Since credit cards were first introduced in the 1970's consumers have become increasingly dependent on the increased purchasing power they provide. As a result more and more small business owners who previously accepted only cash or checks have embraced customers paying with credit cards. In fact today you can use a credit card to buy just about anything, including fast food which traditionally was a cash only business.
Merchants accepting credit cards as payment open themselves to increased business and profit but not without a fee. Now in what has been referred to as the worst economic downturn in decades, credit card processors are increasing the price of convenience and in some cases putting small business out of business. The number of businesses filing for bankruptcy is on the rise and the current state of the economy does not bode well for companies struggling to stay afloat. Some credit card giants have responded by demanding a cash reserve from merchants who process credit cards. This move may be good for the credit card processor but also the final blow for many small businesses.
When a consumer uses a credit card to pay for a purchase the transaction must first be approved or authorized to guarantee the merchant receives payment. When a credit card is swiped, information is transmitted to a processor which acts as a middle man between credit card issuers and merchants. The processor is responsible for issuing credits to the merchant and debits to the issuer . By approving the transaction the processor also becomes responsible for customer refunds. Once a refund is issued to a consumer the credit card company pulls money from the processor who in turn pulls money from the merchant. This is where the cash reserve comes into play. When a business files for bankruptcy someone has to take a loss and in most cases it is the processor. By requiring a cash reserve the processor is then protected in the event a business fails or does not have the financial resources to cover a refund.
The size of the reserves vary and can easily equal up to two months worth of transactions. More importantly if a business does not pony up the required reserve the processor can simply hold payments owed to the merchant until the reserve is met. For a large business the reserve can easily reach millions. Financial institutions claim these cash reserves are required only of businesses that present a "high risk" and consumers benefit by being protected if they seek refunds.
Unfortunately this strong arm tactic will either break small businesses who are already struggling to make it through the recession or prompt merchants to no longer accept credit cards as a method of payment. While credit card companies and processors continue to make decisions based on the need to reduce risk, it appears they are overlooking the two most important factors for their future success. Without consumers using credit cards or merchants who accept credit cards the need to eliminate risk will become a moot point.