What is a Merchant Account Reserve?

A merchant account reserve is money your acquiring bank or processor sets aside in case of emergencies. It’s similar to a security deposit for an apartment rental or collateral for a loan.  

If your business experiences difficulties and struggles to pay the bills, your processor can use money held in your reserve account to cover the costs associated with your processing account. Funds from a merchant account reserve are most commonly used for financial losses associated with chargebacks.

Because COVID-19 has drastically changed consumer expectations and shopping habits, many merchants are experiencing an increase in chargebacks. As a result of the new risk, banks are taking extra precautions by adding reserves to merchant accounts that didn’t have them in the past.

If you are experiencing cash flow issues because of reserve requirements brought about by COVID-19, contact Midigator® today. We’ll get your chargebacks under control so your reserve account will be less restrictive and easier to manage.

Merchant account reserves can cause some confusion and frustration. But the more you know, the easier a reserve will be to manage. Read our complete guide or jump to a section below:

Example of How a Reserve Account Is Used

Bob owns a company that makes custom kitchen cabinets. Ms. Miller is remodeling her kitchen and hires Bob. 

Bob’s employees build and install beautiful oak cabinets. Ms. Miller pays Bob. Bob pays his employees. Then Bob begins work on his next project. 

A month later, a door falls off Ms. Miller’s cabinet. Upset, Ms. Miller calls her bank and demands a chargeback. The bank credits her account and turns to Bob’s bank for reimbursement. 

Bob’s bank checks his processing account and finds there isn’t enough money to cover the chargeback. To make matters worse, Bob won’t have money in his account any time soon — he doesn’t get paid until he finishes his next construction project.  

Since Bob doesn’t have funds available in his processing account to cover the cost of the chargeback, his reserve account is debited instead. 

Merchants Required to Have an Account Reserve

Merchant account reserve requirements are set on a case-by-case basis. Many factors influence who needs to have one, but generally the riskier the merchant the greater the need for a reserve. 

Merchants with these characteristics usually need a reserve account: 

  • Low or erratic personal credit score
  • No prior processing history
  • Reputational risk from products the bank doesn’t want to be associated with
  • Industries that are highly regulated where there is a greater probability of regulatory oversight 
  • Industries with limited regulations where consumer complaints are common 
  • History of high chargeback rates 
  • Card-not-present sales via online, mail, or telephone orders
  • International sales
  • Subscription sale
  • Free-trial sales
  • Large-ticket sales
  • Delayed deliveries
  • High processing volume

Merchants may dislike the cash flow restrictions caused by a reserve account. But the added security of a reserve is what makes it possible for many merchants to process payments. The reserve functions as a security interest to help the processor limit its exposure to financial loss caused by excessive chargebacks. A processor wouldn’t agree to take on a merchant’s risk without extra protection. 

That said, there are still some high-risk merchants that won’t be approved for processing even with a reserve. 

The Different Types of Merchant Account Reserves

All merchant account reserves serve the same purpose: to set aside money that can be used when a merchant’s general account doesn’t have sufficient funds to cover the unexpected financial loss caused by chargebacks. 

Yet there are significant differences in how reserve funds are collected, how long they are withheld, and when they are returned to the merchant. 

There are three types of merchant account reserves, and the type required depends on the merchant’s risk level.

Up-Front Reserve

An up-front reserve — sometimes called a minimum reserve — is just what the name implies. Before payment processing privileges can begin, the merchant must deposit a certain amount of money into the reserve account.

There are usually three ways for merchants to provide these up-front funds:

  • Obtain a line of credit or business loan.
  • Transfer money from a different account.
  • Allow the processor to withhold all revenue (minus fees) until the reserve amount is met.

The amount of money needed to fund an up-front reserve depends on several variables, such as the business’s industry and how the business operates. Generally, the amount is equal to about one month’s processing volume. For example, if the business is expected to process $20,000 a month, there would probably be at least that much in the reserve.

Up-front reserves are typically required if the merchant is new and has little to no processing history.

Hypothetical Example of an Up-Front Reserve

Reserve Amount Required: $20,000
Deposit Type: Processing Revenue

MonthMonthly SalesAmount WithheldReserve BalanceAmount for Deposit (less any fees)
January$18,000$18,000 $18,000$0
February$19,000$2,000$20,000 $17,000
March$20,000$0$20,000$20,000

Capped Reserve

A capped or accrual reserve is gradually funded with each transaction processed until the minimum amount is met. Typically, a processor holds anywhere from 5% to 20% from daily settlements.

Once the predetermined amount has been deposited into the reserve account (which is usually equal to about one month’s processing volume), the processor will stop collecting funds. However, the withheld funds will remain in the reserve account until after the merchant has stopped processing payments with that particular bank.

Hypothetical Example of a Capped Reserve

Reserve Amount Required: $10,000
Percent Withheld: 10%

MonthMonthly SalesAmount WithheldReserve BalanceAmount for Deposit (less any fees)
January$18,000$1,800
= 10% of sales
$1,800$16,200
= sales - amount withheld
February$19,000$1,900$3,700$17,100
March$20,000$2,000$5,700$18,000
April$21,000$2,100$7,800$18,900
May$20,000$2,000$9,800$18,000
June$19,000$200$10,000$18,800
July$20,000$0$10,000$20,000
August$21,000$0$10,000$21,000

Rolling Reserve

Like the capped reserve, a rolling reserve is also funded gradually with about 5-20% of daily settlements.

