The History and Evolution of Chargebacks
The history of chargebacks isn’t very old, but this consumer protection mechanism has rapidly evolved in a relatively short time span. While they still serve their original purpose, consumers have learned ways to exploit the use of chargebacks.
A chargeback is the process of returning funds to a cardholder after a credit card transaction has taken place. The funds are forcibly removed from the merchant’s account by the cardholder’s bank (called the issuer).
The credit card chargeback was initiated as an act of consumer protection. This regulation is aimed at protecting the rights of consumers as opposed to the earning potential of businesses.
Most countries have their own form of consumer protection, and chargeback laws vary by region. While the fine print may not be universal, the concept is: cardholders have the right to file disputes against transactions of their choice.
Chargebacks in the USA
The Truth in Lending Act of 1968 laid the groundwork for credit card chargebacks. However, payment industry experts recognize The Fair Credit Billing Act of 1974 as the invention of chargebacks. Debit card holders were awarded reversal rights courtesy of Jimmy Carter’s 1978 Electronic Fund Transfer Act.
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Rules and Regulations
The card networks (Visa, MasterCard, Discover, American Express, etc.) have thorough rules and regulations regarding the chargeback process. In theory, these regulations form an efficient system for ruling on credit card transaction disputes.
Reasons for Filing a Chargeback
Each card network has an extensive list of chargeback reason codes. These reason codes address issues like:
- Unsatisfactory products or services
- Billing errors
- Undelivered products or services
- Unauthorized charges
Unfortunately, over the years, the reasons for filing a chargeback have evolved. Many cardholders use the process in a manner other than originally intended.
In fact, it could be argued that, despite the numerous chargeback reason codes, all transaction disputes are caused by one of three things:
- Merchant error
- Criminal fraud
- Friendly fraud
Friendly Fraud Explained
Friendly fraud is also described as chargeback fraud because perpetrators use the chargeback system to fraudulently cheat merchants. Rather than contact the merchant for a refund, friendly fraudsters contact the bank for a chargeback.
Friendly fraud can include a variety of dishonest behaviors.
- The cardholder experiences buyer’s remorse and views a chargeback as the easiest way to get a refund.
- The cardholder claims the product was faulty when, in reality, it was of acceptable quality.
- The cardholder claims the product or service was never received when in fact, it was.
- The cardholder doesn’t want to pay for a transaction made by an authorized family member.
The Evolution of the History of Chargebacks
Chargebacks are a much needed form of consumer protection. However, cardholders have learned how to manipulate the system and exploit loopholes.
The inventors of chargebacks couldn’t foresee friendly fraud. Who could imagine the average consumer resorting to cyber shoplifting? And because the original protective legislation couldn’t predict these fraudulent consumer behaviors, there are ways modern consumers can cheat the system. Until industry-wide changes are implemented to close the loopholes, friendly fraud will continue to run rampant.
Another issue that has become painfully clear throughout the history of chargebacks is the role technology plays. The popularity of eCommerce has grown by leaps and bounds. Unfortunately, opportunities for fraud have increased at an almost proportional rate, but fraud detection technologies have failed to keep pace.
Because of the improper use of chargebacks, both consumers and merchants are suffering. Merchants pay chargeback fees, increase their processing risks, and lose revenue with each chargeback filed.
Meanwhile, consumers are also being penalized, usually without their knowledge. To compensate for inevitable chargeback fees, merchants are raising their prices. Consumers who are caught committing chargeback fraud could pay bank fees and forfeit their card account.
Hopefully, the history of chargebacks will serve as a lesson for the future. If you are a new merchant, or just discovering chargebacks for the first time, let us help you create a chargeback management system that will reduce risks before they become liabilities.