What is chargeback fraud and how do you prevent it?

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Andy Tweddle, Payments writer
8 Mar 2022
two debit cards

According to a 2021 United Nations report, online retail sales in the United Kingdom increased from $84 billion in 2018 to $130.6 billion in 2020. While an increase in online sales helped many businesses survive over the pandemic, more online transactions meant more opportunities for ecommerce fraud, including chargeback fraud.

It’s also estimated that up to 86% of total chargebacks could be cases of intentional or unintentional friendly fraud. And according to the Chargeback Field Report, the majority of participating merchants noticed a significant increase in chargeback fraud across 2021, with nine in ten merchants admitting it was a big concern for their business.

With that in mind, let’s define what’s meant by chargeback fraud, what it involves, and ultimately how best to prevent it.

What is chargeback fraud?

Chargebacks were introduced as a means of providing extra protection for debit and credit card users, allowing them to get their money back in case of an issue with the merchant or purchase, such as if they haven’t been able to receive a refund, or they believe they were charged incorrectly.

A chargeback is essentially the reversal of a credit or debit card payment. Whereas with standard refunds, it is the customer that requests their money back from the merchant, with chargebacks, the customer’s bank or card issuer retrieves the funds via a reversal on the customer’s behalf.

A customer may raise a chargeback dispute with their bank for the following reasons:

  • A customer is unsatisfied with the items they paid for and want to receive their money back

  • A customer doesn’t recognise the charge on their credit card statement and believes it wasn’t them making the payment

  • The customer was expecting a refund which they haven’t yet received on their account

  • An error occurred with the sale, such as a customer being charged twice for one order, being charged the wrong amount or being charged for a subscription plan after cancelling

  • The vendor is no longer operating, making it impossible to request a refund

These are all legitimate reasons for chargebacks, but a customer might also make a false chargeback claim which is considered chargeback fraud. For instance, a clear case of chargeback fraud is a customer claiming not to recognise a payment on their credit card statement and pursuing a chargeback with their bank, despite in actuality knowing that they did indeed make that purchase.

Typically, the bank will take the customer’s side during a chargeback request, refunding the charge and processing a chargeback dispute with the merchant. This essentially means that the business indirectly repays the customer and will have to pay chargeback fees ranging from £10 to £20.

Is chargeback fraud the same as friendly fraud?

Chargeback is sometimes referred to as friendly fraud. This is because the fraudster is simultaneously a real customer, using their own card details.

Often, friendly fraud is an intentional attempt to defraud the merchant, akin to shoplifting online. However, friendly fraud can also include mistaken chargeback requests, where a customer simply doesn't recognise the legitimate payment on their bank statement and decides to contact their bank to dispute it. It can also include ‘family fraud’, where a child or partner makes a transaction on a relatives card, and the relative disputes the transaction.

What are the costs related to chargeback fraud?

Chargebacks, whether legitimate or fraudulent, affect a business’ revenue and will inevitably increase their chargeback rate, which is the percentage of sales that experience a chargeback request. And there are a number of direct and indirect costs, which result from chargeback fraud, including:

Direct costs

Chargeback fees

Every chargeback claim comes with a fee attached. Chargeback fees typically range from £10 to £20 per claim. This, in addition to credit card processing fees, can amount to a hefty sum.

Lost inventory

In the case of chargeback fraud, your ecommerce business will need to refund the purchase, however the customer is under no obligation to return you their purchased goods, if the bank agrees with the customer’s chargeback request.

Monitoring programme costs

Card schemes (like Visa and Mastercard) monitor your chargeback ratio (also called chargeback rate). If the ratio is too high (Visa’s threshold is 0.65% whereas Mastercard’s is 1%), you may be placed on their monitoring program. Once you’re on a programme, you can be charged monthly fines and fees, until your chargeback ratio falls to below the relevant threshold.

Indirect costs

Operational costs

Processing an order involves operational costs and resources. These include production costs, packaging, shipping, logistics and transportation of goods. When chargeback fraud occurs, none of these expenses are remunerated, meaning lost time, resources and money.

This is without mentioning the time, personnel and resources required to dispute any chargebacks. Often this entails hiring dedicated fraud analysts and participating in a fraud monitoring programme. According to a 2021 Kount study, 70% of businesses have invested in some form of dedicated fraud monitoring.

Cost of lost opportunity

Every order which results in chargeback could have been a successful order with another customer. Chargebacks therefore cause the indirect cost of a lost opportunity for revenue. Over time, these costs can compound and impede company growth.

How can businesses fight chargeback fraud?

A business can fight chargeback fraud by submitting a rebuttal letter to the issuing bank with evidence indicating that the dispute is fraudulent. This process is known as representment. After submitting the letter, it is up to the issuing bank to review it and come to a decision.

A rebuttal letter should be short and to the point and include the following:

  • Transaction receipt: this can be obtained from your payment gateway. It will include the AVS and CVV match, verifying that the cardholder is the same individual that carried out the transaction

  • The order invoice: this should include details of items sold, the date the purchase was made, a customer name, billing and shipping addresses and a tracking number

  • Tracking confirmation: this should prove that the items did arrive. If you’re selling software, you may need to find another way of proving that the customer received and used the product

  • Your company’s terms and conditions: include specific sections relevant to chargebacks

  • A copy of your checkout page: on this page there should be a box that customers must tick agreeing to your terms and conditions

How to prevent chargeback fraud in the first place

There are several precautionary measures you can take to help minimise the risk of chargeback fraud affecting your business:

  • Send confirmation emails for all orders: this makes it harder for fraudsters to ‘forget’ that they made a payment to your business, and legitimate customers are more likely to recognise it on their statement

  • Require a signature upon delivery: this serves as proof of delivery, making it harder for customers to claim they never received their order

  • Use alternative payment methods: chargeback fraud can be reduced by using payment methods alternative to credit and debit card payments. Open banking does not have a chargeback mechanism, but instead its own consumer protections designed to keep both customers and businesses safe

How can open banking help you prevent chargeback fraud?

Open banking payments — often referred to as instant bank transfers at checkout — are a great way to eliminate chargebacks altogether by avoiding credit card processing entirely.

The TrueLayer Payments API enables shoppers to pay instantly in a few clicks. The consumer has a more straightforward path to a refund if something goes wrong, as only three parties (the customer, the merchant, and the open banking payment provider), all with direct relationships, are involved in the resolution.

Find out more about open banking payments and how they can benefit your business in our comprehensive guide.

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