How the Payment Facilitator Model Is Designed to Protect Merchants

For years, small merchants were underserved by the payments system. It was not cost-effective for banks to serve the needs of the smallest businesses, limiting the forms of payment many of them could accept.

In recent years, more and more options have arisen to bridge this gap. Increasingly, other types of providers are the ones to work directly with small and micro merchants.

But not all options are created equal when it comes to protecting merchants and the payments system overall. Significant protections for merchants are built into the payment facilitator (sometimes called payfac) model. And this can have important implications for the businesses served.

Underwriting and onboarding

Payment facilitators’ activities and their relationships with their submerchants are tightly regulated by the card brands. In addition to requiring the acquiring bank to underwrite the payment facilitator, network rules require payfacs to underwrite and monitor their submerchants on an individual basis, with oversight from the acquiring bank.

Why does this matter to merchants who are operating legitimately? The underwriting rules ensure that the payfacs themselves are vetted, but they also guard against payfacs taking on merchants who are unscrupulous, lowering reputational and financial risk for the payfacs and its other submerchants. They also lower the risk of payfacs going out of business unexpectedly, leaving the merchant without processing services.

Contrast this approach with that of marketplaces, for example, which connect sellers and consumers on one website or app. Acquirers underwrite and onboard the marketplaces themselves, and they treat them as they would merchants. They monitor transactions on a marketplace’s platform as if they come from a single entity rather than individual sellers. The marketplace is solely responsible for vetting and monitoring its merchants and reporting to them about their individual activity. The level of oversight the marketplaces are subjected to is left up to the individual acquiring bank.

Funds settlement

The settlement of funds is also typically handled with stringent oversight in the payfac model. In most cases, submerchant funds are segregated from the payfac’s funds into what is known as a “for benefit of” (FBO) account. The payfac typically retains control over the merchant experience by providing instructions to the bank on how and when to pay out the funds, but the bank retains control of the money. Payfacs do not have access to those funds.

In this way, the merchant is protected from losing their money if the payfac goes out of business for some reason. FBO accounts also prevent the payfac from commingling their merchants’ sales with their own funds and using it for purposes other than paying those merchants what they are owed. And finally, the bank has a direct view into the payfac’s activities, so they are better able to detect inappropriate activity.

Returning to the marketplace example, acquiring banks must settle funds from sales directly to the marketplace rather than to the individual sellers. The marketplace has control over the funds in their own account and how those funds will be paid out to the merchant. They are also solely responsible for determining fees and providing reconciliation statements to their merchants.

The oversight that is built into the payment facilitator model is important because it helps prevent the introduction of bad actors into the payments system. But it’s also beneficial to the merchants themselves.

While small and micro merchants are better served than ever before by a choice of payment providers, it’s important for them to understand how the different oversight of the models ultimately protects them.