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									                       Merchant Processing Policy and Procedures

Note: This is a sample policy. You must modify this policy and procedures to suit your institution’s
individual practice and it must be based on your role in the merchant processing cycle.


Merchant processing is the settlement of electronic payment transactions for merchants. Merchant
processing activities involve gathering sales information from the merchant, obtaining authorization for
the transaction, collecting funds from the card-issuing bank, and reimbursing the merchant.

The processing of sales transactions for merchants by banks does not directly affect the bank’s balance
sheet except through settlement accounts and reserve balances. However, merchant processing can create
significant off-balance-sheet contingent liabilities that may result in losses to the bank.

Most merchant processing transactions originate from retail credit card purchases, but debit card
purchases, smart card purchases, and electronic benefits transfer transactions are increasing sources of
processing volume. Merchant processing is a business of high volumes and low profit margins.

Generally, a high level of sales and transaction volume is needed to create a profitable operation as a
result of the low income generated per transaction. Processing high transaction volume carries risk; only
efficiently run departments can successfully maintain the necessary cost controls and effectively manage
the accompanying transaction and credit risks.

Types of Merchant Processors

The role and accompanying risks of banks and third-party organizations varies. The most common
participants in merchant processing are acquiring banks, agent banks with and without liability, and third-
party organizations.

Acquiring Banks

A bank that contracts with merchants for the settlement of credit card transactions is an acquiring bank or
an acquirer. Acquiring banks contract directly with the merchant, or indirectly through agent banks or
other third-party organizations, to process credit card transactions.

Agent Banks with Liability

Agent banks contract with merchants on behalf of an acquiring bank. Agent banks are typically
community banks that do not directly offer merchant processing services to their merchant customers.
These banks refrain from contracting with merchants on their own because they lack the management
expertise or the necessary infrastructure needed to serve as an acquirer.

Acquiring banks generally provide all backroom operations to the agent bank and own the bank
identification number (BIN)/Interbank Card Association (ICA) number through which settlement takes
place. A BIN/ICA number is an individual member’s unique identification number that facilitates clearing
and settlement through Visa and MasterCard. Depending upon the contractual arrangement with the
acquirer, the agent bank may be liable in the event of chargeback or fraud losses.

Agent Banks without Liability (Referral Banks)

Many community banks have referral arrangements with acquirers. In a referral arrangement, the acquirer
performs the underwriting, executes the merchant agreement, and accepts responsibility for merchant
losses. The acquiring bank may pay the referring bank a fee for brokering the merchant relationship.

Agent banks occasionally refer or want to sign merchants that do not meet the acquirer’s underwriting
guidelines. The acquirer may accept the account on the condition that the agent bank signs an agreement
indemnifying the acquirer against losses. When a referral bank indemnifies the acquirer for losses, it
becomes an agent bank with liability for those merchants indemnified.

Indemnification agreements are typically used when the agent bank has other account relationships with
the merchant and, as a customer service, wants to assist them in obtaining processing services. Bank
management and examiners should be familiar with the limits on a national bank’s ability to indemnify a
transaction, as outlined in 12 CFR 7.1017.

Third-Party Organizations

Third-party organizations include any outside company the acquiring bank contracts with to provide
merchant processing services. In addition to soliciting merchants, independent sales organizations
(ISOs)/member service providers (MSPs) may perform some or all of the following services for aquirers:

    •   Processing merchant applications

    •   Processing chargebacks

    •   Detecting fraud

    •   Servicing merchant customers

    •   Providing accounting services

    •   Selling/leasing electronic terminals to merchants

    •   Processing transactions

    •   Authorizing purchases

    •   Capturing data

Acquiring banks frequently outsource functions to third-party organizations to control costs. An
acquirer’s sales and transaction volume may not justify the cost of in-house data processing, or the bank
may not want to staff a direct sales force. Acquirers can benefit from the technological expertise and
capabilities of third parties without having to develop the systems and infrastructure themselves.

