Chargeback operations is a hassle for any merchant or institution. Fraud and customer disputes are time-consuming, costly, and labour-intensive — elements that limit your business growth. For any merchant or financial service, effective fraud prevention and chargeback resolution is crucial for the safety of customers and your business.
Fraud is a growing problem for digital payment services. The cost of fraud in the US to fintechs and financial services is a reported $3.84 for every dollar lost, and that number is increasing on average by 2.8% each year. According to a Nilson report, fraud losses via payment cards amounted to $28.65 billion in 2020. The financial damages involved with criminal activity affects all businesses, and the chargeback review process is designed to combat the problem of fraudulent charges. Unfortunately, what started as helpful consumer protection laws have created lengthy dispute processes that do not always favour the merchant or financial service.
We will look into the entire chargeback process and show how you can take measures to reduce dishonest chargeback claims, helping protect your business and its bottom line from the hurtful cost of fraud.
Table of Contents:
- What Is Chargeback Fraud?
- What Types of Chargeback Fraud Exist?
- True Criminal Fraud
- Friendly Fraud
- Merchant Error Disputes
- How Does the Chargeback Fraud Process Work?
- Customer Chargeback Request
- Second Review
- Chareback Fraud Consequences for Business
- Direct Chargeback Repayment Costs
- Loss of Goods
- Credit Card Fees
- Bank Fees
- Operational Costs
- Reputation Damages
- How to Fight Wrongful Chargeback Claims
- Repair the Issue Through Customer Service
- Use Merchant Purchase Inquiries
- Collect a Burden of Proof
- Create a Reason Code Template
- Sumbit Chargeback Evidence
- Track and Prevent Chargebacks
- Do Customers Always Win Chargeback Fraud Claims?
What Is Chargeback Fraud?
To fully understand chargeback fraud, you first need to know what chargebacks are.
The chargeback process is a set review system designed to increase the safety of online and credit card payments. Before chargebacks, any purchases made from lost or stolen cards left the cardholder liable, with few ways of getting their money back. Giving customers the ability to dispute purchase amounts and fix any errors associated with their physical and digital cards created buyer confidence, helping build business trust.
The chargeback process also protects banks, businesses, and financial services, as it provides you with a legal way to evaluate, refund, or refute any misuse of a credit card. All parties involved (the buyer, the selling merchant, and the payment service) want to defer the fraud losses, and a standard method to review a transaction and correct any wrongful amounts ensures the safety of digital transfers for everyone.
Chargeback fraud is when the fairness and security of the chargeback process is exploited for money or financial gain. Whether on purpose, through user error, or from bad actors abusing the system, chargebacks and its extensive review systems can leave a business exposed to additional financial risk. After transaction fees, penalties, loss of time, and the waste of goods, the true opportunity cost of a 100$ chargeback claim is said to be around $240, amounting to 40 billion in lost revenue each year. Someone must bear the cost of chargeback errors, and whether they occur with or without intent, the theft is considered chargeback fraud.
What Types of Chargeback Fraud Exist?
There are three types of chargeback fraud as defined by most financial institutions:
- True Criminal Fraud: Criminal intent is the most obvious and direct example of bad actors abusing the system of digital payment trust, often involving a stolen credit card, personal information, or identity of an unsuspecting victim. A fraudulent actor can use the taken credit card to initiate several purchases, leaving the original card owner to begin a chargeback process to prevent or reverse those losses. It is in both the financial service and the legal card-owners interest to limit the criminal activity of this kind and reduce the total chargeback requests.
- Friendly Fraud: Friendly Fraud is when a customer makes a purchase with a card, initiates and wins a chargeback claim, and then wrongfully keeps both the item and the claimed money, leaving either the merchant or bank to cover the loss. Certain cases of friendly fraud are accidental and stem from post-payment issues such as shipping delays or unaccounted packages, but some malicious users game technical systems or company policies to their advantage.
- Merchant Error Disputes: Merchant error chargebacks are caused by system issues, poor customer service, unwanted or wrongfully charged payments, or faulty product fulfillments. These scenarios can lead to accidental friendly fraud and still result in chargeback claims that hamper revenue growth and profits.
Occurance Of Chargeback Fraud Per Transaction
Criminal Fraud — 5-10%
Friendly Fraud — 60-80%
Merchant Error — 10-20%
How Does the Chargeback Fraud Process Work?
The chargeback process follows a set review system between all the involved stakeholders who attempt to locate the fraudulent activity and then assign who is responsible for the charges.
- Customer Chargeback Request: The cardholder calls up their financial service when they notice an incorrect payment on their credit card statement (they usually have 45 – 180 days to make their chargeback claim) and requests information or a money refund. Sometimes a credit card or bank may flag suspicious account activity and notify the user beforehand, leading to the chargeback claim.
- Review: The issuing financial service runs an in-depth evaluation of the suspicious transaction and then contacts the merchant for proof of legitimacy (shipping confirmation, invoices, transaction receipts, etc). Many credit cards will refund the chargeback money to the customer at this point and send a standard chargeback dispute notification to the merchant.
