Fintech Guide to Chargeback Management | Lithic

Fintech Guide to Chargeback Management

May 20, 2022

Nawar Idrus

Fraud and Chargebacks Lead

Table of Contents

If you’re setting up or running a card program, it’s only a matter of time until you run into your first chargeback scenario.

Whether you’re new to chargebacks or you’re looking for ways to improve your chargeback management process, this guide is designed to help fintech founders understand the intricacies of chargebacks and how to build a strategy to manage them effectively as they occur.

Founder TL;DR

Why are disputes and chargebacks important to fintechs

Disputes happen when a cardholder contacts their card issuer and challenges a transaction on their account. Disputes are intended to protect cardholders from fraudulent activity. A chargeback is one possible outcome of a dispute, and it results in an issuing bank forcibly reversing a credit or debit card charge after a customer successfully disputes a transaction.

From a compliance standpoint

  1. Disputes on debit and prepaid cards are regulated by the EFTA and Regulation E. This regulation allows consumers to challenge transaction errors (disputes) or get refunds when a legitimate error is revealed (chargeback). Credit or charge card disputes are regulated by the Truth in Lending Act (TILA) and Regulation Z.
  2. Failure to comply with Regulation E may lead to significant penalties, such as $1,000 in statutory damages or class action damages that could reach hundreds of thousands of dollars.

Card networks also have policies limiting cardholder liability, like Mastercard and Visa having “zero liability” policies that protect cardholders from unauthorized transactions.

From a business standpoint

In short, chargebacks are crucial because the fintech running the card program is responsible for the associated fees, the interchange reversal, and managing disputes.

Friendly fraud is anything but friendly to fintechs

Chargebacks typically stem from merchant error or fraudulent activity, with “friendly fraud” being the leading cause, responsible for 61% of all chargebacks and costing merchants about $48 billion annually.

Friendly fraud occurs when a cardholder disputes a purchase made by them or a household member, often seen in three situations:

  1. The cardholder misidentifies a purchase on their statement and mistakenly believes it’s fraudulent.
  2. An unauthorized user in their household makes a purchase, and the cardholder disputes it after realizing the transaction looks unfamiliar.
  3. A legitimate purchase is claimed to be problematic or undelivered, leading to a chargeback.

While such disputes may seem innocent, the statistics reveal the more troubling nature:

This not only incurs significant costs for businesses but can also promote negative behavior among cardholders if left unchecked.

Chargeback Reasons

Chargebacks arise from various legitimate and fraudulent factors, including:

Fraud

This encompasses unauthorized transactions due to stolen card information or friendly fraud.

Customer dissatisfaction

Customers unhappy with a purchase might file a chargeback without attempting to resolve issues directly with the merchant first.

Shipping problems

It’s estimated that shipping issues account for 26% of chargebacks.

Unrecognizable business name

When the transaction's business name differs from what's expected (e.g., CATWASH201 vs. Fine Feline Grooming Service), customers may assume fraud.

Failure to cancel subscription

Customers often forget to cancel subscriptions after free trials, leading to chargebacks when transactions begin.

Chargeback Codes

Every chargeback reason has an associated code used by banks to categorize the reason for a chargeback. For a comprehensive view of reason codes, see Chargebacks911 reason guide.

How the chargeback management process works

Stage 1: First Chargeback

Timeframe: A cardholder has up to 120 days from the settlement date to initiate a chargeback.

The issuer pays a flat fee to the card network for processing the dispute, regardless of the outcome.

Stage 2: Second Presentment

Timeframe: 45 calendar days from the date the First Chargeback is submitted.

This occurs when the Acquirer rebuts the Issuer’s chargeback claim, reaffirming the charge’s validity within 45 days.

Stage 3: Pre-Arbitration

Timeframe: 45 calendar days from the date of the Second Presentment.

Allows the Issuer to contest the dispute again and submit claims demonstrating inconsistencies in evidence from the Acquirer.

Stage 4: Pre-Arbitration response

Timeframe: 45 days from the Issuer’s pre-arbitration filing submission.

This is the last chance to resolve a chargeback before deciding on arbitration.

Stage 5: Arbitration

If a dispute cannot be settled between the issuing and acquiring banks, it may proceed to arbitration by the card network, incurring fees and legal costs for the losing party.

What a successful chargeback program looks like

To develop a successful chargeback program, key components include:

Execution

Fast chargeback filings are crucial for success, particularly at the beginning of the time window.

Cardholder Experience

A trained support team can enhance customer interactions, decreasing churn risks and fostering brand loyalty.

Internal Controls

Implementing good internal processes ensures unnecessary chargebacks are minimized while conducting proper fraud checks.

Chargeback observations from the field

Noteworthy insights from consumer use cases include:

Questions to ask when evaluating an issuer processor

A well-managed chargeback program can be a strategic advantage for fintechs. Key questions to consider include: