How do you stop bad merchants from racking up chargebacks, selling unauthorized high-risk products or services or taking advantage of outdated fee schedules? What about protecting buyers from bad business, predatory practices or outright fraud?

Merchant underwriting is one of the most crucial tasks in the payments space; it helps ensure that your merchants are legitimately identified, of proper financial condition, and conform with your risk policies. Unfortunately, error-prone manual processes and workflows regularly lead to critical errors, lost revenue and missed warning signs. Without the right tools, these missteps can cost unnecessary time, money and sleepless nights (not to mention incurring debilitating fines).

Thankfully, with the help of technology, legacy underwriting processes are evolving to be faster and more accurate. 

So, what is merchant underwriting, why is it so important for both payment providers and SaaS organizations and how is technology addressing the challenges that have traditionally made it so difficult? In this article, we’ll take a closer look at this all-important payments process and how modern tools are revolutionizing the field.  

What Is Merchant Underwriting?

Merchant underwriting is a due diligence process that assesses a merchant’s potential risk before onboarding them. It’s a key process that helps companies determine whether merchants align with a company’s risk tolerance, are safe to do business with and establishes an initial estimate of downstream risk management costs (potentially defining what fees should be charged). With proper due diligence, companies can protect themselves, their customers, their sponsor bank(s) and their profits from unexpected fraud, unsavory activities and losses.

Most merchant accounts undergo two key underwriting stages: initial underwriting, which happens at the beginning of a merchant’s relationship with a processor, and ongoing risk-based monitoring, which monitors merchant risk as it evolves over the lifetime of the merchant relationship. 

Initial Merchant Application Screening

In most cases, initial underwriting happens when a provider receives a new merchant processing application. In the case of payment facilitators (PayFacs) like PayPal, it occurs when a business signs up to become a sub-merchant. During the initial screening, an underwriter will review the application and merchant information to generate a risk profile. 

Underwriters will analyze a variety of information, such as:

  • Vital business information
  • Business structure
  • Existing business history
  • Credit data
  • The merchant’s industry
  • The products/services the merchant sells
  • Transaction volume
  • Chargeback history

Initial underwriting is risk-based and dynamic, so not every merchant will undergo the same process. For instance, a merchant in a higher-risk industry will go through a more thorough underwriting process than one selling lower-risk goods or services.

While most providers underwrite merchants when they first receive an application, some delay underwriting in favor of a faster merchant onboarding experience. For instance, PayPal lets new users sign up right away but with tight limits on their accounts. Merchants can start selling but will be unable to withdraw funds for up to 21 days. A merchant’s vertical (such as higher-risk industries like travel or gambling) can also impact their account status post onboarding. 

Once PayPal’s underwriting team completes the risk assessment, it will either approve the merchant and extend, reduce or lift those initial limits or decline the merchant altogether. Unfortunately, this means that a merchant may spend several weeks selling their products or services, only to not pass the company’s underwriting checks and be unable to readily access their revenue.

Underwriters also perform KYC (Know Your Customer) and AML (Anti-Money Laundering) checks on merchants to remain compliant with regulations. These checks involve verifying a merchant’s identity using documentation like their government-issued ID, entity registration documents, bank statements, etc. AML is particularly important in the financial industry as it ensures bad actors aren’t exploiting weaknesses in processing to move laundered money, commit fraud or get around sanctions. 

Whether underwriting happens immediately or after a short delay, every merchant goes through an initial underwriting process — no matter how they sign up for payments. 

Ongoing Monitoring

Merchants are rarely static; their businesses grow and evolve, opening the door to new types of risk. Ongoing assessments track and manage that risk by actively monitoring and periodically re-underwriting merchants. This allows providers to keep a close eye on their merchant portfolio and monitor for account or behavioral changes. 

Ongoing monitoring also enables payments companies to sniff out merchant fraud and identify questionable behavior. Bad actors may lie on their merchant applications to get past initial underwriting or to access favorable pricing.

Common fraud schemes that can sneak past initial underwriting include:

Transaction laundering: An approved merchant processes transactions on behalf of an unapproved one. 

Business changes: A merchant applies under a low-risk business model and then, once approved, changes their business model to include higher-risk activities. 

Bust-out fraud: A fraudster opens a merchant account and uses it to access lines of credit, potentially for years, before disappearing without repaying the credit.

These types of fraud are nearly impossible to detect during initial underwriting. Thankfully, by regularly comparing a merchant’s ongoing data to their original applications, payment companies can stay ahead of changes and ensure risk is managed, pricing is up to date and bad relationships are severed. 

Ongoing monitoring is also extremely important for maintaining a tight AML framework. It allows providers to maintain compliance and ensure things like money laundering, fraud and cybercrime don’t slip through the cracks. 

