Gloomy economic trends are causing a spike in first-party "friendly" fraud, where consumers try to reverse legitimate transactions by claiming fraud, and the card networks are giving merchants more tools to deflect these chargebacks.
But the move also carries the risk of higher fraud costs for banks.
Mastercard in October 2022
Changes in the existing process could be messy for merchants, which don't want to infuriate consumers more than necessary, and for banks, which will have to pour more resources into battling chargebacks that merchants previously shouldered.
The moves come as the rate of consumers filing transaction disputes is rising — 35% during the first three quarters of 2022, while the average chargeback amount rose to $192.53 last year, up 16% from $166.69 in 2021, according to the fraud-technology firm Sift.
Consumers labeled 70% of payment card transaction disputes as fraud during the first nine months of last year, which aligns with the overall trend of rising unauthorized card fraud resulting from stolen account data and other third-party fraud schemes.
But Sift said 23% of U.S. cardholders it surveyed last year anonymously admitted to participating in at least one act of first-party fraud, presumably in response to the tightening economy.
It's not surprising that with rising inflation, an uneven job market and new Commerce Department data indicating U.S. holiday-season spending actually declined by an adjusted 0.2% in December, many cash-strapped consumers are looking for ways to erase card charges.
But fed-up merchants, who bear the lion's share of the estimated $100 million annual cost of all chargebacks, hope to get a break this year from some of these losses, particularly via Visa's new "Compelling Evidence 3.0" policy the card network
Beginning in April 2023, Visa will allow merchants to submit "compelling evidence" proving a pattern of legitimate transaction history to demonstrate the likelihood that a disputed purchase was legitimate. Merchants may provide two of the following: a card customer's IP address; a device ID or fingerprint connecting the consumer with the device conducting the transaction; or a shipping address or an account login tying the customer to the disputed purchase.
There's optimism among the merchant and card-issuing community that Visa's new policy could resolve a lot of friendly fraud and deter consumers from attempting to disavow legitimate transactions, fraud experts said.
The changes could also simply shift more of those costs to banks.
Consumers typically file most disputes with merchants, who lose $3.75 for every $1 lost to fraud due to the total administrative costs plus fines, according to Sift's data. Merchants hope to push some of those costs back to banks — at least in cases where merchants can prove consumers are perpetrating first-party or friendly fraud.
"Issuing banks that partner with Visa will potentially end up experiencing more fraud loss when the new Visa Compelling Evidence rules change, and they'll need to resolve these issues with their own customers to determine liability" for chargebacks, said Brittany Allen, a trust and safety architect at Sift.
Visa's move could go a long way to helping to clear up confusion over which transactions are the bank's responsibility and which are the merchant's, said Julie Conroy, head of risk insights and advisory at Aite-Novarica.
"The biggest challenge is that there is a lot of gamesmanship in chargebacks between issuers and merchants, and the process for a merchant to work through the chargeback process — when an issuer has ruled their compelling evidence isn't enough — is long and expensive," Conroy said.
Regulation E of the Electronic Fund Transfer Act requires banks to give provisional credit to customers within 10 days of initiating a debit card charge dispute, which is not necessarily enough time for banks to prove first-party fraud, Conroy noted.
"Banks are wary about the potential backlash of consumer complaints to the CFPB if they start declining disputes in a significant way," Conroy said, referring to the Consumer Financial Protection Bureau.
She added that banks will lean on collaborative dispute-management engines provided by Ethoca, a Mastercard subsidiary, and Verifi, which is owned by Visa, to adjudicate these disputes when Visa's policy kicks in, while certain large banks have their own models to detect "serial first-party fraud."
Before last year, most friendly fraud skewed toward card customers disputing online gaming purchases and online subscriptions, but recently it's expanded to more channels including restaurants and travel, as consumers look for loopholes to claim fraud and get a refund, said Monica Eaton, founder of Chargebacks 911, which markets chargeback protection tools to merchants.
As more transactions moved online during the pandemic, the frequency of friendly fraud incidents grew, forcing a reckoning between merchants and issuers, Eaton said.
Both sides will have to tread carefully as the card networks' policies unfold, because neither banks nor merchants want to alienate their customers, she said.
Banks challenge friendly-fraud claims only some of the time, while merchants traditionally have absorbed more friendly fraud as the cost of doing business, but it's becoming too much for them to bear, according to Eaton.
"With significantly more people looking to return products in an economic downturn, if a retailer's return process has too many points of friction where they're too slow to respond to consumers, this could prompt more consumers to file their chargeback directly with the bank," she said.
Digital goods and services (including online subscriptions) generated the highest number of disputes last year, as many consumers claimed they didn't authorize the charges or they weren't delivered, according to Sift.
Retail purchases generated the second-largest bucket of card disputes. Generating the most disputes were clothing at 21%, followed by subscription goods at 19% and electronics at 18%.
