Everyone is talking about “Big Data” and the opportunities it presents for the financial industry. The movement in the industry suggests that to make better credit decisions, you must use a lot more data.

This can mean acquiring new sources of external data, but it also can mean using the data you already have to more effectively and intelligently evaluate risk.

During a presentation at a recent industry conference, the value of using data from internal sources became abundantly clear. For this article, I’ll limit the scope of the big data conversation to the use of internal data in merchant underwriting.

The presentation conveyed the importance of both underwriting risk and ongoing monitoring in the merchant space. Underwriting merchants is a different type of risk management. Unlike credit cards, an actual line of credit is not extended. The risk comes from the merchants’ response to significant changes in sales activity.

For example, if the volume of sales, pricing or product type changes dramatically there could be a problem. Unlike a traditional loan, probability of default in the next 18 months isn’t really a relevant question. The important question is whether anything risky or unusual is likely to cause the merchant to abandon their business and take your money with them.

While solid underwriting practices are as critical here as with any credit product, it was clear that the bigger opportunity to manage risk lay with effectively monitoring the portfolio of active merchants.

Unlike consumer credit cards, where new regulations limit the ability of issuers to change terms quickly when a consumer suddenly presents a higher risk, merchant acquirers still retain some flexibility to withhold payments. This allows them to actively monitor the performance of their merchants and respond quickly when there are signs of a problem.

An example of this was shared by a merchant acquirer. Two of their merchant customers were furniture stores. Both ran profitable businesses for years and both were dependent on a supply chain to deliver goods quickly.

A dock strike closed their supply chains creating a backlog of unfilled orders. The acquirer recognized the change in one store’s transaction streams by examining their own big data – few new charges, increased chargebacks and refunds. They contacted that store owner and learned that he was overwhelmed with orders he couldn’t fulfill. They worked together to address most of the issues and eventually ended up with only a $10,000 loss.

Unfortunately, they didn’t identify loss indicators occurring in the other store until it was too late. The store owner, overwhelmed and feeling helpless, abandoned his business, taking all of his liquid receipts with him. The merchant acquirer had to absorb more than $300,000 in chargebacks. In identical situations, the ability to recognize problematic trends early made all the difference.

The financial loss from a single merchant can range from thousands to even millions of dollars, therefore it is essential that merchant acquirers and ISO’s continually monitor and evaluate their merchants and quickly react to credit and fraud risk indicators. 

In many cases, merchant acquirers are monitoring their accounts using a spreadsheet. This might seem simple to those using databases and complex analytics, but it can be effective. Even a monthly, manual review can uncover your greatest ongoing risks.

Other companies have techniques and tools that allow them to evaluate new merchant applications in real-time and proactively monitor merchant accounts by applying automated risk triggers to signal potential problems.

In the end, the goal of every risk manager, regardless of their industry or product type, is to identify and manage risk that emerges in their portfolio as the economy and their clients evolve.

You have the data needed to identify these risks, the question remains if your processes are identifying risks at each stage of the customer lifecycle. As critical as underwriting is, ongoing account monitoring is vital to effective risk management.

Eric Lindeen is the marketing director for Zoot Enterprises, located in Bozeman, Mont. His email is eric.lindeen@zootweb.com. 


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