Merchant account

A merchant account is a type of bank account that allows businesses to accept payments by debit or credit cards. A merchant account is established under an agreement between an acceptor and a merchant acquiring bank for the settlement of credit card and/or debit card transactions. In some cases, a payment processor or independent sales organization is also a party to the merchant agreement. Whether a merchant enters into a merchant agreement directly with an acquiring bank, or through an aggregator such as PayPal, the agreement binds the merchant to obey the Operating Regulations established by the card brands.

Methods of processing credit cards

Today a majority of credit card transactions are sent electronically to merchant processing banks for authorization, capture and deposit. Various methods exist for presenting a credit card sale to "the system." In all circumstances either the entire magnetic strip is read by a swipe through a credit card terminal/reader, a computer chip is read, or the credit card information is manually entered into a credit card terminal, a computer or website. The earliest methods, submitting credit card slips to a merchant processing bank by mail, or by accessing an Automated Response Unit (ARU) by telephone, are still in use today but have long been overshadowed by electronic devices. These early methods used two-part forms and a manual device for mechanically imprinting the embossed card number information onto the forms.

Credit card terminal

A credit card terminal is a stand-alone piece of electronic equipment that allows a merchant to swipe or key-enter a credit card's information as well as additional information required to process a credit card transaction. A credit card terminal is a dedicated piece of equipment that only processes credit cards although it is common for related transactions including gift cards and check verification to also be performed. A credit card terminal typically must be plugged in to a power supply and connected to a telephone line. However, some terminals may be powered by batteries and communicate over the Internet or through a cellular phone data network. When a credit card is processed (either swiped through the magnetic stripe reader or keyed-in to the keypad), it contacts the network to verify if the credit card can be authorized. The transaction is then stored on the machine until the polling window is opened. The machine will either upload the electronic funds directly to the merchant bank, or a polling service provider will dial in to collect, process then submit the data to the merchant bank. The most popular credit card terminals consist of a modem, keypad, printer, magnetic stripe reader, power supply and memory card. They have had the same basic design since the 1980s. As with computers, there is a wide range of memory capacities and other features like built-in printers and debit card pinpads that affect the manufacturing cost of a credit card terminal.

Automated Response Unit (ARU)

An ARU (also known as a voice authorization, capture and deposit) allows the manual keyed entry and subsequent authorization of a credit card over a cellular or land-line telephone. With this method a merchant typically imprints their customer's card with an imprinter to create a customer receipt and merchant copy, then process the transaction instantaneously over the phone.

Payment gateway

A payment gateway is an e-commerce service that authorizes payments for e-businesses and online retailers. It is the equivalent of a physical POS (point-of-sale) terminal located in most retail outlets. A merchant account provider is typically a separate company from the payment gateway. Some merchant account providers have their own payment gateways but the majority of companies use 3rd party payment gateways. The gateway usually has 2 components: a) the virtual terminal that can allow for a merchant to securely login and key in credit card numbers or b) have the website's shopping-cart connect to the gateway via an API to allow for real time processing from the merchant's website.

Level 2 or Level 3 Processing - Purchasing Cards

Visa and Mastercard have created a specialized type of credit card used primarily by government agencies and businesses. Increasingly, corporations and government agencies are relying on this form of payment to compensate their service providers and suppliers. Businesses benefit by receiving their funds quickly and by winning competitive bids and government contracts where purchasing cards are the required form of payment. The downside, however, is the increased costs associated with receiving these payments. These costs will usually be much higher than accepting a standard consumer credit card.

The solution is that some businesses may qualify for ways to process these transactions that allow them to pay lower fees if they can supply additional information, called "level 2 or level 3 data". For example, if government transactions are over $5,000, businesses can significantly reduce their transaction costs by including "level 2 or level 3 data" about the purchase along with each transaction. Examples of level 2 or level 3 data is a purchase order number associated with the transaction that the credit card will be paying. This data is passed on to the purchaser so that it may be many times easier to reconcile the transaction. If all the required data is not collected and passed on during the transaction, the merchant can have surcharges added to the basic fees or be forced into a non qualified transaction category.

Merchant Account Marketing

Merchant accounts are marketed to merchants by two basic methods: either directly by the processor or sponsoring bank, or by an authorized agent for the bank and additionally directly registered with both Visa and MasterCard as an ISO/MSP (Independent Selling Organization / Member Service Provider). Marketing details are by card issuers like Visa and MasterCard, and are enforced by various rules and fines. A few of the largest processors also partner with warehouse clubs to promote merchant accounts to their business members.