Acquiring banks sometimes receive third-party services indirectly. For example, an ISO/MSP may
contract directly with a data processor or network provider, and the ISO/MSP passes the service onto the
bank. Banks can also receive services indirectly through an ISO/MSP that contracts with another
ISO/MSP to provide services.

There are hundreds of third parties providing services, and the quality of the services can vary widely.
Banks should exercise strong due diligence and maintain strong vendor management programs for third-
party organizations.


Rent-a-BIN describes an arrangement in which an acquiring bank permits ISOs/MSPs to use the bank’s
BIN/ICA number to settle merchant credit card transactions. The bank has minimal operational
involvement. The ISO/MSP retains the majority of income, and the bank receives a fee for the use of the

The acquiring bank that owns the BIN/ICA number always retains risk of loss as well as responsibility for
settlement with the associations. Banks are held responsible based on the contractual provisions of the
card association membership. Therefore, bank management should rigorously oversee and control these
arrangements to ensure that the ISO/MSP is appropriately managing the risk. Oversight controls are
important, even if the ISO/MSP shares in the liability.


The board of directors of [insert the name of your bank] is committed to engaging in merchant processing
activities that are commensurate with the safety and soundness expectations of our stockholders and of
our federal regulator. We direct management to institute procedures and internal controls that are safe
and sound and comply with any formal or informal guidance that may be issued from time to time by
[insert the name of your federal regulator].


The board understands that merchant processing carries three primary risks for our bank. They are
strategic, credit, and transaction risk. If we fail to control these risks we may also face compliance,
reputation, and ultimately liquidity risk. Management is directed to conduct a risk assessment before
undertaking any merchant processing activity and to present it to the full board of directors for discussion
and approval.

Strategic Risk

In assessing the strategic risk presented by merchant processing, the board directs management to
consider the following questions:

    •   How well can the bank keep pace with technology and competition in this area?

    •   What industries should the bank pursue as users of this product?

    •   Should the bank use third-party providers and to what extent?

Other strategic considerations should include:
    •   The current business environment to determine whether the line of business can be managed
        safely and profitably

    •   The need for a highly specialized and reliable infrastructure

    •   The potential impact of the activity on earnings and capital

    •   The liability for fraud and chargeback losses and for bankcard association

    •   The need for a strong vendor management program (See Vendor Management Policy and

    •   The risk and reward analysis of whether the bank can generate adequate sales without taking
        unacceptable risks

    •   The generation of deposits from the settlement of merchant processing activities

Management should also consider the possible reputation risks involved in merchant processing.

Credit Risk

Credit risk arising from chargebacks is a significant risk to an acquirer’s earnings and capital. Although
processing credit card transactions is technically not an extension of credit, the acquiring bank is relying
on the creditworthiness of the merchant.

Merchant chargebacks become a credit exposure to the acquirer when either the merchant declares
bankruptcy or is otherwise financially unable to pay. If a merchant cannot honor its chargebacks, the
acquiring bank must pay the card-issuing bank. Banks have often been forced to cover large chargebacks
when merchants have gone bankrupt or committed fraud.

Transaction Risk

We understand that as an acquiring bank we are faced with transaction risk daily as we process credit card
transactions for our merchants. This risk arises primarily from the settlement process. Settlement is the
process of transmitting sales information to the card-issuing bank for collection and reimbursement of
funds to the merchant. Transaction risk can also arise from a bank’s failure to process a transaction
properly, inadequate controls, employee error or malfeasance, a breakdown in the bank’s computer
system, or a natural catastrophe.

When considering transaction risks, management must ensure that the bank has internal controls in place
to minimize those risks since a failure anywhere in the transaction process can result in risks to the bank’s
earnings and capital. Some of those failures include but are not limited to:

    •   Failure to monitor the merchant acceptance process, including those generated by ISO/MSP

    •   Failure to process chargebacks properly and in a timely manner, as specified in the bankcard
        associations’ rules, can result in operational and credit losses

    •   Failure to provide adequate staffing for chargeback processing and fraud monitoring can result in
        preventable operational and credit losses that occurred because of high workloads
    •   Failure to comply with bankcard associations’ operating rules can bring substantial fines

