Potential Changes to Historical Exposure/Loss Relationships in Acquiring
Intuitive, but nevertheless surprising, the acquirers that have taken the most risk historically have generally been the best at managing that risk—but we wonder if this relationship will hold true during the EMV transition.
There has traditionally been a consensus in acquiring around the estimation of credit exposure in a merchant portfolio. Exposure is a function of chargeback rate and the time it takes for consumers to initiate chargebacks, return rate and the time it takes for consumers to return items, and the delayed delivery characteristics of a portfolio, all of which sum to the amount of chargebacks an acquirer might see when merchants go out of business.
Most acquirers have had credit exposure that ranges from 50 basis points to 200 basis points of sales volume. However, there is an inverse relationship between the amount of exposure acquirers take and their losses as a percent of that exposure. The exposure at risk-intensive acquirers results in losses less frequently than the exposure at low-risk acquirers.
However, with the EMV migration, at least temporarily, there is a new variable in the equation in the form of chargebacks of consumer fraud for non-EMV-compliant merchants. With the liability shift, the least secure party bears the risk of certain types of consumer fraud; therefore, if the merchant is not EMV-compliant but the cardholder is, then the merchant absorbs counterfeit and sometimes lost and stolen fraud risk.
First Annapolis estimates that acquiring industry exposure levels have risen 5% to 10% as a result of the liability shift, a number that will fall as the migration progresses. However, the exposure is highly asymmetric and is concentrated in a subset of merchant industries that are vulnerable to counterfeit and lost and stolen fraud. (And these merchant industries are not the same as the chargeback-intensive businesses that acquirers have found risky in the past and learned to manage.) An individual acquirer could have much more substantial increases in exposure depending on how its portfolio is comprised. Different skill sets, different risks, in different merchant industries—time will tell if historical loss relationships persist.
Figure 1: Relationship Between Losses and Exposure Relative to Volume
For more information, please contact Marc Abbey, Managing Partner, firstname.lastname@example.org, specializing in Merchant Acquiring.
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