Recently we have been receiving questions like: “Who bears the risk of underwriting: the gateway, the payment processor, or the merchant acquirer?” or “Why do some gateways ask about existing acquiring partner or merchant acquirer bank relationships while others do not?” To find answers to such questions, we need to clearly understand, “who is who” in payment processing industry, how one type of entities differs from another, and what types of relationships they have. Therefore, we have decided to write an article, in which we can clearly outline the role of each entity and explain, how acquiring banks, payment processors, and payment gateway providers are “related to each other”.
Merchant acquirer and payment processor
In some cases, relations between acquirers and processors are “one-to-one” (as in the case of Vantiv, for example). Although, Vantiv’s acquirer is Fifth Third Bank, most people consider Vantiv as both processor and merchant acquirer (things will change now with Vantiv’s acquisition by WorldPay). Other processors, such as First Data and TSYS, have established partnerships with multiple acquiring banks.
A payment processor serves as the technical arm of a merchant acquirer. It provides a technology, allowing to authorize transactions and, potentially, receive transaction settlement information. In other words, processors handle the technical side of the merchant services, including movement of funds. However, they do not assume financial liability for the merchant acquisition process. This responsibility and risks lie with acquiring banks, as explained in our previous article on the importance of acquiring bank partnerships. Risk departments of acquiring banks decide, whether merchant applicants should be underwritten or not (whether merchant accounts should be issued or not).
Beside that, acquirers handle physical remittance of funds to merchants through bank accounts associated with these merchants. That is, acquiring banks are the entry point into the banking system for the processors. Therefore, it is the merchant acquirer that assumes the financial liability.
For example, if a merchant authorizes a transaction through a processor, the funds for this transaction need to be remitted back to the merchant. In order to be able to fund the merchant the respective amount (into the merchant’s bank account), the processor has to be part of a banking system. Technically, it is the merchant acquirer that is the part of the banking system. Consequently, there is always an acquiring bank behind a processor.
Payment gateway, payment facilitator, and acquiring bank
Payment gateways act as platforms that streamline access for merchants and payment facilitators to multiple processors, simplifying this access from technical viewpoint. Some people may assume that payment gateways, such as PayPal or Stripe, handle underwriting andbear the liability and risk.
In fact, some companies realize that it is beneficial for them to “hide” providers of both acquiring and processing services behind their own brands. As a result, thanks to modern onboarding mechanisms and processing technologies, it may, indeed, seem that onboarding and underwriting are done by the payment gateway provider, and it is the gateway provider that assumes the risks. True, technically a large gateway company can become a merchant acquirer and processor “all-in-one” if it integrates directly with Visa and/or MC. However, in a general case, there should be an entity, such as an acquiring bank, that provides acquiring services behind the gateway.
Distribution of functions between merchant acquirers and other entities
The terms of partnership between a gateway and a merchant acquirer vary depending on the specific business arrangement. Some acquirers offer their services to gateways and payment facilitators at lower prices, but in exchange, gateways and PayFacs assume greater risk for their sub-merchants.
For example, a gateway, allowed to issue merchant accounts to applicants at low prices and, therefore, entitled to a larger share of residual revenue, may be required to assume 100% liability for credit card chargebacks.
Usually, chargeback-related risk is assumed by acquiring banks, and that is another reason why it is acquirers’ risk departments that make decisions concerning merchant underwriting. However, at the modern market we are witnessing the emergence of multiple payment facilitators. Beside payment facilitation, many of them also provide gateway services. So, in some particular cases the underwriting risk may be assumed by a PayFac, as a result of its particular arrangement with a merchant acquirer. A lot of information on payment facilitators’ role in merchant services can be found in our respective article.
Every processor has an established acquiring partnership. An acquiring bank assumes underwriting-related risks and liabilities. Acquirers’ main functions are as follows.
- Acquirer’s risk department decides whether to underwrite a prospective merchant or not.
- Acquirers fund merchants (as well as payment facilitators) from their portfolios through their respective bank accounts.
In some cases certain risks can be assumed by a gateway provider or a PayFac in exchange for better acquiring terms (larger residual revenue shares).