Merchant accounts, while essential for facilitating electronic transactions, inherently carry a level of risk. To mitigate this risk, banks may mandate the establishment of a merchant account reserve, which involves setting aside a predetermined portion of a merchant’s revenue.

A merchant account reserve is a predetermined portion of a business’s revenue held in reserve by an acquiring bank. When a business establishes a payment processing account, the bank or processor may retain a fraction of the transaction revenues in a reserve account. These reserved funds function similarly to an escrow account required for a loan, assuring protection for both the merchant and the bank in the event of sudden financial liabilities.

This reserve serves as a protective buffer against unforeseen liabilities stemming from chargebacks or fraud. Payment processors and acquiring banks employ this risk management strategy to safeguard against potential losses associated with a merchant’s transactions.

Why Do Acquirers Mandate Account Reserves?

A merchant account reserve is designed to limit financial repercussions for the institution associated with their merchants’ activities.

Cardholders have the right to dispute purchases in cases of fraud, misuse, or errors. However, if a merchant experiences an unexpected surge in chargebacks, the potential financial liabilities could exceed the merchant’s available account balance.

Failure to cover these chargebacks would leave the acquirer liable for them. Therefore, by implementing a merchant account reserve, the payment processor can help ensure the security of their funds.

From the bank’s perspective, an account reserve serves several key purposes:

1. Offset Liability for High-Risk Businesses

Certain industries, such as travel, adult entertainment, and telemarketing, are classified as “high risk” due to their elevated susceptibility to chargebacks or fraud. Merchants operating in these sectors often need to maintain reserves, as they present a higher risk to payment processors.

2. Maintaining Trust

Reserves may be mandatory for new businesses without a credit history or those with a history of financial instability. This requirement is intended to reassure the payment processor, guaranteeing that sufficient funds are available to cover returns, refunds, or chargebacks, thereby preserving a trusting relationship.

3. Stabilizing Cash Flow Fluctuations

Some businesses experience significant variations in transaction volumes due to seasonal factors. A reserve helps smooth out these fluctuations and safeguard against sudden shortfalls during periods of low activity, particularly in seasonal businesses characterized by sales peaks followed by lulls.

Types of Merchant Account Reserves

Not all account reserves are identical, as payment processors use different methods for acquiring and holding funds.

The most common types of reserves include:

Rolling Reserves

WIth a rolling reserve, a percentage of each credit card deposit is withheld for a predetermined period before being released. Typically, 5-15% of the account balance is held back, with a specific hold duration. This reserve model ensures that funds are continuously available to cover potential liabilities as new funds replace those released from the reserve.

Capped (Accrual) Reserves

A capped reserve accumulates funds by withholding a percentage of monthly sales until reaching a fixed cap, often half of the merchant’s monthly processing volume. Once the cap is reached, no additional funds are held in reserve.

Up-Front Reserves

Up-front reserves involve an initial lump-sum deposit based on the expected monthly transaction volume, which acts as a security deposit for the payment processor. No further percentage of monthly sales is withheld during the agreement period.

Special Reserve Accounts

In addition to the general reserve types mentioned, some payment processors offer specialized reserve accounts tailored to specific business models. These special reserve accounts, such as the PayPal reserve hold, Amazon rolling reserve, or Stripe rolling reserve, are designed to accommodate unique operational and security requirements while effectively managing transaction-related risks. These accounts often come with additional features and requirements customized to the processor’s specific needs.

Renegotiating Merchant Reserves

There is no hard-and-fast rule for when merchants should be allowed to renegotiate their reserve requirements. It can be considered when transaction history, perceived risk, or other factors align favorably.

Renegotiating reserves can be viewed as a gesture of good faith to accommodate the evolving needs of merchant customers. It can strengthen the long-term partnership between banks and businesses, and allow greater flexibility for merchants.