Common Merchant Underwriting Challenges

Good underwriting is key to minimizing risk and maximizing profits. But, with merchant fraud still rampant, where is the underwriting process failing? Traditionally, merchant underwriting challenges arise from two factors — speed and complexity. 

Traditional Underwriting is Slow

Thorough risk assessments require underwriters to check dozens (or, in the case of high-risk merchants, hundreds) of data points. For each application, the underwriter has to verify the merchant’s information manually, checking complex databases and conducting in-depth identity verification.

Unsurprisingly, doing the job right is time-consuming — often taking days or weeks to vet a new applicant. The problem is that slow underwriting leads to long approval times, a frustrating dilemma for merchants who want to start selling quickly. As a result, it isn’t uncommon for underwriters to overlook or rush through essential checks to move applications along. Failing to perform adequate checks, though, can lead to inconsistent assessments and missed red flags, letting risky merchants slip through the cracks in the name of speed and customer experience. 

Traditional Underwriting is Prone to Human Error

Another major setback is human limitation. With so much data to analyze before an accurate assessment can be made, it’s easy for underwriters to miss critical details or fail to make connections that would expose a merchant’s true risk. Unfortunately, this is an unavoidable consequence of traditional, manual merchant underwriting. 

Everything from fatigue to experience, or lack thereof, can impact the results of manual risk assessments; even a great underwriter can still miss checks or misinterpret results on an off day. Because underwriters are often pressured to work faster and keep the merchant onboarding pipeline moving, mistakes can add up quickly. 

How Automation and AI Are Revolutionizing Merchant Underwriting

The traditional choice between speed or consistency isn’t good enough, especially in today’s complex digital environment. Thankfully, modern technology is making it easier to underwrite merchants quickly and accurately. 

By leveraging advances in artificial intelligence (AI) to quickly and consistently analyze data, automated underwriting systems are making it faster, easier and cheaper to underwrite merchant applications while catching more red flags. Automation also allows providers to schedule risk-based periodic reassessments without driving up costs related to manual reviews or causing bottlenecks. It enables analysts to move credible merchants along with fewer roadblocks and spend more time on merchants with true risk exposure — a win-win for everyone. 

Automation Maximizes Consistency — The Key to Great Underwriting

Automation is perfect for repetitive tasks. The best automated underwriting tools can check over 100 data points, in near-real-time, by analyzing industry databases, web searches and even Google Maps imagery. Users simply define which checks to run for each merchant type, and the system does the rest.

Afterwards, the system will generate a risk report outlining its findings, including any yellow or red flags detected during its analysis. It can even make recommendations based on pre-set risk thresholds, enabling human underwriters to confidently approve, deny or flag applications for further review. The result is a merchant underwriting process that is far more accurate and consistent than manual checks.

Automation Eliminates the Underwriting Bottleneck

Automated underwriting tools, especially the newest generation powered by AI, can access a database, find necessary information, analyze it and incorporate it into a risk score in a fraction of the time it would take a human underwriter. That speed makes a huge difference in applications requiring dozens or even hundreds of checks; it makes it possible to perform a complete, accurate risk assessment in a few minutes rather than days or weeks. 

Automated underwriting enables human underwriters to spend less time on repetitive busy work and more time analyzing complex, higher-risk applications. It also eliminates the traditional bottleneck caused by manual processes; turning underwriting from a payment provider’s slowest process into one of its fastest. That, in turn, results in faster approvals, happier merchants and a more competitive offering. 

With automated underwriting, companies can have merchants approved and selling in a fraction of the time without merchants needing to worry about losing access to their accounts due to a delayed, post-onboarding underwriting process.

The Importance of Automation for Software-Driven Embedded Payments

Embedded software payments are gaining rapid adoption, changing how businesses and consumers shop and pay. This technology makes it faster and easier for businesses to sign up for payment processing through the software they already use daily. 

A slow underwriting process that delays approval for days or weeks breaks the perception of convenience, disrupting the benefits that make embedded payments so attractive. To ensure that doesn’t happen, payment providers with software solutions and SaaS companies offering payments need fast, automated underwriting — whether they develop a solution in-house or team up with an industry partner instead. 

Let NMI Handle Merchant Underwriting for You

At NMI, our goal is to simplify merchant underwriting and onboarding, whether you want to own the process yourself or pass the heavy lifting to a partner. We have two solutions that offer various levels of control: NMI Payments and NMI MRM.

  • NMI Payments is an embedded payments solution that enables partners to sell complete merchant services almost instantly. With NMI Payments, our team underwrites merchants on your behalf, relying on decades of experience and advanced automated tools to ensure the fastest possible approvals and the lowest possible risk
  • NMI MRM is our all-in-one merchant relationship management solution. It gives partners access to advanced AI-powered underwriting and ongoing risk assessment tools, enabling teams to confidently streamline and enhance the underwriting process 

To find out more about how NMI makes merchant underwriting a breeze, contact a member of our team today.

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