If you’ve ever had reserves placed on your merchant account, you know it’s a frustrating but sometimes necessary thing to enable electronic payments. A reserve is a way to manage risk for high risk transaction processing. Think of a business that sells a good product, but that product caters to emotional purchases and has a lot of return volume or chargeback volume. Sometimes, to protect itself, the acquirer institutes a merchant account reserve that is like an insurance fund against unpaid claims down the road.
The challenge is, and what most merchants don’t know, is that reserve accounting at most ISOs is abysmal. In fact, one of the nations largest acquirers, Square, got a lot of heat for its policy on rolling reserves in prime pandemic time. Imagine how miffed the Forbes reporter would have been if they got a peek at how lazy Square’s reserve accounting is.
So how can you tell whether your company is managing your reserve account properly?
How can you know whether you’re doing business with an ISO that can be trusted with fiduciary responsibility for your merchant’s reserve funds?
The ISO needs to be able to access the settlement platform reserve balance AND the sponsor bank account where the reserve balance is held. When you access both of these resources, your dollar amounts should be an exact match – all the time and every time. Sounds simple right?
Let’s go over what it means first and then I’ll scare you with how often this isn’t the way.
When reserve balances at the bank level and the processor ledger are the SAME, it means that we know the exact reserve balance for every single merchant subject to a reserve in our portfolio. It also means that we can drill down to each addition to or subtraction from that reserve balance for each merchant.
Again, simple right?
It’s not – it takes a few critical pieces to get merchant account reserves right and many payments companies fail miserably, albeit without malice, at managing this important piece of the business.
- Lazy Accounting – rather than break out the balance of the reserve account, many payments companies track just the lump total of reserve balance instead of breaking it down into is individual pieces and components.
- Improper Accounting – this balance, whether it is tracked properly on an itemized level, or whether it is tracked as one lump number, is NOT revenue. Yet, many payments companies treat this as a revenue item instead of a contra-liablity line item (a contra account is one that offsets another account – think of how accumulated depreciation offsets the value of an asset). There are sadly many cases where this has happened and accounting “gray area” happens all too often even with public companies (think potential unfunded pension liabilities as an example). If you didn’t understand all that accounting talk, just know this – it’s no good.
- Third-Party Accounting – 99% of the agents and ISOs out there are “retail” ISOs. They don’t handle underwriting or risk and have no access to ledger accounts nor could they do anything about it if they did. They rely on their processor and don’t or can’t verify reserve balances.
Why You Should Care About Reserve Accounting
Without itemized accounting of your reserve balances it’s going to feel a lot like social security payments (i.e. a Ponzi scheme). As releases are allowed, what balance are they being released against? All is well until the well runs dry.
Questions to Ask About Reserve Accounting
- Where are reserve funds held?
Answer: in a controlled account with the sponsoring bank - How is the reserve balance verified?
Answer: There should be a required reconciliation report to the sponsor bank on a regular basis - How can I see the balance for a specific merchant and a detailed ledger?
Answer: they should provide you a report or access to view this information on your own. You can then verify this against the merchant’s statement or activity in your CRM or access system.
