February 3, 2020
Written by
James Davis
Written by James Davis
Senior Technical Writer at United Thinkers

Author of the Paylosophy blog, a veteran writer, and a stock analyst with extensive knowledge and experience in the financial services industry that allows me to cover the latest payment industry news, developments, and insights. Read more

Reviewed by
Kathrine Pensatori
Product Specialist at United Thinkers

Product specialist with more than 10 years of experience in the Payment Processing Industry. I help payment facilitators and PSPs solve their various payment processing issues. Read more

The Role of an Acquiring Bank in Transaction Processing

More and more present-day companies need to process electronic payments. Some of them already managed to make a transition from cash-based operations to online transaction processing. Following their example, new market players are trying to find the best solutions that would allow them to process electroinc payments for their core products.

What it takes to process transactions electronically

Let us now take a look at essential components of electronic payment processing solutions. Some might associate electronic payment processing with particular devices or applications installed on these devices. However, in reality, the situation is a bit more tricky. True, when you purchase a product or service online, you are using some software or interface for that. However, through this interface, you are accessing the international payment and banking system. Connection to this system allows companies to accept electronic payments for their products.

What acquiring banks are

The main connection hub, linking a company to the banking system is its acquiring partner. People often loosely use the concept of an acquirer or acquiring bank, confusing it with an ordinary commercial bank. In fact, a commercial bank can become an acquirer, but in order to do that, it has to get a special authorization from card associations. An acquiring bank certified by Visa, MC, and/or other card networks gets the right to issue merchant accounts to businesses that want to accept electronic payments. If you have a traditional commercial account, you still have to get a merchant account in order to become a part of transaction processing world. It is through this account that all your business operations are performed.

What acquiring banks do

Official terms are: “an acquiring bank issues a merchants account” or “an acquirer underwrites a business as a merchant”. This underwriting procedure means that the acquirer shoulders all potential risks associated with your business, especially, financial risks. The major threats related to transaction processing, result from consumer and merchant fraud, as well as insolvency of consumers and merchants (for instance, in the context of chargebacks and refunds). In case of any conflicts some entity has to step in, assume the responsibility, and bear the costs. The burden of these costs and risks falls on the underwriter, i.e. the acquirer.

In order to allow merchants to process transactions and, at the same time, offset the related financial risks, many acquirers prefer to withhold special merchant services reserves from merchant profits. But how can an acquirer protect itself if the merchant has no profits or processing history yet? Well, the main instrument is a more or less rigorous KYC mechanism. All those applying for a merchant account go through verification procedures. Their industry type, geography of origin, prospective transaction processing volume, and processing history (if any) are verified.

Key steps to transaction processing

Ironically enough, the term “acquirer” is not the first thing that comes to mind when you think about transaction processing. Most of us, naturally, associate it with payment processors, or payment gateways. In reality, the first thing to do if you want to accept electronic payments is finding an acquiring partnership. Both payment processor and payment gateway are secondary concerns. They address technical aspects of transaction processing, while your acquiring partner handles the legal, financial, and business aspects.

Some might argue that a small business can get a merchant account from an independent sales organization (ISO) or a payment facilitator (PayFac). Well, merchant accounts resold by an ISO are still issued by some acquiring bank. And a PayFac, usually, underwrites multiple merchants under the same merchant ID, but before it can do that, it still has to be underwritten by an acquirer. Moreover, in exchange for the right to participate in merchant lifecycle (including underwriting, funding, and transaction processing) a PayFac assumes part of financial responsibility associated with merchant’s business.

Even if a small-size merchant doesn’t contact directly with an acquirer, the acquirer is still deeply involved in its lifecycle. It just stands much closer to the top of the “food chain” of merchant services market.

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