Deep Dive: How AI Helps FIs Fight False Chargebacks

Criminals are not the only security threats financial institutions (FIs) and their merchant clients face — these entities often need to defend themselves against consumers as well.

Friendly fraud has been on the rise for years, with customers contacting their banks to falsely assert that their credit cards have been used online for unauthorized purchases. These instances are painful for merchants and FIs alike, as the former could lose money on sales and already-delivered goods, and the latter are forced spend considerable time and effort handling unwarranted claims.

Undeserved chargebacks are no trivial issue, either, as the number of such false claims rose 41 percent between 2016 and 2018. Merchants also appear reluctant to dispute friendly fraud, as many seem to believe they do not have the resources to do so or that they cannot adequately prove chargebacks are fraudulent. Recent reporting stated that retailers contest only 25 percent of friendly fraud incidents, for example, which results in a multitude of customers undeservedly winning these cases. The pandemic could be encouraging these unwarranted disputes, too, as the uptick in card-not-present (CNP) transactions from consumers shopping online leads to a corresponding rise in CNP fraud claims.

This month’s Deep Dive explores why consumers engage in friendly fraud and how FIs and merchants can adopt technologies like artificial intelligence (AI) and new authorization strategies to better curb the problem.

Why Customers Go Bad

Chargebacks are intended to safeguard consumers from thieves or malicious merchants, but the feature can be abused in certain instances. Unscrupulous customers can inaccurately assert that card payments were unauthorized or that the items they purchased never arrived, then urge their banks to reverse the transactions. Other shoppers, meanwhile, make claims for less nefarious but nonetheless damaging reasons.

Some frustrated consumers may not recognize the difference between requesting refunds from retailers and filing chargebacks with their FIs, which can lead them to seek redress from their banks when they should have lodged complaints with merchants. Consumers in other cases may simply not recognize the transactions on their billing statements, mistakenly believing the purchases were fraudulent.

FIs must thoroughly investigate chargeback cases to protect customers when fraud does occur, but the process can be cumbersome. Card issuers that are convinced of their customers’ truthfulness ask merchant acquirers to extract money from sellers’ accounts, which can then be used to refund consumers for disputed purchases. Acquirers may debate the chargebacks with the issuers, or merchants may provide their acquirers with evidence of the transactions’ legitimacy and ask the acquirers to dispute the claims. Merchants often struggle to produce information to prove their cases, however, and FIs may find it challenging to quickly ascertain the truth. This can ultimately result in lengthy efforts to investigate cases that should not have been filed, sapping employees’ time.

The Cost Of Undue Chargebacks

Retailers suffer significantly from friendly fraud, reportedly losing $35 billion to such issues in fiscal year 2019 alone. Customers who file chargebacks receive refunds from merchants, and FIs typically impose heavy fees on these retailers. Consumers also do not need to return the items they receive in these cases, saddling retailers with inventory costs in addition to other expenses. Businesses could even see FIs freeze their accounts if they are deemed to have accrued too many chargebacks.

FIs also lose money to fraudulent chargebacks because they must dedicate a significant amount of staff time to investigating claims and managing disputes. This can take focus away from other projects and reduce the profit they make on each customer or transaction. Keeping retailers and consumers satisfied thus requires quickly and accurately assessing chargeback filings.

Combining Friendly Fraud

One 2019 report that polled 200 merchants found that businesses struggled to contest false chargebacks, even as they confronted high levels of such abuse. Respondents believed 46 percent of the chargebacks filed against them were due to friendly fraud, for example, and 56 percent of responding firms said that the number of wrongful chargebacks had grown over the past three years. Thirty-one percent of the businesses cited “identifying friendly fraud” as the most difficult part of their chargeback management, however, while 29 percent pointed to the effort needed to dispute such claims as a significant challenge.

Card networks, FIs and merchants are all working to fight this growing problem. Some card networks have launched services to help merchants communicate with customers about unrecognized transactions before unnecessary chargebacks are filed, for example. Retailers are meanwhile asking customers to supply more data during checkout, including details that criminals would be unlikely to possess, such as addresses or card verification value (CVV) codes. This can help merchants prove that the individuals making purchases are legitimate customers. Retailers are also working to more clearly display information on how customers can request refunds rather than resort to chargebacks.

FIs are also taking aim at the issue, leveraging advanced analytics solutions to help them better distinguish between genuine and illegitimate claims. AI tools can reportedly help banks review claims and draw on customers’ data to inform their evaluations. This could allow FIs to determine whether shoppers previously patronized the merchants in question, for example, and whether disputed transactions fit preexisting behavioral profiles.

Friendly fraud is unlikely to subside anytime soon, especially as the pandemic pushes more purchasing online and gives malicious as well as confused consumers more opportunities to file false chargebacks. FIs may thus be wise to upgrade their chargeback management strategies, as doing so could allow them to keep customers safe and mitigate harm for merchants and FIs.