- Deliberation: The card holder’s bank decides to uphold or dispute the chargeback request of the customer, passing the fees over to the merchant or customer depending on who is found at fault.
- Second Review: The party deemed responsible for the chargeback losses has another opportunity to fight their case and amass additional information as evidence of their claims.
- Arbitration: If either the customer, the financial institution, or the merchant disagree with the decided chargeback costs, arbitration begins. Arbitration is governed by the credit card association and their decision is final. All parties can take the arbitration decision to the court of law for recourse at their own expense if they so desire. The arbitration process incurs additional costs, so most institutions and merchants do all that they can to avoid this step if possible.
The review cycle can happen multiple times to ensure that a fair dispute process can occur before arbitration, allowing the at-fault party time to refute any bank issued decisions. MasterCard, Discovery, and American Express allow for two cycles of pre-arbitration review, while Visa limits their review process to one. Within each of the review cycles, the issuing bank temporarily gives the chargeback funds to both parties as a simple version of escrow, returning the held money from whoever loses the dispute.
Chargeback Fraud Consequences For Business
The entire chargeback process causes several different forms of financial loss for any business or financial service:
- Direct Chargeback Repayment Costs – If found at fault, the total charge plus any additional expenses incurred during arbitration are applied.
- Loss of Goods – In the case of friendly fraud, the money plus the merchandise is lost, doubling the total value cost of the item.
- Credit Card Fees – Credit card companies charge transaction fees for each payment transfer, regardless of if you are found at fault for the fraudulent chargeback or not.
- Bank Fees – Many banks or issuing institutions levy set fees for any chargeback, no matter the outcome.
- Operational Costs – If an item is recovered because of incorrect chargebacks, system errors, or reversed friendly fraud, costs involved with shipping and inventory still apply. There are also cybersecurity and cybersecurity infrastructure that adds to your expense. Teams also spend time adjusting systems to account for breakages.
- Reputation Damages – A reputation of failed dispute claims and a lack of security against malicious fraud will hurt customer trust and can even have extended consequences with credit card networks. After several wrongful chargeback claims or an increase in disputes, credit cards can limit activity through their Dispute Monitoring Programs (DMPs), and banks often lower their authorization rates.
How to Fight Wrongful Chargeback Claims
There are several actions you can take to fight an incorrect chargeback claim.
- Repair the Issue Through Customer Service: The most effective method of dispute resolution occurs before the chargeback process, and it involves resolving the claim between the merchant and the cardholder. Instead of initiating the laborious review system, attempt to prevent the customer dispute through refunds, store credits, or other client-centric options. This practice is very useful for chargeback claims of small monetary amounts.
- Use Merchant Purchase Inquiries: Some credit cards offer fast-tracked dispute resolution for businesses that prevent the chargeback process where you can supply additional information such as transactions records or receipts before an official review, helping eliminate many chargebacks made in error.
- Collect a Burden of Proof: Any collected records you provide that prove the legitimacy of your sale will weigh heavily in your favour. New software integrations and point-of-sale systems collect data such as IP addresses and delivery notifications that help you win your case with a credit-card association.
- Create a Reason Code Template: Chargeback reason codes classify each disputed claim to make the review process easy for all involved. Examples include “No Valid Authorization”, “No Receipt Signatures”, or “ EMV Counterfeit”. Creating paperwork according to reason codes allows you to send the right information to fight your claim (e.g. if the reason for the dispute is a missed delivery, send tracking codes).
- Submit Chargeback Evidence: Once you submit your evidence to either the issuing bank or credit card, the rest of the ruling process is out of your control. You can pursue arbitration if the review process is deemed unfair, and you can elevate large chargeback fraud into the courts of your jurisdiction for more aggressive dispute resolution.
- Track and Prevent Chargebacks: Take note of what types of fraud are occurring and take steps to prevent them. Discover which reason codes you have a good chance of winning in arbitration and take the steps needed to protect yourself and your customers, lowering your overall risk exposure and improving your chargeback dispute ratio.
Do Customers Always Win Chargeback Fraud Claims?
Chargebacks do cost your time, effort, and expense, but the process is designed as a fair system — you have a good chance of winning a fraud claim if you collect and present a wealth of pertinent information. Compelling and direct evidence that demonstrates a faulty claim has a high probability of winning a dispute. Maintain all deadlines, and take advantage of any software applications that can collect the needed data, helping to lower your costs while offering comprehensive customer reports for evidence.
Attempt to keep your chargeback ratio at 1% — anything above that will label you as a high risk. Take proactive steps to help limit the three types of chargeback fraud, as neither you, the customer, the credit card, or financial service want the chargeback process to even begin. Overt fraud prevention helps increase brand trust, customer engagement, e-commerce security, and will protect your bottom line from aggressive fees and dispute costs. If a chargeback claim does occur, take the necessary steps to provide evidence to your case, as clear proof can result in a winning dispute. If a business error occurs and you know you will lose any chargeback claims, attempt to resolve the issue before beginning the chargeback process, saving time and expense.