Marketing by Banks

A bank that has a merchant processing relationship with Visa and Mastercard, also known as a member bank, can issue merchant accounts directly to merchants. To reduce risk, some banks limit approval to merchants in its geographical area, those with a physical retail storefront, or those that have been in business for 2 years or more.

Marketing by Independent Sales Organization (ISO)/MSPs

To market merchant accounts, an ISO/MSP must be sponsored by a member bank. This sponsorship requires that the bank verify the financial stability and suitability of the company that will be marketing on its behalf. The ISO/MSP must also pay a fee to be registered with Visa and Mastercard and must comply with regulations in how they may market merchant accounts and the use of copyrights of Visa and Mastercard. One way to verify if an ISO/MSP is in compliance is to check a website or any other marketing material for a disclosure "company is a registered ISO/MSP of bank, town, state. FDIC insured". This disclosure is required by both Visa and Mastercard and will cause a fine of up to $25,000 if it is not clearly visible. In almost all cases, if there is no disclosure, the company is likely to be an uninformed 4th party or worse. In many cases unregistered operators have been responsible for some of the worst horror stories from merchants.^{[citation needed]}

Rates and fees

A Merchant Account has a variety of fees, some periodic, others charged on a per-item or percentage basis. Some fees are set by the merchant account provider, but the majority of the per-item and percentage fees are passed through the merchant account provider to the credit card issuing bank according to a schedule of rates called interchange fees, which are set by Visa and Mastercard. Interchange fees vary depending on card type and the circumstances of the transaction. For example, if a transaction is made by swiping a card through a credit card terminal it will be in a different category than if it were keyed in manually.

Discount Rates

The discount rate comprises a number of dues, fees, assessments, network charges and mark-ups merchants are required to pay for accepting credit and debit cards, the largest of which by far is the Interchange fee. Each bank or ISO/MSP has real costs in addition to the wholesale interchange fees, and creates profit by adding a mark-up to all the fees mentioned above. There are a number of price models banks and ISOs/MSPs use to bill merchants for the services rendered. Here are the more popular price models:

3-Tier Pricing

The 3-Tier Pricing is the most popular pricing method and the simplest system for most merchants, although the new 6-Tier Pricing is gaining in popularity. In 3-Tier Pricing, the merchant account provider groups the transactions into 3 groups (tiers) and assigns a rate to each tier based on a criterion established for each tier.

First Tier - Qualified Rate

A qualified rate is the percentage rate a merchant will be charged whenever they accept a regular consumer credit card and process it in a manner defined as "standard" by their merchant account provider using an approved credit card processing solution. This is usually the lowest rate a merchant will incur when accepting a credit card. The qualified rate is also the rate commonly quoted to a merchant when they inquire about pricing. The qualified rate is created based on the way a merchant will be accepting a majority of their credit cards. For example, for an internet merchant, the internet interchange categories will be defined as Qualified, while for a physical retailer only transactions swiped through or read by their terminal in an ordinary manner will be defined as Qualified.

Second Tier - Mid-qualified Rate

Also known as a partially qualified rate, the mid-qualified rate is the percentage rate a merchant will be charged whenever they accept a credit card that does not qualify for the lowest rate (the qualified rate). This may happen for several reasons such as:

• A consumer credit card is keyed into a credit card terminal instead of being swiped
• A special kind of credit card is used like a rewards card or business card

A mid-qualified rate is higher than a qualified rate. Some of the transactions that are usually grouped into the Mid-Qualified Tier can cost the provider more in interchange costs, so the merchant account providers do make a markup on these rates.

The use of "rewards cards" can be as high as 40% of transactions. So it is important that the financial impact of this fee be understood. So therefore, merchants will be charged the qualified plus the mid qualified rate. Example: If your qualified rate is 1.5% and the mid qualified rate is 1 %, your effective rate would be 2.5 %.

Third Tier - Non-qualified Rate

The non-qualified rate is usually the highest percentage rate a merchant will be charged whenever they accept a credit card. In most cases all transactions that are not qualified or mid-qualified will fall to this rate. This may happen for several reasons such as:

• A consumer credit card is keyed into a credit card terminal instead of being swiped and address verification is not performed
• A special kind of credit card is used like a business card and all required fields are not entered
• A merchant does not settle their daily batch within the allotted time frame, usually past 48 hours from time of authorization.

A non-qualified rate can be significantly higher than a qualified rate and can cost the provider much more in interchange costs, so the merchant account providers do make a markup on these rates.

6-Tier Pricing

As a result of the Wal-Mart Settlement and to compete against PIN-based debit cards (which are processed outside of the Visa and Mastercard networks), Visa and Mastercard lowered the interchange rates for debit cards well below those for credit cards. Some providers can pass on the lower cost of these cards directly to merchants. Consequently, the 3 tiers programs have added 2 classifications for debit cards that are processed without a PIN or with a PIN for a total of 6 rate classifications.

