What is a Chargeback?
A chargeback occurs when a cardholder reports an unauthorized charge on their credit card statement. Many times the card is reported as either lost or stolen. Typically, a fraudulent chargeback is the result of unauthorized use of a lost or stolen credit card. Sometimes a cardholder intentionally claims that a charge is unauthorized so that he can keep the products. This is referred to as ‘friendly fraud’.
The chargeback mechanism exists primarily for consumer protection. Holders of credit cards issued in the United States are afforded reversal rights by Regulation Z of the Truth in Lending Act. United States debit card holders are guaranteed reversal rights by Regulation E of the Electronic Fund Transfer Act. Similar rights extend globally, pursuant to the rules established by the corresponding card association or bank network.
A consumer may initiate a chargeback by contacting their issuing bank, and filing a substantiated complaint regarding one or more debit items on their statement. The threat of forced reversal of funds provides merchants with an incentive to provide quality products, helpful customer service, and timely refunds as appropriate. Chargebacks also provide a means for reversal of unauthorized transfers due to identity theft. Chargebacks can also occur as a result of friendly fraud, where the transaction was authorized by the consumer but the consumer later attempts to fraudulently reverse the charges.
One of the most common reasons for a chargeback is a fraudulent transaction. In this case, a credit card is used without the consent or proper authorization of the card holder. In some cases (e.g. online transactions), a merchant is responsible for charges fraudulently imposed on a customer. Fraudulent card transactions often originate with criminals who gain access to secure payment card data and set up schemes to exploit the data.
Chargebacks can also result from a customer disputes. Other types of chargebacks are related to technical problems between the merchant and the issuing bank.
Merchant Chargeback Penalties
Acquiring banks typically charge merchants a penalty for each chargeback received. In addition, Visa and MasterCard may levy severe fines against acquiring banks that retain merchants with high chargeback frequency. Acquirers typically pass such fines directly to the merchant. Merchants whose ratios stray too far out of compliance may trigger card association fines of $100 or more per chargeback.
Consumers may abuse the chargeback mechanism at the expense of merchants. For example, consumers who experience buyer’s remorse, or engage in other forms of friendly fraud, may habitually reverse transactions.
Card issuers who file a chargeback with an identity-theft related reason code have no obligation (and in fact have financial disincentive) to report the consumer’s account as compromised. As a result, consumers have an incentive to report any unwanted item on their bank or credit card statement as fraudulent.