10. Risk & Underwriting
Risk is underlying theme of payments; technology, features, guidelines, merchant on-boarding process are designed to reduce the risk.
The rates (TDR or MDR) are barometer of that risk in the payment eco-system.
An e-commerce company may have rate of 1.80% on credit cards but an education institute will enjoy 1%. Reason for this differential rates is ‘the risk’ in these two different types of merchants.
Similarly, differential rates apply on POS (point of sale machine) and online transaction. In POS (CP-Card Present) case the transaction charges are much lower compared to online payments (CNP-Card Not Present)
Think of it like insurance premium of a term policy… premium amount for a 28 year old non-smoker will be much lower than that for a same age person who smokes. Insurance companies view second person more riskier (as probability of doing claim settlement earlier is higher)
So, what are the risks in payment eco-system (for aggregator or acquirer)?
a. Fraudulent transactions
b. Chargeback related risk
Some of these risks (e.g. frauds, breaches) are related to technology and processes so regulators, card schemes, banks, processors, payment service providers put lot of effort in enabling secure systems
Example: Velocity checks (limits on transactions, amount), risk management engines (IP tracking, device fingerprints, behaviour mapping), tokenization, encryptions, PCI Compliance, 2nd Factor Authentication
Fraudulent transactions may result in loss of revenue for both merchant and aggregator.
There are certain risks associated the merchant that an aggregator on-boards. So in payments it is important to do ‘a lot of’ business (you know… it’s a volume game) but more than that, it is important to do business with ‘RIGHT’ merchants as it involves reputational and financial risks.
How to decide on ‘RIGHT’ merchant?
- Merchant’s business model
What merchant is selling, whom merchant is selling, what are the deliverables, mode of delivery, what is business cycle (daily, sporadic, seasonal), what is the vintage, merchant’s financials, founders/director background, what are the deliverables, what are cancellation or refund related policies etc.
- Collect and verify merchants credentials
(Company documents, authorised signatory’s documents etc.)
Every merchant has different business model, an e-commerce company may deliver goods in a day and other one may take 15 days. A merchant may delivery service online (ticketing) but other will do physical delivery (e-commerce). A merchant may allow refunds (e-commerce) and other one may not allow refunds (examination fee). So aggregator should understand merchant’s business model, processes, policies, information available on customer touch points to ‘underwrite’ the merchant.
Why underwrite?
Aggregator is just facilitator of payments, the banks are the one who issue merchant id (MID), process payments and move funds. So aggregator is underwriting (taking guarantee) the merchant to use bank’s payment system.
So aggregator has to be careful while on-boarding the merchant and follow due diligence to make sure right merchant with reasonable business model is on-boarded. Whoever is deemed as risky is not on-boarded because cost of doing business with wrong merchant is tremendously high and has potential to wipe out aggregator’s a day or week’s profit margin.
Example; PG Charge: 2%, back-to-back cost = 1.90%
so aggregator has to process 2000 transactions of Rs.500 each to make profit of Rs.1,000 and only one valid chargeback of Rs.1000 due to bad merchant will wipe out that entire profit.
Imagine if there was a fraudulent transaction for Rs.20,000. You can calculate how many transactions an aggregator has to process to make up for that loss of profit.
Businesses start, prosper or close… Yesterday’s start-ups are today’s unicorns and yesterday’s biggies are now out of business. New business models evolve every day. Just because there is risk that doesn’t mean aggregator’s shouldn’t do business but need to mitigate that risk with clever underwriting.