Interchange Plus Pricing

Some providers offer merchant account services priced on an "interchange plus" basis. These accounts are based on the "interchange" tables published by both Visa Visa Interchange and MasterCard MasterCard Interchange. This type of pricing creates a discount rate by adding interchange rates, fees, assessments, markups and other costs.

Bill Backs

A bill back is a relatively new price model and a variation on interchange plus pricing. It has some variations but the basic concept is that the merchant pays interchange on the statement that the transactions took place and then pay all other fees, like dues, fees and assessments, etc. on the next month's statement. It requires a great deal of time to research the actual cost per transaction with the bill back system. Some merchants feel this form of pricing is very misleading.^[who?]

Other Fees

Nuisance Fees

Nuisance Fees are charged when a card is declined and then swiped again this results in a so called "nuisance fee" for each additional swipe. This fee can be very costly to the merchant upwards of $20 dollars is common for a "nuisance fee".

Authorization fee

The Authorization fee (actually an authorization request fee) is charged each time a transaction is sent to the card-issuing bank to be authorized. The fee applies whether or not the request is approved. Note this is not the same as Transaction fee or Per Item fee.

Statement fee

The statement fee is a monthly fee associated with the monthly statement that is sent to the merchant at the end of each monthly processing cycle. This statement shows how much processing was done by the merchant during the month and what fees were incurred as a result.

Many times, the statement fee is not directly linked to "paper" statements but rather general overhead. This means that a provider would not waive this fee if a merchant chose to have a "paperless" statement.

Monthly minimum fee

The monthly minimum fee is a way to ensure that merchants pay a minimum amount in fees each month to cover costs from the provider to maintain the account and to create minimal profits. If a merchant's qualified fees do not equal or exceed the monthly minimum they will be charged up to the monthly minimum to satisfy their minimum fee requirements.

Example: A merchant has signed a contract with a $25.00 monthly minimum fee. If all the fees for the most recent month of processing total only $15.00, this merchant will be charged an additional $10.00 to meet their monthly minimum requirements. Sometimes there are fees that are charged that are not a part of the monthly minimum, such as statement fees. It is industry standard to charge a monthly minimum.

Batch fee

A batch fee (also known as a batch header fee) can be charged to a merchant whenever the merchant "settles" their terminal. Settling a terminal, also known as "batching", is when a merchant sends their completed transactions for the day to their acquiring bank for payment. Some providers perform this automatically. It is important to close a batch every 24 hours or a higher rate will be assessed by Visa or Mastercard. The term "batch header" originally came from processing pre-electronic terminal era, when each batch of credit card receipts was turned in to the merchant's local bank for deposit. The batch header was a mini report summarizing those receipts bundled within.

Customer Service fee

The customer service fee (also known as a maintenance fee) can be charged by some providers to pay for the cost of customer service. Also referred to as a "merchant support fee", "customer support fee", or simply, "service fee" by some merchant providers.

Annual fee

The Annual fee can be charged by some providers to pay for costs of maintaining the merchant's account. Sometimes these fees can be quarterly. The fee can be from $79–$399.

Early Termination fee

The early termination fee can be charged by some providers if the merchant ends the contract before the end of the contract term. While contract terms of 1–3 years are typical, some providers have terms of up to 5 years with a one year prior notice to cancel or the fee will be assessed. Some providers also assess all statement fees and monthly minimums remaining when the contract is terminated. Some providers may also assess a "lost profit" fee based on an assumption of profits they concluded they would have earned during the full term of the contract.

Chargeback fee

The chargeback is the largest risk that is presented to banks and providers. This is not to be confused with a refund, which is simply a merchant refunding a transaction. In the Visa and Mastercard rules, the merchant's processing bank is 100% responsible for all the transactions that the merchant performs. This can leave the provider open to millions of dollars of potential losses if the merchant operates in an illegal or risky manner and generates many chargebacks. The providers pass this cost on to the merchant, but if the merchant is fraudulent or simply does not have the money, the provider must pay all the costs to make the card holder whole. The chargeback risk is the largest part taken into consideration during the contract application and underwriting process. Some banks are much more stringent than others when assessing a merchant's chargeback risk.

