Innovation: How Banks and Businesses Can Fight Fraud and Chargebacks Should Regulation Fail
With the CFPB's future in the hands of the Supreme Court, Chargebacks911 Founder Monica Eaton says more collaboration between banks and businesses is needed to protect themselves and consumers should a decades worth of regulation be undone.
How best to handle payment disputes that arise between cardholders and merchants is a point of some controversy.
The problem is framed as a zero-sum contest where the needs of merchants must be weighed against the rights of cardholders. Conventional wisdom says that anything benefitting merchants must do so at the expense of cardholders and vice versa.
Regulatory pressures from agencies like the Consumer Financial Protection Bureau (CFPB) have, therefore, largely ignored the merchant perspective in favor of expanding cardholder protections. Unfortunately, this focus has consequences that continue to drive increased costs for merchants and the financial institutions caught in the middle.
Fortunately, technology presents us with the opportunity to build a collaborative solution that benefits all parties in the transaction process without prioritizing the needs of one over another.
The need for cardholder protections
Obviously, there's a strong case to be made for prioritizing consumer protection.
When the CFPB was established in 2011, their express purpose was to safeguard consumers against abusive and predatory financial practices. This was seen as a necessary precaution in a post-2008 environment.
Protecting consumers against fraud and abuse is the right thing to do. It also helps to provide a solid bedrock for the market at large. If consumers have confidence in their protection, they'll be more willing to transact online.
Cardholders have the right to ask their issuing bank to intervene in disputes by filing a chargeback; essentially a forced refund. This fundamental guarantee underpins much of the growth in the online market over the last two decades. Without it, one could argue that far fewer people would confidently shop online.
For instances of true fraud, payment disputes should be easy to resolve and require minimal effort by cardholders. Adding excessive friction or burdensome obstacles would have downstream consequences for the entire ecommerce industry.
The problem is that, as cardholders have gotten more comfortable with the dispute process, they've learned ways to abuse the system. This activity is largely accidental and done out of convenience, with the misconception that going to their bank is simply a faster option than contacting the merchant directly.
The problem of chargeback abuse
Many of the chargebacks filed by cardholders this year will be based on invalid claims.
Consumers increasingly see chargebacks as the first course of action when trying to resolve any issue with an online merchant. Card issuers have made it very easy to dispute a charge; this was seen as a "necessary evil" required to cope with the surge of e-commerce sales. To that point, it's often faster for consumers to contact their bank than to contact the merchant when they are unhappy. It's so easy, in fact, that many chargebacks are unintentionally initiated by cardholders simply seeking information about a transaction.
This has led to a boom in chargeback abuse (or "friendly" fraud), costing the industry billions of dollars annually. Historically, this problem was thought to primarily impact merchants, but recent reports prove the consequences and costs are far-reaching and widespread. One recent study found that this type of first-party fraud was the most prevalent fraud attack method confronting the payment industry in 2021, rising from fifth place in 2019. The cost of a chargeback is not just borne by merchants; it is also disbursed among financial institutions.
The current system encourages merchants to provide feedback, but the lack of standardization and the compression of operational timelines often result in forfeiture. In the absence of dispute response data, this growing vacuum contributes a new obstacle in the quest to offset the consequence of fueling a "frictionless" utopia.
The LexisNexis True Cost of Fraud study estimates that merchants ultimately lose $3.60 for every dollar in direct fraud costs. This multiplier is partially due to the resources required for merchants to effectively manage chargebacks.
The need for merchant rights
The current chargeback system was codified long before ecommerce or online banking were a concern. While there have been several updates to the chargeback process in recent years, the underlying logic has remained largely unchanged.
Under the present system, the burden of disputes falls overwhelmingly on merchants, with acquirers and issuers in close second. The process of a dispute is costly for everyone involved, though.
Digitization is a good thing, but it requires a balanced application. Consumers, for example, can click a button to raise a chargeback, but most banks still require merchants to submit lengthy documents and provide varying guidance on the format and timelines.