But unlike a capped reserve that withholds a static amount of funds indefinitely, a rolling reserve is in a constant state of collecting and releasing funds. The amount retained in a rolling reserve is dynamic and changes each month.

When a rolling reserve is first established, the processor will collect and hold money for 6-12 months. Then, assuming the merchant’s risk hasn’t increased during that time, the processor will begin to release some money each month into the merchant’s general account. As new funds are added to the reserve the oldest funds are released.

The amount held in up-front and capped reserves is static — these reserves don’t typically increase as the business grows. However, rolling reserves are dynamic and scale simultaneously with the business’s sales volume. As a result, rolling reserves are the most common type of reserve because they offer the processor the greatest protection.

Hypothetical Example of a Rolling Reserve

Amount of Time Funds are Withheld: 6 months
Percent Withheld: 10%

MonthMonthly SalesAmount WithheldReserve BalanceAmount ReleasedAmount for Deposit (less any fees)
January$18,000$1,800
= 10% of sales
$1,800$0$16,200
= sales - amount withheld
February$19,000$1,900$3,700$0$17,100
March$20,000$2,000$5,700$0$18,000
April$21,000$2,100$7,800$0$18,900
May$20,000$2,000$9,800$0$18,000
June$19,000$1,900$11,700$0$17,100
July$20,000$2,000$11,900
= previous balance + amount withheld - amount released
$1,800
= amount withheld in January
$19,800
= sales - amount withheld + amount released
August$21,000$2,100$12,100$1,900
= amount withheld in February
$20,800
September$22,000$2,200$12,300$2,000$21,800
October$20,000$2,000$12,200$2,100$20,100

Tips for Managing Merchant Account Reserves

Here are some tips that can minimize the impact that reserves have on your business.

Consult the Underwriting Team

The type, amount, and duration of the reserve are typically determined and disclosed during the merchant account application process. Be sure to review the terms before signing the contract.

When you apply for a merchant account, you’ll work with the processor’s sales team. A sales rep might have general information about reserves, but it’s the underwriting team that will decide the exact requirements for your account.

If you have specific questions, ask your sales rep to bring someone from underwriting into the conversation.

Make sure you are transparent during the application process. If you aren’t, the underwriter may not fully understand the potential risks associated with your business. If that happens, your processor could add a reserve after processing has begun to protect against the newly discovered threats.

Check Your Cash Flow

Before you sign the contract for your merchant account, run the numbers. Review your monthly operating figures. Will you have sufficient cash flow while funds are being withheld?

If not, think about what other options you might have. For example: 

  • Could you use other payment methods until your company is stable enough to qualify for an account without a reserve? 
  • Should you drop some items from your inventory so your company wouldn’t be perceived as such a high risk?
  • Could you take on a business partner who has a better credit score? 
  • Would the processor allow you to pay higher processing fees in exchange for a lower reserve percentage? 

You don’t have to automatically accept the terms that are offered. Try to think outside the box and explore options that might make your reserve less restrictive. 

Ask For a Review

After you’ve been processing for a while and have some historical data to review, ask your processor to reevaluate your situation. 

If you have had consistently low chargeback counts, ask if your reserve amount could be decreased and some of your withheld funds released.

Think About the Future

If your processing agreement is terminated, your reserve funds won’t immediately be returned. 

Even though you aren’t processing any new transactions, customers can still dispute the sales you’ve already made. The processor will retain your reserve account funds to cover any chargebacks that are filed. 

Most chargebacks have to be initiated within 120 days of the transaction. But sometimes, disputes can be issued up to 540 days later. Your merchant agreement will outline the timeline for returning reserve account funds and explain how long you’ll be responsible for disputes. 

Be sure to take this delay into consideration. If you plan to open a new merchant account, you may need to have money in multiple reserve accounts at once.

Prevent Chargebacks

Chargebacks can have a significant impact on several different aspects of your business — including the amount of money that’s tied up in a merchant account reserve. 

If you are lucky enough to be approved for a merchant account without a reserve (or relatively little withheld), don’t get too comfortable!

Reserves typically begin when payment processing privileges begin, but your processor might add one at a later date if your chargeback activity increases. 

Therefore, it’s important to constantly monitor your chargeback situation and do all you can to keep risk in check. 

We have dozens of blog articles that offer valuable chargeback prevention tips. If you haven’t already, be sure to check them out. You can find them here

Get Your Chargebacks Under Control with Midigator

Chargeback management is an essential task, but it can be complicated and time-consuming. 

At Midigator, we believe the challenge of running a business should be delivering great products or services, not managing payment risk. We want to remove the complexity of payment disputes so businesses can get back to business. 

If you’d like help simplifying your chargeback prevention responsibilities so your merchant account reserve is more manageable, contact Midigator today. Our team of experts can help improve your cash flow and enhance your bottom line. 

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