    •   Failure to monitor daily sales transactions can result in substantial operational losses from
        fraudulent activity

    •   Failure or inability to provide timely transmission of funds to merchants or third parties can result
        in operational losses, reputation risk, and liquidity risk

    •   Failure to monitor the service quality and fulfillment (e.g., sales, chargeback processing, fraud
        monitoring, customer service, or automated clearinghouse (ACH) file creation) provided by third-
        party organizations can result in operational and credit losses, fines, and a negative reputation

    •   Failure to monitor and compare initial merchant activity and pricing with actual merchant activity
        and pricing can result in unprofitable operations


The board appoints [insert the name or title of the officer in charge of merchant payment processing] as
the senior officer responsible for all merchant processing activity, including sales, operations, and fraud

All managers, supervisors, and employees in this department will have written job descriptions that detail
not only their job duties but the qualifications required to hold their position.

All merchant processing staff should be sufficiently trained in their positions so that they possess a full
understanding of the process for which they are responsible. Staffing levels should be reviewed
periodically and should be commensurate with the workload in each area.

Management should ensure that all employees have written procedures for their job. Exceptions to this
policy or written procedures must be documented and approved by the senior officer in the department.
The procedures must include but are not limited to:

    •   Establishing new business

    •   Monitoring existing business

    •   Handling ISOs and MSPs

    •   Handling complaints with merchants

    •   Conducting settlement procedures

    •   Processing merchant retrievals and chargebacks

    •   Fraud monitoring and reporting

    •   Handling exceptions to procedures, including sign off requirements

    •   Training new staff

The board directs management to ensure that they and the board receives regular reports so we may
continually assess and gauge the risk of the merchant processing department. Some of the key reports the
department should produce are:

    •   New account acquisitions

    •   Account attrition

    •   Portfolio composition

    •   Sales volumes

    •   Chargeback volumes

    •   Chargeback aging

    •   Fraud

    •   Department profitability

Agent Banks

[Insert the following if your bank is an agent bank.]

As an agent bank, it is mandatory that merchant processing management fully understands our bank’s
financial liability for chargeback and fraud losses, as well as our responsibilities under the agreement with
the acquirer. The board directs management to establish appropriate risk controls and ongoing monitoring
of the acquirer that includes sales activity, chargebacks and fraud investigations. All agreements with
acquiring banks will be approved by the bank’s legal counsel.

Referral Banks

[Insert the following if your bank is only a referral bank.]

As a referral bank, the board understands that we need only minimal controls to monitor our relationships
with acquirers. However, management must review our agreements to determine if they include any
indemnification language. If so, our internal controls and monitoring procedures must be more
comprehensive and similar to those required of agent banks due to increased liability.


Accepting New Merchants

We will require a signed merchant application and agreement for each new merchant account. The
following information must be obtained on the application. The board understands that forms will be
modified and updated from time to time; however, new forms and agreements must be approved by bank
counsel and must include at a minimum the following merchant information for underwriting purposes:

    •   Business information, including but not limited to:
    — Name, address and phone number (obtain physical and mailing address)

    — Tax identification number

    — Type of entity and appropriate documents (e.g., corporate resolution, partnership agreements)

    — Customer relationship with our bank (e.g., checking account, cash management services)

    — Type of business/product or services offered

•   Owners/officers information, including but not limited to:

    — Name, address, phone number

    — Social security number

    — Date of birth

    — Percent of ownership (must add up to 100 percent)

•   At least two trade references

•   At least one bank reference

•   Details of volume of sales and products/services sold

    — Monthly volume

    — Average sale amount

    — Highest sale amount

•   Details of method of sales (must add up to 100 percent)

    — Card present (swiped)

    — Card present (keyed)

    — Card not present (keyed) (mail, telephone, or fax orders)

    — Card not present (Internet)

•   Return/refund policy description

•   Percent of products sold to consumers, business, and government (must add up to 100 percent)

    — If seasonal merchant, then list high months.

