considering offering services to a retailer that sells a product it claims is endorsed by a celebrity, the card brands require that the submerchant verify the endorsement. Without that, related transactions may be considered a violation of the brands’ standards. If a PF wants to onboard a merchant that streams copyrighted material, it may ask for the agreement or license that allows it to do so legally.

Pretending to be a dreaded “banker” by wearing a suit and tie and moving to New York may not be part of a payment facilitator’s operating model. But certain underwriting practices undertaken by more traditional lending institutions are still relevant to PFs. Take the ideas; leave the ties.