Risk Management Examination Manual for Credit Card Activities Chapter XIX
continually analyze their merchant portfolios along similar guidelines. Acquiring banks typically
compile a prohibited or restricted merchant list which includes the types of merchants they are
unwilling to sign or are willing to sign only under certain circumstances.
While the extent of product and marketing evaluations varies, considerations normally include
review of the merchant’s business plans, merchandise, and marketing practices and materials
(for example, catalogs, brochures, telemarketing scripts, and advertisements). In addition,
shipping, billing, and return policies can be reviewed for unusual or inappropriate practices (for
instance, customers being billed long before merchandise is shipped). These considerations can
help determine, among other things, if: the business is of a type that typically has high charge-
back rates; the merchant is selling a legitimate product; sales methods are legitimate and not
deceptive; product quality and price are consistent with projected sales and charge-back rates;
and customers will be satisfied with products ordered. Merchants offering low-quality products or
services tend to incur more charge-backs, thus dissuading many banks from signing them.
The merchant's sales volume and time frame within which product delivery is completed are other
considerations to evaluate risk. Generally, the greater the sales volume and the longer the time
between transactions and product delivery, the greater the risk. For example, when a restaurant
closes, an acquiring bank typically has less exposure to charge-backs for undelivered goods and
services. In contrast, the failure of a travel agency could expose an acquiring bank to substantial
charge-backs due to the high volume of reservations common in the travel agency business.
Certain types of merchant businesses can present increased risk. Although there are many
reputable merchants whose sales transactions occur without a credit card being present (card-
not-present merchants), these merchants generally present higher charge-back risks for
acquiring banks. In particular, mail order and telemarketing (MO/TO) merchants and adult
entertainment services merchants, in aggregate, tend to display elevated incidents of charge-
backs. Merchants without an established storefront (for example, door-to-door salesman and flea
market vendors) also typically pose greater risk for charge-backs. The risk of charge-back is also
higher if the merchant sells products for future/delayed delivery
, such as airline tickets, health
club memberships, travel clubs, or internet purchases. The increased risk associated with future
delivery of products results, in part, because customer disputes are normally not triggered until
the date of delivery. High charge-back rates are also generally associated with certain selling
methods, such as sales pitches involving gifts, cash prizes, sweepstakes, installment payments,
multi-level marketing, and automatic renewals unless the consumer opts out. Association
regulations define certain broad business categories as high-risk merchants. These categories in
general present higher risk, but each individual merchant in the category may not necessarily be
high risk. Appropriate procedures and risk controls for high-risk merchants generally include:
• Criteria for determining the types of merchants the bank is or is not willing to sign and
under what circumstances.
• Increased emphasis on underwriting considerations regarding products and
marketing in evaluating the merchants.
• Limitations on the volume of high-risk merchant transactions processed relative to
the bank’s total merchant portfolio.
• Criteria for determining the appropriate level of holdback or reserve accounts to
sufficiently cover the level of credit risk.
• Appropriate pricing of these merchants in relation to the charge-back risk and any
costs associated with increased monitoring.
• Heightened monitoring and problem resolution. For example, for charge-back
monitoring, banks may set lower charge-back thresholds for required remedial action
and/or a shorter timeline for problem resolution for those merchants exceeding
acceptable charge-back thresholds.
• Compliance with bankcard regulations regarding registration of certain high-risk
merchants and assigning proper Merchant Category Codes (MCC)
to merchants.
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