•   Schedule of fees described in detail and agreed to by merchant

•   Type of hardware/software
   •   Bank information for authorization for ACH transactions

   •   Application/agreement signed by owners and agreement personally guaranteed by all owners

   •   Site inspection information completed by sales representative

Note: If you use applications received from an ISO or an MSP, then you should include procedures about
how these applications will be reviewed and the information verified by bank employees.


Management is directed to implement an approval process of merchants based on both the risk and sales
volume of merchants. Senior officers must approve merchants that are high risk or have substantial sales
volume. Commercial lending officers should underwrite the creditworthiness of large merchants and
present a credit summary to the loan committee or other suitable committee of the board. Underwriting
limits may vary from time to time and will be submitted to the board annually for approval by the senior
officer in charge of merchant processing.


Management should have detailed underwriting procedures that include a background check of the
merchant. The bank’s underwriting standards should require the following steps at a minimum:

   •   An application signed by the merchant.

   •   A processing agreement signed by the merchant.

   •   A signed corporate resolution, if applicable.

   •   An on-site inspection report or verification of business.

   •   Credit bureau reports, as allowed by the Fair Credit Reporting Act, on the principal(s) of the

   •   Financial statement or credit reports on the business.

   •   Analysis of the merchant’s activity using recent monthly statements from the merchant’s current
       or most recent processor, if possible.

   •   Verification of trade and bank references.

   •   Evidence the merchant is not on the Member Alert to Control High Risk Merchants (MATCH)
       list. MATCH is a file of merchants who have been terminated for cause. It is available either
       online or through batch process. The Special Merchant File, a sub file of MATCH, contains a list
       of merchants who have been classified as special merchants because of an audit or other
       information developed by MasterCard. MATCH acts as an important tool to help assess risk prior
       to approving a merchant.
Additional Underwriting Procedures for Internet Merchants

Because of the inherent fraud risk in businesses who only do business on the Internet, management should
determine whether delaying settlement or establishing additional reserves or holdbacks should be used for
an Internet merchant. When reviewing a potential Internet merchant, the underwriter must require the
following information appear on the merchant’s website:

    •   Customer service number (toll-free preferable)

    •   E-mail address to contact the company

    •   Statement on security controls

    •   Delivery methods and timing

    •   Refund and return policies

    •   Privacy statements (permissible uses of customer information)

[Insert for Agent Banks]

As an agent bank, we will use the acquiring bank’s underwriting criteria when developing our
underwriting procedures. Acquiring banks will expect our bank to reimburse them for losses due to
inappropriate underwriting.


The following types of merchants are considered higher risk and must undergo a more rigorous review
and be approved by the senior officer in the department:

    •   Pharmaceutical merchants

    •   Travel businesses/travel clubs

    •   E-wallet/e-cash

    •   Online cigarette/tobacco sellers

    •   Internet auctions

    •   Membership clubs (health clubs, diet clubs, dating clubs)

    •   Pre-paid telephone cards

    •   High-volume mail/telephone order

[Insert other merchants/businesses your bank considers high risk.]


The bank will not open merchant accounts for:
    •   Adult service merchants

    •   Internet gambling sites

    •   [Insert any other prohibited or restricted merchants at your bank.]


Management should have procedures in place to continually monitor high-risk and high-volume
merchants. The level and detail of monitoring will depend on the size of the merchants requiring reviews.
Management should develop a threshold for periodic reviews and consider the following factors:

    •   Volume

    •   Concentrations

    •   Risk level of merchant

    •   Chargeback history

It is imperative that when the merchant is also a commercial lending customer, that information flows
freely between the departments. Both the merchant processing department and the commercial loan
department should have specific procedures in place to inform the other about any change in the
merchant’s credit quality. For example, the merchant processing manager should be on the routing list for
the problem loan report.

[Insert the following if you are an acquiring bank with agreements with agent banks.]

As an acquiring bank, we will periodically review the financial condition of all agent banks assuming loss
liability. We need not review a referral bank’s financial condition.


