The Green Sheet Online Edition
February 23, 2015 • Issue 15:02:02
Advances in data, automation speed FI merchant boarding
Each product line offered by a financial institution (FI) carries varying degrees of risk. This risk is borne by the FI and correlates to increases in required diligence, time and costs needed to properly assess a potential customer. Underwriting a business loan provides considerably greater risk (and financial return) than providing a business checking account, with payment acquiring falling somewhere in between.
The process of underwriting and boarding merchants is undergoing a renaissance, led by early innovators with new business models. Online lenders, payment service providers (PSPs) supporting micro-merchants, and alternate payment schemes have emphasized online applications, quick decisioning and streamlined boarding.
In general, stalwart FIs with a long history of serving the business community have been slow to embrace these innovations, in part, because they have to transition their successful, legacy systems and processes rather than build something designed on a clean slate. During this renaissance, institutions that modernize their approach, incorporating new data sources and automation, where applicable, will continue to have an advantage over those that stick with "tried and true" legacy processes.
Conditional approvals benefit underwriters
An example of one new method is conditional approval. Innovative acquirers are no longer relegating applicants to a simple yes or no decision, but sometimes extending a yes with caveats. This is particularly relevant in merchant acquiring, where the approval caveats may include delayed settlement and transaction thresholds.
With conditional approvals, a review of the merchant's recent history and careful post-approval monitoring of merchant activity allow innovators to embrace new, unknown and seemingly risky merchants and drive incremental revenue without assuming undue risk. Whereas long-established FIs are slow to embrace this type of approval model for higher risk merchants, these merchants often grow into successful, stable businesses that benefit the innovative underwriter.
Given rapid industry change, FIs are wise to take a fresh look at underwriting policies and procedures to maximize business opportunities. Just as zero bad debt from customers in merchant credit often translates to lost sales, an over-tightened underwriting process can lead to missed business.
The need for speed (and automation)
Online applications, fast enrollment and continuous underwriting – innovations once exclusive to the servicing of micro-merchants – are finding their way up-market to small and midsize businesses. As merchants demand faster decisioning and competitive rates from their banking partners, FIs are increasingly challenged to reduce costs and application processing time.
To pick up the processing pace, some acquirers are revising underwriting workflows with technology and data sources that meet several requirements, including:
- Data delivery via API. APIs are computer-to-computer requests, responses and automated communication. The client typically "calls" the vendor's application, which then transmits the results.
- Fast response times. Underwriting is approaching near real-time information, often measured in seconds instead of minutes or days.
- Relevancy. Data that is relevant is applicable and inclusive of the applicant pool.
- Predictive value. Models based on data science generate a score or probability that a meaningful future event, such as merchant fraud, will occur.
- Online Applications. Self-serve forms enable a merchant to apply for an account electronically.
Here's an example. A European PSP was processing approximately 3,000 merchant applications per month. At the average speed of 30 minutes to manually review each application, the client needed roughly 10 full-time staff to process prospective merchants.
Paper applications and long decision cycles simply do not meet the expectations of some merchants, especially when they have other alternatives. By using APIs and relevant data, the European PSP is now able to preliminarily approve 61 percent of new applications, quickly decline 25 percent and manually review 14 percent. Enhancing the process helped decrease the time needed to review 3,000 new merchant applications by 93 percent, while maintaining current acceptance levels (See Figure 1).
Whether a business provides commercial loans, payment acceptance (that is, credit cards or automated clearing house), or other business services to merchants, many of the same principles apply when it comes to diligence. The principles cited herein serve to reduce both the time and the cost to process an application. This, in turn, leads to greater profitability by reducing the costs to process a set number of applications, or allowing for greater throughput and more applications processed with a set budget and resources.
requiring manual review
|Manual review minutes
Cost effective information
With perfect information, an analyst could accurately assess the risk a merchant poses to future continuity and profitability. Yet even if perfect information were available, it would be cost prohibitive. The key is balancing underwriting costs with the value of information, omitting sources that are too expensive or provide minimal predictive value. To get the most information value using the least amount of time, innovators commonly use two approaches:
- Least cost decisioning. This is the concept that early, inexpensive tests in the diligence process can eliminate the necessity of costly further steps. An early process step, like pulling a credit score, or an even more detailed score, at the time of application, can help to identify merchant applications with poor prospects, leading to the elimination of high-risk merchant applications early in the process, saving time and money. Similarly, a very favorable score might allow the analyst to bypass some further diligence steps and fast-track boarding.
- Continuous underwriting. This concept took root with the boarding of the micro-merchant population, the very smallest merchants who typically do not have a direct business banking relationship. Often minimal diligence is undertaken initially with micro-merchants, but the terms are usually more restrictive and the transaction costs higher than what a merchant typically receives in a traditional, more thorough underwriting process. As the merchant matriculates and grows in revenue, payment transactions, working capital, and commercial lending needs; additional diligence steps are taken.
There are two reasons to continuously underwrite a merchant:
- A. To ensure the merchant doesn't later engage in illegal or noncompliant activity for which the FI bears liability
- B. To retain the best customers
Over time, merchants often ask for and shop around for better terms, hoping to lower transaction fees, limits or funding hold times. Here the process of continuous underwriting enables the FI to determine if the risk profile has changed since initial boarding. The FI could offer more favorable terms, where appropriate, and retain a customer that otherwise might churn to a competitor.
Successful FIs are staying ahead of industry changes in the underwriting process with conditional approval, automation and lower-cost information. Best practice dictates that companies enhance their current underwriting processes with real-time, predictive insights into a merchant's likelihood of future risk, and boost their processes using the right partners to reduce the number of manual reviews. By enhancing underwriting processes and tools, FIs will find they are boarding better merchants, faster, and with more confidence in their decisions.
Matt Ward-Steinman is the Vice President of Solutions Development at G2 Web Services, a leading provider of merchant risk management services including compliance, due diligence, and fraud prevention. For more information about G2 Web Services, or to learn more about their enhanced diligence services, visit www.g2webservices.com.
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