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March 7, 2016

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Card Chargebacks: Sorting Out the Facts

For years, I have heard conflicting statements by card issuers and acquiring merchants about the impact of chargebacks on their businesses. A chargeback is a demand by a card issuer for a merchant to make the issuer whole for the loss of a disputed transaction by a cardholder. Because of consumer liability protections afforded under various regulations and the card brand's liability rules, the issuer or the merchant typically incurs the final loss. The issuer initiates a chargeback when a cardholder disputes a transaction on the statement—for one of a variety of reasons—if the issuer believes the merchant is financially liable under the particular card network's operating rules. Merchants may accept the chargeback and assume the loss, or they may dispute it if they believe they were in compliance with the network rules.

The debate over the amount of chargeback losses to merchants has continued over the years because of a lack of independent research, but all that has changed with a study published in January by my colleagues at the Federal Reserve Bank of Kansas City. Senior economists Fumiko Hayashi and Rick Sullivan along with risk specialist Zach Markiewicz examined chargeback and sales data from October 2013 through September 2014 from selected merchant acquirers who process more than 20 percent of network-branded card transactions in the United States. While the study examines the full chargeback landscape of four-party networks (Visa and MasterCard) and three-party networks (American Express and Discover), the focus of this post is on their findings related to card fraud—both card present (CP) and card not present (CNP)—for the four-party networks. PIN debit transaction chargebacks were not included in this study.

Some of the study's key findings are:

• Overall, merchants incur 70–80 percent of all chargeback losses.
• Fraud is the most common chargeback reason and accounts for approximately 50 percent of total chargebacks in value.
• The average value of a fraud chargeback was $200, compared to $56 for the average sales transaction. Clearly, the criminals are going after higher-dollar value goods.
• The merchant loss rate in the CNP channel of 14.17 basis points (bps) is significantly higher than the 1.02 bps loss rate for the CP channel.
• As the chart shows, the merchant categories incurring the highest fraud rates were the travel and department store categories. Grocery stores had the lowest.

As previous posts have noted, the Federal Reserve is making a concerted effort to collect fraud data for non-cash payment channels to develop a holistic view and understanding of fraud trends. The Kansas City Fed is looking to repeat its study in the near future, when it will also include PIN debit transaction chargebacks. As our payments system evolves and user payment preferences change, it is vital for payments system stakeholders to be able to determine how these changes are affecting fraud losses being sustained by the various stakeholders.

By David Lott, a payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed

March 7, 2016 in card networks , cards , consumer protection | Permalink

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