The board directs management to ensure that merchant accounts are priced appropriately throughout the
life of the contract. The board further directs the management information system department to ensure
that management and the board have adequate information systems and reports in place to measure the
profitability of the merchant processing department. Pricing policies will be discussed at the highest level
of management and approved by the board.

[Insert for Acquiring Banks]

Management should ensure that an income statement is prepared and analyzed that shows all direct and
indirect costs of the merchant operation.

[Insert for Agent Banks]

The board directs management to review, monitor, and analyze the fees related to our agent bank
activities to ensure that we operate efficiently and at least earn enough to recoup the fees charged by the
acquirer and cover our other costs.

The board directs management to employ a sound fraud detection system either by reviewing appropriate
exception reports or, if cost effective, through the use of fraud detection programs. The fraud monitoring
system should concentrate on higher risk merchants, but all merchant activity should be reviewed and
monitored for unusual activity.

[Insert your own fraud detection procedures here.]


We must have strong internal controls to accurately process chargebacks and retrieval requests in a timely
manner. There are strict bankcard association rules and regulations to which we must adhere. The bank
card associations can fine our bank if we have a high level of chargebacks or if they believe we do not
have adequate internal controls, procedures, or risk mitigation policies in place to protect us from losses.


Management should consider the following risk mitigation procedures for excessive chargebacks:

    •   Establish merchant reserve accounts or holdback accounts

    •   Fund a general reserve account similar to our allowance for loan and leases loss (ALLL)

    •   Purchase chargeback insurance

[Insert your procedures here.]

Chargeback losses must be appropriately listed on our call report as noninterest expense. Collected funds
should be reported as other noninterest income. Uncollectable fees should be reversed from income in a
timely manner.


As an acquiring bank, management should understand and assess the risk to our payment systems from
merchant processing activities. The board directs management to review its vendor management policy
and procedures to ensure that we have written agreements with all third parties involved in the settlement

The agreements should detail responsibilities, payment arrangements and schedules, and contingency
plans. Additionally, management should have proper monitoring controls in place over parties in the
settlement process. Controls should include:

    •   Quality assurance

    •   Audits

    •   Onsite visits

    •   Performance reporting
    •   Financial monitoring

Our agreements with processors should contain a provision that allows us to obtain third-party reviews
from our processors. In general, our vendor management policy should apply to merchant accounts and


Due Diligence

We will conduct a due diligence background check of each principal of an ISO/MSP. The financial
capacity of the ISO/MSP and its principals must also be analyzed to verify the organization’s viability and
capacity to absorb losses. Management is further directed to conduct periodic reviews of the financial
condition of each ISO and MSP.


It is our policy to follow the bankcard associations’ specific guidelines for written contracts between
acquirers and the ISO/MSP. The written contracts will clearly set out the responsibilities of each party,
compensation and liability arrangements, allowable uses of the acquiring bank’s name, and reasons the
contract can be terminated. All contracts with ISOs and MSPs will be reviewed by our bank counsel.

Onsite Inspections and Audits

Merchant processing management should periodically conduct onsite inspections and audits of the third-
party organizations. Audit reports should be generated, and the third party management should be
required to respond to identified issues. If the third party is required to have specialized audits, such as
SAS 70 audits, we will obtain a copy for review.

Contingency Planning

We will also ensure that the third-party processor and network providers have contingency plans in place
to continue operations in the event of a disaster. If an ISO/MSP is providing the backroom operations, we
will also ensure that the ISO/MSP has a contingency plan.

We will obtain a copy of the plan and review it to determine that it is adequate.

Loans to Third-Party Organizations

We understand there may be additional risk exposure and possible conflicts of interest when lending to
third-party organizations that perform services for the bank. Therefore, it will be the policy of our bank
not to lend to ISOs or MSPs.

[If you decide to lend to third-party organizations connected with your merchant processing function,
then detail the guidelines here.]


The board directs the internal audit manager [insert a name or title here, if appropriate for your bank] to
include the merchant processing department in its audit plan. The merchant processing department
should prepare a written report and present it with management responses to exceptions to [insert the full
board of directors of the audit committee].

The board of directors approved and adopted this policy on ________________________.

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