If a merchant encounters a chargeback they may be assessed a fee by their acquiring bank. A potential chargeback is presented on behalf of the card holder's bank to the merchant's credit card processing bank. A reason code is established by the card issuer to properly identify the type of potential chargeback based on the card holder's complaint. The most common complaint is that the card holder can not remember the transaction. Usually, these potential chargebacks are corrected when the merchant's processing bank sends over more details about the transaction. Some providers charge a fee for this service, known as a "Retrieval Request". A chargeback can also be related to a fraud or similar dispute that the card holder is claiming to the merchant. This fee can be charged by some providers whether the chargeback is successful or not and is not dependent on the amount of the chargeback.

Currently both Visa and Mastercard require all merchants to maintain no more than 1% of dollar volume processed to be chargebacks. If the percentage goes above, there are fines starting at $5000 – $25,000 to the merchant's processing bank and ultimately passed on to the merchant.

In all cases, a chargeback will cost the merchant the chargeback fee, typically $15–$30, plus the cost of the transaction and the amount processed.

Payment Card Industry Data Security Standard (PCI DSS)

PCI DSS was created by the Security Standards Council as a set of rules merchants must adhere to in order to reduce fraud throughout the industry. The goals of the PCI DSS Standards and corresponding rules are as follows:

• Build and Maintain a Secure Network
  • Install and maintain a firewall configuration to protect cardholder data
  • Do not use vendor-supplied defaults for system passwords and other security parameters
• Protect Cardholder Data
  • Protect stored cardholder data
  • Encrypt transmission of cardholder data across open, public networks.
• Maintain a Vulnerability Management Program
  • Use and regularly update anti-virus software or programs
  • Develop and maintain secure systems and applications
• Implement Strong Access Control Measures
  • Restrict access to cardholder data by business need-to-know
  • Assign a unique ID to each person with computer access
  • Restrict physical access to cardholder data
• Regularly Monitor and Test
  • Track and monitor all access to network resources and cardholder data
  • Regularly test security systems and processes
• Maintain an Information Security Policy
  • Maintain a policy that addresses information security for employees and contractors

The Durbin Amendment

On October 1, 2011, new rules go into effect that lower the debit card interchange fees the Visa and MasterCard networks charge merchants.

The changes — resulting from Durbin Amendment passed last year as part of the Dodd–Frank Wall Street Reform and Consumer Protection Act — would appear to be a plus for merchants. But are they?

At issue are the so-called “swipe” fees passed along to businesses as part of their credit card processing agreement with their merchant services provider. Interchange fees were originally imposed by the credit card networks to offset their costs of fraud prevention and processing the transaction.

Swipe fees vary depending on the type of card used in a transaction (credit, debit, prepaid) and the merchant; typically, larger merchants have more negotiating power when it comes to fees than smaller merchants.

Prior to the implementation of the Durbin Amendment, the swipe fee for a debit card transaction averaged 44 cents. Under Durbin, the Federal Reserve has set a cap of .05% + 21 cents per transaction (22 cents if the card has security features). (It is important to note that the new rules apply only to Visa and MasterCard debit cards — not credit cards — and only to card issuing banks with more than $10 billion in total assets.)

Card processing costs are often a merchant’s second highest expense after labor, so lower swipe fees for debit cards should be a welcome development, particularly as the cards have grown in popularity with consumers, surpassing both checks and credit cards. Debit card transactions in the U.S. totaled 25 billion in 2006; by 2009, the number had reached 38 billion.

Issuing banks like debit cards because they’re profitable, generating $16 billion in transaction fees in 2009 alone. To make up for the anticipated loss in revenue from the lower swipe fees, many banks have begun tacking on new checking account fees, raising minimum balance requirements and have threatened to cap the dollar amount for debit transactions and end debit card rewards programs. At the same time, banks are trying to renew customer interest in more profitable credit cards and prepaid debit cards with offers of low interest and rewards bonuses.

So, what’s the bottom line for merchants? It depends, to a large degree, on how customers react over the next year or so. If they stick with paying for their purchases with a PIN-based debit card, merchants should come out ahead because those transactions incur a lower swipe fee. If they pay with a credit card, the interchange fee is calculated as a percentage of the sale (usually about 2%), which can quickly exceed the capped 21 cent swipe fee they’d be charged for the same transaction on a debit card.

See also

• Merchant services
• Credit card
• Credit card terminal
• Payment gateway
• Electronic Commerce
• Interchange fees
• Credit card fraud
• Chargeback insurance
• Payment card industry (PCI)
• Cardholder Information Security Program (CISP)

References

• Visa Interchange Visa Interchange rate table.
• MasterCard Merchant Rules PDF guidelines for all businesses that accept MasterCard credit cards.
• Visa USA - Accepting Visa Guide and information for accepting Visa and other credit cards.
• PCI SCC Reference Document PCI SSC Quick Guide.