Second-Party Friendly FraudAre Banks Unintentionally Helping Cardholders Abuse the Chargeback Process?

February 24, 2023 | 5 min read

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Second-Party Friendly Fraud

In a Nutshell

Fraud can generally be broken down into three categories: first-, second-, and third-party fraud. Most chargeback abuse is considered first-party fraud, because the buyer requests a chargeback without a valid reason to do so. But what happens when a bank initiates an invalid dispute on the cardholder's behalf? In this article, we dig into how banks may be implicated in second-hand chargeback fraud.

So-Called “Second-Party” Friendly Fraud is on the Rise, Overwhelming Merchants with Costly Chargebacks

In a recent article, we talked about the growing problem of second-party fraud. This often happens when a cardholder allows another party to use their account information to commit fraud. However, did you know that cardholders and banks also sometimes engage in unintentional second-party chargeback abuse?

The Rising Tide of Chargeback Fraud

eCommerce merchants today are grappling with a record — and ultimately unsustainable — number of chargebacks.

A chargeback occurs when a consumer contacts their bank and claims that a charge on their account is unauthorized and should be refunded. It’s a common occurrence; in the United States, this happens roughly 600,000 times per day.

Many of these claims are invalid. For example, the cardholder might simply have forgotten about a charge, or is unable to recognize it on their statement. You have the option to fight these invalid chargeback claims. But, if you’re like most merchants, you probably won’t.

The representment process is tedious and rigid. Even if you do fight back, the average win rate is depressingly low.

This is a serious problem for eCommerce merchants. Over the last three years, so-called friendly fraud has become the number-one source of fraud as reported by merchants are forced to deal with. It also has a multiplier effect that extends damages well beyond the amount of the disputed charge in question. Every dollar disputed represents a loss to the merchant of $3.36. All totaled, friendly fraud is projected to cost more than $132 billion this year.

What is “Second-Party” Friendly Fraud?

Friendly fraud is an issue the retail industry must become more adept and more aggressive about dealing with.

As if the existing problem weren’t bad enough, though, second-party friendly fraud is now growing and compounding the industry’s difficulties. This refers to cases of friendly fraud that are not initiated by the consumer per se; instead, they’re initiated, either directly or indirectly, by the customer’s bank.

There are several factors driving the increase in fraudulent second-party chargebacks. Some of them apparently materialize as part of the financial institution’s risk mitigation process.

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The credit card issuer might see a charge that appears questionable or unusual. For example, the bank may flag a transaction that is much larger than normal for that customer’s typical spending habits, or which is conducted with a disreputable merchant.

The bank typically contacts the consumer to confirm that this is a legitimate charge. If the consumer validates the transaction, then the card issuer approves the charge, and the matter ends. On the other hand, the consumer may deny recognizing the charge. In this case, the bank or card issuer will initiate a chargeback on it.

In some cases, the bank may approve the transaction, but then flag it for a potential chargeback in order to protect the consumer should the charge be a case of fraud or identity theft. There are even some cases in which a bank may initiate a chargeback on the customer’s behalf without ever contacting the buyer.

In any of these cases, if the buyer does not have a valid reason for the chargeback, it could be considered a case of second-party friendly fraud.

Bad Habits Take Root

This form of friendly fraud is not meant to be malicious. Regardless, in this situation, the bank is having it both ways. They’re protecting their relationship with the customer by approving the charge, while simultaneously protecting themselves by setting up the merchant to be penalized if there turns out to be a problem.

Of course, there can still be bad actors involved in the process. Chargebacks can be an effective way for banks to minimize losses resulting from charge-offs, for example.

An issuer could file a batche of bad debt as chargebacks to avoid having to cover the cost themselves. Because of a loophole in the law, the banks don’t have to prove that the chargebacks were initiated by consumers, which is a huge problem.

This can also encourage consumer abuse of the chargeback process (i.e. first-party fraud) as well. Once consumers file their first chargeback for a valid reason, they see how easy it is to get their money refunded. This may encourage them to go on and file fraudulent chargebacks, which some do repeatedly.

All of this has created an unfortunate mindset among bank operators and consumers alike. Customers have learned how to “get something for nothing,” while financial institutions have become so afraid of incurring penalties or upsetting their customers that they have lost sight of proper dispute protocols. This is not an easy thing to undo.

Fighting Back

It’s difficult to curb fraudulent tendencies, especially those that bear no immediate consequences for the perpetrator. It’s not impossible, though.

If merchants don’t want to accept fraudulent chargebacks as a “cost of doing business,” there are ways they can contest them without ruining the rapport they’ve made with true customers. It’s true that the rules and policies around chargebacks are complex, as are the procedures. However, there are increasingly sophisticated technologies available to deal with those complexities, with much less human intervention required.

Transaction dispute services from Chargebacks911® are sustainable, transparent, and able to scale with you. We are like blockchain to the chargeback mitigation process. You need a chargeback management service that:

  • Is integrated with dozens of international banks.
  • Understands and works with international currencies in real time.
  • Is doing business with the same processors you work with.
  • Has layers of service levels available for merchants based on their needs.

Ready to learn more? Contact Cb911 today and request a free demo of our services.

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