Chargeback

A chargeback is the return of funds to a consumer, forcibly initiated by the consumer's issuing bank. Specifically, it is the reversal of a prior outbound transfer of funds from a consumer's bank account, line of credit, or credit card.

Chargebacks also occur in the distribution industry. This type of chargeback occurs when the supplier sells a product at a higher price to the distributor than the price they have set with the end user. The distributor then submits a chargeback to the supplier so they can recover the money lost in the transaction.

Overview

The chargebacks mechanism exists primarily for consumer protection. U. S. credit card holders are afforded reversal rights by Federal Reserve Regulation Z under the Truth in Lending Act. U. S. debit card holders are guaranteed reversal rights by Federal Reserve Regulation E under the Electronic Funds Transfer Act. Similar rights extend globally pursuant to the rules established by the corresponding card association or bank network.

A consumer may initiate a chargeback by contacting their issuing bank, and filing a substantiated complaint regarding one or more debit items on their credit card statement. Chargebacks are the consumer's last line of defense against unscrupulous merchants. The threat of forced reversal of funds provides merchants with added incentive to provide quality products, helpful customer service, and timely refunds as appropriate. Chargebacks also provide a means for reversal of unauthorized transfers due to identity theft.

Reason codes

With each chargeback the issuer selects and submits a numeric "reason code".^[1] This feedback may help the merchant (and acquirer) diagnose errors and improve customer satisfaction. Reason codes vary by bank network, but fall in four general categories:

• Technical: Expired authorization, non-sufficient funds, or bank processing error.
• Clerical: Duplicate billing, incorrect amount billed, or refund never issued.
• Quality: Consumer claims to have never received the goods as promised at the time of purchase.
• Fraud: Consumer claims they did not authorize the purchase, or identity theft.

One of the most common reasons for a chargeback is known as a fraudulent transaction. A credit card is used without the consent or proper authorization of the card holder. In some cases, a merchant is responsible for charges fraudulently imposed on a customer. Mostly, fraudulent card transactions originate with criminals who gain access to secure payment card data and set up schemes to exploit those data.

Chargebacks can also result from a customer dispute over credit. This type of chargeback is usually described as credit not processed. A customer may have returned merchandise to a merchant in return for credit, but credit was never posted to the account. In this example, the merchant is responsible for issuing credit to its customer, and would be charged back.

Other types of chargebacks are related to technical problems between the merchant and the issuing bank, whereby a customer was charged twice for a single transaction (duplicate processing) or other various mistakes. Yet other chargebacks are related to the authorization process of a credit card transaction, for example, if a transaction is declined by its issuing bank and the account is still charged.

Another reason for chargebacks is when a customer does not receive the item they paid for. In this case, a chargeback is initiated and the payment to the merchant is reversed.

Merchant recourse

For transactions where the original invoice was signed by the consumer, the merchant may dispute a chargeback with the assistance of their acquiring bank. The acquirer and issuer mediate in the dispute process, following rules set forth by the corresponding bank network or card association. If the acquirer prevails in the dispute, the funds are returned to the acquirer, and then to the merchant.

Merchant penalties

The merchant's acquiring bank accepts the risk that the merchant will remain solvent over time, and thus has an incentive to take a keen interest in the merchant's products and business practices. Reducing consumer chargebacks is crucial to this endeavor. To encourage compliance, acquirers may, at their discretion, charge merchants a penalty per chargeback received. Payment service providers, such as PayPal, have a similar policy.^[2]

In addition, Visa and MasterCard may levy severe fines against acquiring banks that retain merchants with high chargeback frequency. Acquirers typically pass such fines directly to the merchant. Merchants whose ratios stray too far out of compliance may trigger card association fines of $100 or more per chargeback.^[3]

Other types of chargebacks

Accounts may also incur credit reversals in other forms, such as these:

• ATM reversal: An ATM deposit envelope is found to have less funds than represented (if any) and a chargeback is made to correct the error. This could result due to a counting error or intentional fraud by the account holder, or the envelope or its contents could have been lost or stolen. If an overdraft results and the amount is too high or cannot be covered in a short period of time, the bank will sue or press criminal charges, unless the account holder has been the victim of the latter scenario, identity theft, or other fraud, and files a sworn police report.
• Bank error correction: A bank error credits the account with more funds than intended and makes a chargeback to correct the error. If an overdraft results and it cannot be covered in time, the bank could sue or press criminal charges.
• Direct deposit chargeback: A direct deposit is made to the wrong account holder or in a greater amount than intended and a chargeback is made to correct the error.
• Returned check deposit: The account holder deposits a check or money order and the deposited item is returned due to NSF (Not Sufficient Funds), a closed account, or being discovered to be counterfeit, stolen, altered, or forged. This could occur due to a deposited item that he knows to be bad, or he could be a victim of a bad check or a counterfeit check scam. If an overdraft results and it is too huge or cannot be covered in a short period of time, the bank could sue or even press criminal charges.

Criticisms

Unscrupulous consumers may abuse the chargeback mechanism at the expense of merchants.

• Consumers who experience buyer's remorse, or engage in other forms of friendly fraud, may habitually reverse transactions.
• Issuers who file a chargeback with an identity-theft related reason code have no obligation (and also a financial disincentive) to report the consumer's account as compromised. As a result, unscrupulous consumers have an incentive to report any unwanted item on their bank or credit card statement as "fraud".

See also

• Chargeback insurance
• CVV2
• Friendly Fraud

References

1. ^ http://www.corporate.visa.com/pd/rules/pdf/visa-international-operating-regulations.pdf
2. ^ PayPal user agreement. Section 4.5 lists chargeback info. Section 8 lists chargeback fees. https://www.paypal.com/µs/cgi-bin/webscr?cmd=p/gen/ua/policy_pbp-outside
3. ^ http://www.corporate.visa.com/pd/rules/pdf/visa-international-operating-regulations.pdf