Before considering a merchant’s application, an acquiring bank or a payment processor requests them to put an upfront reserve—an amount your processing bank can use to recover from the monetary issues that might emerge later.
This reserve is used against the exposure to financial risks, such as an increased number of chargeback requests. Reserves are not just for the protection of the acquiring banks, but they are equally important for the merchant’s safety. Read on to learn more about the upfront reserves, why they are required, how much reserve is needed to create a merchant account, and who needs it.
What is an Upfront Reserve?
Working with a high-risk merchant carries significant risk for the payment processor. There can be many legal issues that can shut the business down for good. Reserve accounts refer to the place where a portion of the merchant’s income is held temporarily to cover possible chargebacks, refunds, and other claims.
If a customer issues a chargeback against a transaction and their request is approved, the merchant has to refund the amount. The acquiring bank uses this reserve to clear the refunds and chargebacks. In most cases, payment processors request a rolling reserve only, but if it’s a high-risk merchant, they might request an upfront reserve as well.
An upfront reserve, as the name suggests, is the amount that a payment processor holds in the merchant’s reserve account before they start operation. It has nothing to do with the merchant’s income or weekly sales. It’s rather a fixed amount that the merchant has to deposit into their reserve account for safety purposes. The upfront reserve amount can vary greatly depending on the merchant’s processing volume for the month, but it’s usually between 50 and 100 percent of their monthly processing volume. For example, if you are allowed to process transactions worth $200,000 a month, your upfront reserve balance must be between $100,000 and $200,000.
Different Types of Reserve
As mentioned above, the reserve is used to cover chargebacks, financial obligations, refunds, and other issues that might emerge from credit card transactions. The main purpose of this reserve is to mitigate the financial risks of the payment processor. Let’s take a look at the different types of reserves.
- Upfront Reserve: It is the amount stored in the merchant’s reserve account before they start processing credit card transactions. The upfront reserve is calculated based on the merchant’s risk profile, the industry they operate, the chargeback ratio, and other factors.
- Rolling Reserves: In addition to the upfront reserve, the payment processor can keep a specific percentage of the amount from the merchant’s daily or weekly income and hold it for a short period. The amount is then transferred to the merchant’s account, usually within 30-180 days. The rolling reserve doesn’t have a fixed percentage. It varies depending on the merchant’s sales volume and their income. Usually, it is 10% of your sales volume.
- Capped Reserve: The capped reserve refers to the total amount the payment processor can hold in the merchant’s account. Once this threshold is reached, the acquiring bank can no longer put money in the reserve.
How Does It Work?
The payment processor collects a specific amount of money and puts it in the merchant’s reserve account to recover from the financial losses if the merchant’s account is terminated in the future. Although this amount acts as financial security, it is still the merchant’s money. If your account activity doesn’t indicate any trouble or you have not incurred any chargeback or any financial loss in the past few months, the upfront reserve will be given back to you.
Not just for safety purposes, but the upfront reserve can be used to increase your processing volume over time. For instance, if you are currently approved for a monthly processing volume of $150,000, you can raise it to $200,000 by putting an extra $50,000 into your reserve account.
How is the Reserve Collected?
The upfront reserve is deposited either immediately or in installments based on the merchant’s risk profile. In most cases, the merchant submits a fixed dollar amount to the processing bank. The amount is decided based on the merchant’s sales volume. There’s also an alternative method, in which the merchant doesn’t deposit the upfront reserve immediately, but their income from the sales is held in this account until the minimum reserve is met.
For example, if you are approved for a $100,000 monthly processing volume, but started accepting credit card transactions without putting any money in the reserve account, your earnings from the sale will be deposited into the reserve account until you have $100,000 in it. As soon as the minimum reserve balance threshold is met, your income from the sales will start to be deposited into your bank account. This kind of reserve is for businesses that do not have any processing history or do not have enough capital to save money in the reserve account before starting a business.
So, where does this reserve amount stay? Well, it’s stored in the non-interest-bearing bank. Your payment processor collects and saves this amount in the reserve. Since it’s linked to your merchant account, you can view the balance in your reserve account on your statement any time you want.
How is Upfront Reserve Different from Other Reserve Types?
The upfront reserve is not requested from every merchant. It’s only required from the high-risk merchant, who’s doing business in an industry that’s associated with legal issues. Capped and rolling reserves are more flexible in that they allow you to put money in the reserve account over time instead of depositing a huge amount at once.
In an upfront reserve, you need to save the funds before starting a business. The biggest advantage of the upfront reserve is that it’s only for a brief period and you will start making money once you have met the reserve balance. No matter the type of reserve, you can rest assured that the entire reserve amount will be credited to your bank account within a few months.
Why Should You Have an Upfront Reserve?
Upfront reserves are not very common in the credit card processing industry. If you are requested to deposit an upfront reserve, you are either accepted for a high monthly processing volume, you have a history of excessive chargeback requests, or you are in a high-risk industry.
If the processing bank believes you can pose a financial threat to their bank or might incur a significant financial loss, they will ask you to deposit an upfront reserve to be approved for the merchant account with them. Alternatively, the processing bank might ask you to deposit the money in your reserve account as you earn from sales. As mentioned previously, the entire amount from your sales will go into the reserve account until the reserve requirements are met.
This leads us to an important question, how can you get the upfront reserve amount back?
Your upfront reserve amount will be transferred to your bank account once you have built a successful and healthy processing history. The reserve is stored to prevent financial liability for the payment processor. If you do not receive any chargeback, refund, or any financial obligations that require reservations, the processing bank will most likely give it back in some time.
However, the amount is not released immediately. It’s rather released in stages, even if you deposited the full amount in the reserve immediately. For instance, the processing bank could release 20% of your reserve initially and every month until the full amount is released and your reserve account is emptied. You can also ask the payment processor to release your reserve.
Where is the Reserve Used?
If you are declared insolvent and you have to shut down your business, the payment processor will use the reserve amount to repay your chargebacks and refunds, and meet other financial liabilities. In 180 days, whatever amount remains in the reserve (after clearing the chargeback and other financial liabilities), will be transferred back to the merchant. Of course, you can check with your payment processor and request an early reserve release, if your merchant allows that.
Industries that offer future delivery services are more likely to receive the upfront reserve request. Examples include concert tickets, airline services, etc. That’s because these services have delivery dates, which are 3-6 months into the future. There’s a chance the buyer may reserve the services and then change their mind in the future. There’s also a high risk of chargeback or refund requests.
For any business dealing with high-ticket transactions, there is an increased risk of chargeback and financial issues. As a result, the payment processor might require an upfront reserve, which is held in your reserve account for a short while, around 180 days until the amount is returned to your account. Upfront reserves are not for every business, and there’s a good chance a merchant won’t be requested to make this fixed deposit. It’s just for high-risk merchants.