Explaining chargeback fraud and how to prevent it

March 16th, 2023

Initiating a card programme can offer numerous advantages, but it requires careful consideration. In addition to securing a processor, bank account provider, and a comprehensive Fintech infrastructure capable of standardising and orchestrating the behind-the-scenes pipework - you also need to have a firm grasp on chargeback fraud.

This article explains chargeback fraud, covering the intricacies of chargebacks and providing strategies to build a successful approach towards managing them. Chargebacks are a costly problem for businesses of all sizes. In fact, there has been a 65% increase in chargeback fraud since the pandemic. Chargebacks can occur for a variety of reasons, including fraud, unauthorised charges, and merchandise that is not as described or not delivered. While chargebacks are a necessary part of the consumer protection process, they can also be a major headache for businesses.

What is the process of a chargeback?

Navigating the chargeback procedure can seem daunting due to its intricacy, but it essentially consists of the following phases:

Initiating a dispute: the cardholder begins by disputing a charge with their card issuer. They may utilise various communication channels such as phone calls, emails, or online portals to initiate this process. Essential information like their card number, the charge amount, and the transaction date will need to be provided. They'll also have to articulate their reason for disputing the charge.
Investigation by card issuer: upon receiving a dispute, the card issuer seeks the merchant's input, trying to comprehend their perspective. The issuer might also examine various supporting materials, like receipts or emails, provided by the cardholder.
Decision-making: the card issuer then evaluates all the provided information to arrive at a verdict. If they rule in favour of the cardholder, they'll reverse the charge and the cardholder will receive a refund. Conversely, if they rule in favour of the merchant, the initial charge is upheld.

In cases where the card issuer cannot reach a conclusion, the dispute might be passed on to the respective card network, like Visa or Mastercard. The card network then steps in, reviewing the case to make a final decision.

The most common chargeback reasons

Chargebacks frequently occur due to various reasons. Here are some of the most common causes:

Unauthorised usage: someone uses your card without your consent to make purchases.
Misrepresentation of goods or services: the goods or services you received significantly varied from their description or agreement.
Non-delivery of goods or services: you made a payment for a product or service that you never received.
Unprocessed return credit: you returned an item or cancelled a service as per the merchant’s return policy, but didn't receive credit for the return.
Continuing recurring billing: you cancelled a subscription service, but it continues to bill you.
Incorrect charging amount: the amount debited was not the agreed-upon price.

Processing errors can occur when the merchant makes a mistake, such as charging the wrong amount, charging the wrong card, or failing to provide adequate customer service. Customer disputes may arise due to delivery issues, product quality, or billing errors.

What is chargeback fraud?

Chargeback fraud is when a customer disputes a valid transaction, and the merchant cannot prove it. This is often referred to as "friendly fraud," when a genuine customer disputes a charge instead of discussing the issue with the merchant.

Criminals will also use stolen credit card details to make payments and then challenge the charge as unauthorised, resulting in chargebacks.

More companies are combating chargeback fraud than ever before. In 2022, there was a 75% increase in merchants implementing new measures to mitigate this type of fraud.

The difference between legitimate and fraudulent chargebacks

Legitimate chargebacks are those filed for valid reasons such as fraud, unauthorised charges, or a discrepancy between the described merchandise and what's delivered.

On the other hand, fraudulent chargebacks are filed based on invalid reasons such as buyer’s regret or a disagreement regarding the quality of goods or services.

Here are instances of legitimate chargebacks:

Fraud: occurs when a customer's credit card is used for unauthorised purchases.
Unauthorised charges: apply to circumstances when a customer's child makes purchases without the parent's knowledge or consent.
Merchandise inconsistency: becomes apparent when a customer orders a product online, but the delivered product differs from the one advertised.
Failure to deliver merchandise: represents instances where a customer's online order is not delivered.