When a merchant provides compelling evidence that the transaction was legitimate, that case must be reviewed and processed by both banks independently. If the case is decided in the merchant's favor, the cardholder is given a copy of the merchant's response, and is then presented with the option to escalate the dispute. For the merchant and many banks, this is a manual, time-consuming process that can prevent merchants and their acquirers from doing anything more than accepting the liability, regardless of whether it's right or wrong to do so.
If a claim is proven invalid in any other area of business, the negative statistic is redacted. Consider credit reports; it would not be fair for a negative entry to be a permanent blemish, even though a consumer could prove that a reported item was incorrect and the powers that be agree on his judgment, would it?
Industry incentives must be aligned to drive the kind of behavior that will deliver the best results. To achieve balance and genuinely improve the customer experience for both consumers and merchants alike, a more efficient and effective exchange of data must be advocated.
The "merchant vs. cardholder" fallacy
There's a misconception that cardholders and merchants are at two opposing ends of this matter. However, the truth is that the negative effects on one ultimately impact the other.
Common wisdom states that by placing too much emphasis on consumer protection, we are asking merchants to accept the status quo of increasing invalid chargebacks as a cost of doing business. This places a financial burden on the industry. However, this burden is ultimately passed onto customers.
In contrast, trying to empower merchants without reexamining the foundations of the dispute process could put consumers at risk.
The path forward isn't to try and protect one party at the expense of another. Instead, it's to develop strategies that serve the needs of merchants, cardholders and banks. By advancing the old way of thinking about how to solve a legacy problem with a historically flawed mindset, we can open the door to fairer policies and easier data exchange processes, far better positioned to drive improvement and bolster cardholder protection.
Under the present system, a significant number of chargebacks are filed by mistake. Cardholders call their bank to inquire about a charge, and with little to no information about the transaction, the bank's only option is to initiate a chargeback.
Currently, two networks — Verifi Order Insight and Ethoca Consumer Clarity — allow merchants to share data with banks in case of a cardholder inquiry. They have proven the benefits of data, but the programs are costly and difficult for merchants to implement. Instead of this more patchwork approach, the goal should be increased data sharing as the default.
A technological roadmap
Modern banks are behaving more and more like software companies, but payment disputes are still largely handled on rails built in the twentieth century. Collaborative solutions and end-to-end data sharing can better inform chargeback decisioning, streamline operational bottlenecks, reduce friendly fraud, and protect cardholders.
Here's an example: as artificial intelligence and machine learning play a larger role in fraud prevention, accurate data to train these systems becomes increasingly valuable. But, with processes that may discourage merchants from responding to disputes, institutions are forfeiting critical data that could be used for preventing fraud.
Consider what would happen if a substantial campaign was launched, aimed at merchants, encouraging them to respond to every case? A campaign educating merchants about the need to respond, either by affirming that a chargeback claim was valid, or that it is invalid, and the transaction should be re-presented?
The resulting data fed into the industry by merchants would provide institutions with substantially more accurate data, and allow for much more accurate fraud detection. They could create more intelligent and self-sufficient models for detection and decisioning.
If merchants responded to more payment disputes, banks would be much better at identifying and preventing fraudulent transactions. Ultimately, we would see far fewer instances of criminal fraud and fewer false declines, which would benefit everyone.
The added caseload could be streamlined through modernization. Instead of relying on disparate, non-standard, paper-based documents, technology could allow merchants to transmit raw data in a globally standardized format. This would empower all parties to use automation, minimize mistakes, and reallocate staff for more efficient operations.
Out with the old, in with the new
Striking a balance through technology is a "win-win" that benefits cardholders, banks, and merchants alike. It should be the objective of all parties, including regulators like those at the CFPB, to advocate for technological solutions to our present-day problems.
Change will not be easy, and we won't see results overnight. However, the value of building a better, more viable system outweighs any costs. The more focus we put towards solutions that align with the needs of merchants, banks and consumers, the easier it will be to solve the few real remaining conflicts. The current system is not sustainable. It's time to try new ideas.
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