Chargebacks Explained: Why Merchant Accounts Carry Risk
Accepting credit card transactions can substantially increase your business’s revenues by making it more convenient for customers to pay for purchases. However, it also introduces a higher level of risk, in the form of chargebacks. This risk is a double-edged sword, both for you the merchant, and for the processing bank that is underwriting your account.
A chargeback is issued when a cardholder disputes a charge on their card, for a number of potential reasons. If the card issuing bank accepts the validity of their complaint, the issuer will immediately refund the customer’s money (without first alerting you!) and then file the chargeback through the acquiring network who in the end drafts the refunded money out of your checking account, and delivers to you the chargeback notice. The merchant will then have 3-4 weeks to dispute the chargeback, which requires providing documentation of the purchase, delivery confirmation, and any other relevant correspondence or proof-of-service. For in-store transactions in which the customer and the card are both present and a signed charge slip can be produced, successfully disputing a chargeback is fairly simple.
However, merchants that conduct the majority of their business through mail, telephone or internet orders have a much more difficult time appealing chargebacks if for example the reason for the chargeback is “Does Not Recognize” or “Unauthorized Use.” These CNP (“Card Not Present”) transactions place responsibility for chargebacks solely with the merchant, rather than the card issuing bank. Because it is nearly impossible to prove with documentation that the cardholder was actually the individual who placed the order in a CNP environment (you may only have an IP address which doesn’t prove much), it is difficult for card-not-present merchants to contest a chargeback successfully under these circumstances.
There are a number of causes for chargebacks though, from clerical errors resulting in duplicate billing, to the item failing to arrive at the shipping address, or not being as described, to identity thieves making fraudulent purchases with other people’s credit cards. Certain industries are fraught with chargeback problems, for example online furniture sales, due to fulfillment timeframes, shipping damage, and expensive return freight costs if the color etc is different than what the cusotmer originally wanted. Less legitimate chargeback problems arrise from customers who deliberately set out to commit “friendly fraud;” making a purchase with their own credit card and then claiming not to recognize the charge weeks later (especially a problem for merchants that deliver digital content).
Here is a detailed explanation of the chargeback cycle:
- Cardholder contacts their card issuing bank to issue the chargeback
- Card issuing bank submits the chargeback to the acquiring bank
- Acquiring bank a) debits the funds from the merchant’s checking account & b) sends the chargeback notice to the merchant
- Merchant receives the chargeback notice, and either a) accepts the chargeback or b) submits a dispute to reverse the chargeback
- Acquirer reviews the dispute, if it is a valid response submits back to the card issuing bank
- Card issuing bank either a) re-posts the transaction to the customer if the merchant’s response is appropriate, or b) submits the dispute to Visa, MasterCard, or Discover for arbitration
- Customer receives the decision, and is either rebilled or confirmion of their chargeback is delivered. The customer can file a 2nd round on the chargeback if they are initially decided against however, and the process repeats.
Chargebacks can be a serious problem for your business; in addition to losing the original cost of the sale, you can be subject to chargeback fees (typically a $25 fee per chargeback received, regardless if you win or lose the chargeback). Also, dependent on the chargeback ratio and a variety of other factors, the processing bank has the potential to close an account if your chargebacks exceed 1% versus your total sales transactions; alternatively a reserve may be required to continue processing. Having your account closed due to excessive chargebacks can be exceptionally dire, as you may be placed on the TMF (MATCH) list, which is a black-list that will likely prevent you from obtaining another merchant elsewhere.
In the end, chargebacks are the reason that “risk” exists for the processing bank that holds your merchant account, because if you are unable (due to insufficient funds or going out of business) to cover the cost of the chargebacks, responsibility for repaying the chargebacks falls on the processing bank. This is the reason that underwriting exists on merchant accounts: for the processing bank to determine how much exposure to a loss your account represents.
Contact Durango Merchant Services today, we have the know-how to help merchants identify chargeback risks, and the fraud protection tools to use when needed!