Here are instances of fraudulent chargebacks:

Buyer's remorse: refers to cases where a customer regrets a purchase after they have already received the goods or services.
Quality disputes: occur when a customer is dissatisfied with the quality of goods or services they have received.
Service disputes: arise when a customer disputes a charge for a service they have received, notwithstanding the service provider's proof that the service was rendered.

It's important to acknowledge that the line distinguishing legitimate and fraudulent chargebacks isn't always definitive. For instance, a customer can file a chargeback claiming buyer’s remorse, but cite a discrepancy in the described and received merchandise. In such scenarios, the card issuer has to investigate the dispute thoroughly to determine the legitimacy of the chargeback.

The negative impact of chargeback fraud

Financial losses, reputational harm and operational expenses are all possible consequences of chargeback fraud. Revenue can be lost, as well as chargeback fees, reducing profitability.

Payment processors and issuing banks may view merchants as untrustworthy due to frequent chargebacks. Investigating and responding to chargebacks may also add extra strain to resources.

Why are disputes and chargebacks important to fintechs and enterprises?

When a cardholder contests a transaction on their account by contacting their card issuer, it is known as a dispute, which is intended to safeguard cardholders from fraudulent activity. If a dispute is successful, it can lead to a chargeback, wherein the issuing bank reverses a credit or debit card charge.

Disputes and chargebacks hold significant importance for several reasons:

Disputes and chargebacks can have a direct impact on the financial health of Fintechs and enterprises. Resolving these issues efficiently is crucial to minimise revenue loss and maintain financial stability.
Handling disputes effectively contributes to building and maintaining customer trust. Transparent and fair resolution processes can enhance customer loyalty, a vital aspect for the long-term success of fintechs and enterprises.
Successfully managing disputes and chargebacks ensures adherence to regulatory requirements, preventing potential legal complications and penalties.

A positive reputation is essential in the competitive Fintech landscape. Handling disputes professionally and swiftly contributes to a positive public perception, attracting new investors, customers and partners.

The data generated from disputes can offer valuable insights into customer behaviour and system weaknesses. Fintechs and enterprises can leverage this information to refine their services, enhance user experiences, and implement improvements based on customer feedback.

Effective chargeback management strategies

By implementing effective chargeback management strategies, companies can reduce their risk of chargebacks and respond effectively to chargeback disputes.

Here are some strategic practices businesses can implement to manage chargebacks:

Implement fraud prevention measures: the root cause of many chargebacks is often fraud. Businesses can substantially lower the likelihood of such fraudulent transactions by adopting preventive measures, which include implementing address verification systems and utilising fraud scoring techniques.
Ensure a clear and concise return and refund policy: it's crucial that customers can easily comprehend your return and refund policy. Make sure it's visibly posted on your website and included in your order confirmation emails.
Provide outstanding customer service: swift and fair resolution of customer issues can deter customers from filing chargebacks.
Track your chargeback data: keep a close eye on your chargeback rate and identify any emerging trends. This data can guide you in highlighting areas that need improvements in your chargeback management practices.
Respond promptly and thoroughly to chargeback disputes: when a chargeback dispute arises, ensure you provide all the necessary documentation to support your claim thoroughly and promptly.

What a successful chargeback programme looks like for fintechs and enterprises?

Fintechs and enterprises can reduce the risk of chargeback fraud by putting in place an effective chargeback management system, incorporating the following measures:

Verify customer information

Merchants should verify customer details (name, billing address and contact info) prior to processing transactions. Integrating a customer-level Know Your Customer (KYC) will help to reduce fraudulent charges.

Use fraud detection tools

Detection tools analyse various pieces of transaction data such as an IP address, device information, and purchase history of customers. For example, matching up the IP address of a customer with their payment address to understand if the transaction is real.

Implementing chargeback policies and procedures

To effectively manage chargebacks, merchants should implement clear policies and procedures. This should include steps to take when a chargeback happens, like collecting evidence, responding to notices, and disputing chargebacks. Doing so will reduce chargeback fraud risk and make chargeback handling more efficient.

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