The Threat of Chargebacks

Ria Golovakova
February 1, 2021
Read time:
3 min

Chargeback abuse (otherwise known as “friendly fraud”) is when a cardholder files to reverse a transaction without a valid justification. Friendly fraud cost merchants an estimated $35 billion in 2019. This number is only projected to have grown over 2020 with the rise of online shopping.

Given these immense costs, what is friendly fraud and what options do merchants have to protect themselves against it?

When a cardholder reports a transaction as fraudulent or requests a chargeback because the product purchased was never provided, the card network (Visa, MasterCard, or AmEx) would take the money for that transaction back from the merchant. The merchant can dispute the chargeback with a receipt and proof that the transaction was not fraudulent, which would make either the cardholder or the bank liable for the cost.

In theory, chargebacks are a good way to protect the consumer from fraudulent transactions. The process works as follows:

  • Bill logs onto his bank account and sees a transaction from Corgi Pizza Co. that he does not recognize.
  • Bill calls his bank, reporting the transaction as fraudulent.
  • The bank consults Corgi Pizza Co, asking about the nature of the transaction. During this process, the funds from Bill are frozen from Corgi Pizza Co.
  • If the bank decides to move forward with the chargeback, it moves the funds back to Bill.
  • MasterCard (Bill’s card scheme operator) processes the chargeback and charges Corgi Pizza Co. a chargeback processing fee.
  • If Corgi Pizza Co. want to contest this decision, they need to deal with MasterCard’s arbitration process.

It may not be apparent from this description, but both banks and card networks usually take the cardholder’s side. This means that if a merchant wants to contest a chargeback, they need to invest a lot of time and resources to submit the relevant paperwork. Disputes can also only be contested over a limited amount of time, typically 45–60 days.

Because the burden of proof falls on the merchant, many businesses simply do not contest chargebacks at all. This means that they lose the value of the original transaction and $20–100 in chargeback fees.

In addition, even if a merchant manages to win the dispute, the chargeback may impact their business. If a merchant gets close or over 1% chargeback rates (percentage of chargebacks within monthly transactions), they may lose the ability to accept card payments altogether.

None of this would be a problem if the system worked as intended and chargeback claims were mostly valid. However, it is estimated that over 85% of all chargebacks are actually friendly fraud.

This problem is only getting worse, as chargeback requests are known to increase in times of economic uncertainty. The current economic situation caused by the pandemic is making people desperate, and more likely to claim transactions as fraudulent in efforts to get items for free.

This means that if Bill did get a pizza from Corgi Pizza Co., he could have claimed that the pizza never arrived or that somebody else logged in his card details on Corgi Pizza Co.’s website. As MasterCard is likely to take his side, Bill will probably get his money back, leaving Corgi Pizza Co. trying to contest the chargeback.

Card networks are unlikely to change their perspectives and begin protecting merchants anytime soon. Thankfully, chargebacks and all of their associated problems do not exist with bank transfers. This means that if your business uses Dapi, you never have to worry about friendly fraud and chargeback fees ever again.

Tags:
Finance
Fintech
Fraud
Payment
Written by:
Ria Golovakova