Why credit card chargebacks are important
The purpose of this article is to improve the understanding of the important concept of credit card chargebacks among merchants, resellers and credit card transaction processors. With better understanding of credit card processing lifecycle in general and chargebacks in particular, they can avoid considerable money losses resulting from online credit card fraud.
Many people do not have a clear picture of the full online credit card processing cycle and mostly concentrate on the initial phase which includes processing and funding. Some are stuck with the misconception that transaction approval is the concluding phase of the process. However, the cycle doesn’t actually stop at this phase. It is important to understand the full lifespan of credit card transactions. Special attention should be given to credit card chargebacks. (To realize, the importance of chargebacks, it is sufficient to check some chargeback statistics ).
Many merchants that do not have thorough understanding of how credit card transaction processing functions often fall victims to chargeback fraud. Consequently, one should keep in mind the possibility of fraud, induced by the nature of credit card chargebacks.
Credit card chargeback concept
Basically, credit card chargeback mechanism is one of consumer protection instruments. In general terms, a chargeback is a cardholder-initiated dispute over a certain amount of money the cardholder assumes to have been charged illegitimately (or in error) for products or services he or she did not get.
A chargeback happens as follows.
First a purchase-related transaction is processed. Afterwards, the buyer discovers that he or she was charged a certain amount of money for a service\product that he or she didn’t actually purchase (or believes he or she didn’t purchase). The buyer contacts his or her bank and asks for a possible reversal of the charge (known as credit card chargeback). The final decision is made by a card association (Visa, MasterCard etc). If the ruling in the chargeback case is made in favor of the buyer (cardholder), the money is withdrawn from the merchant’s bank account and returned to the buyer. Otherwise it remains with the merchant.
A chargeback decision can be subsequently overruled through an arbitration process. In this case a reversal is issued and the money is returned to the merchant. Quite often, regardless of the decision, a chargeback fee is applied. Regardless of the chargeback outcome, the chargeback rate of the merchant (percentage of chargebacks in the total volume processed) is going to rise. The problem is that when it exceeds 1 %, the merchant gets on the MATCH list (also called Terminated Merchant File) and can no longer process credit card transactions.
Most people think that if a credit\debit card transaction is processed and gets funded in their bank account, the process is complete. In reality, there is always a possibility of debit and credit card chargebacks, which can take place up to 60 days after the original purchase is made.
Since most people do not look at their statements every day, there is a possibility of credit fraud around credit card chargebacks.
Let’s address the two possible types of fraud involving credit card chargebacks: consumer fraud and merchant fraud.
The most common chargeback fraud scheme, that should be mentioned, is a consumer-based one. It is implemented by fraudsters who simply make purchases online using stolen cards, i.e. pay for their online purchases with somebody else’s money.
Another chargeback fraud scheme, involving merchant accounts, is more complicated. Let’s assume a fraudster managed to obtain a large set of credit card numbers (possibly stolen from an online store database). The fraudster subsequently obtains a merchant account, uses stolen cards and processes transactions (presumably, not involving large sums, not to get detected by fraud protection tools). The next day the fraudster’s merchant account gets funded, he collects the money and flies to Bahamas (or elsewhere). Within the next 60 days the cardholders discover illegitimate charges on their credit card statements, issue chargebacks and the processor or merchant account underwriter (ISO/bank) is now paying for the lavish vacation of the fraudster with their own money.
It is important to note, that card not present transactions are carrying higher risk of potential fraud. In order to detect and prevent fraudulent CNP chargebacks merchants and resellers can use various tools.
Because of the fraud mechanism described above, all merchants requesting merchant accounts today have to go through a strict underwriting procedure.
Chargeback fraud prevention methods
1) There are some indirect signs, which might indicate high risk of fraudulent CNP chargeback. These signs include risky account locations (billing addresses) outside US, multiple account numbers accompanied by one and the same address, and others.
2) There are prevention tools offered by credit card issuers. These include address verification service (AVS), Verified by Visa (VbV) and MasterCard Secure Code (3D secure), Card code verification (CCV) and others.
3) ISOs and Payment service providers (PSPs) can hold a special chargeback reserve to cover potential credit card chargebacks, issued by merchants’ customers.
In order to avoid money losses resulting from chargeback fraud, merchants, resellers and processors need to understand the transaction processing cycle thoroughly, and introduce respective leverages and tools into their transaction processing systems.