Chargebacks explained
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Chargebacks explained
Explanation of the occurrence of a chargeback, with a detailed breakdown by type and prevention options

Overview

Chargeback is a process by which an issuing bank debits the merchant’s account to return it to the cardholder. All schemes have their own specific rules.

It should be noted that chargebacks are dangerous because their acceptable monthly number can be limited, and exceeding the established norm will lead to the cancellation of your trading account.

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Every credit/debit card provider, whether it’s Visa, Masterсard, American Express Company (Amex), or any other, has certain chargeback thresholds, and exceeding this threshold has several consequences:

  • Your payment processing costs will increase significantly
  • You are enrolled in a remedial program and may pay additional fines
  • You will have to bear these costs for several months after the issues are resolved, and you are reclassified as a low-risk merchant

Explanation

Ultimately, chargebacks are disputes between the merchant and the cardholder, who is not always the customer. The merchant’s acquiring bank handles some aspects of the chargeback, while the cardholder’s issuing bank acts as a judge in deciding the outcome of the dispute. Unlike a traditional refund, where the customer and merchant work together to resolve a problem, a chargeback allows the customer to bypass the merchant and get a refund directly from the issuer.

A chargeback occurs when the issuing bank cancels a card transaction because of:

This includes transactions where an available EMV chip was not used for authorization, where stolen payment card data was used in a card-present or card-less environment, and transactions reported by the Visa Fraud Monitoring Program.
Processing error disputes can include late presentments; incorrect transaction codes, currencies, account numbers, or accounts; duplicate processing, duplicate payments involving payment by other means; and transactions containing invalid data.
This category tends to deal with issues that can crop up between the customer and the merchant, such as merchandise or services not received, recurring transactions that the cardholder attempted to cancel, merchandise that is counterfeit or defective, merchandise that does not match the product description, failure to process a refund credit, and other merchant misrepresentations.
Disputes in this category include transactions processed without authorization or with a declined authorization.

Types

Chargebacks are described by types:

1st Chargeback
The customer queries a transaction with their card issuer by creating a chargeback.
You can dispute the chargeback request at this stage, but you must prove that the transaction is valid and not fraudulent, that the user is verified, and that you provided the service.
Kindly note that there is a processing fee for each chargeback. As for the commission, please contact your account manager. You must monitor these disputes and respond to them as soon as possible.
2nd Chargeback
The issuer declines your defense and opens a pre-arbitration, which Chargebackhit will review.
The card issuer rejects your objections to the cardholder’s application based on the evidence provided.
At this stage, you have two options: Accept the chargeback request + Dispute the chargeback request for the second time - enter pre-arbitration.
If the merchant or cardholder disputes the transaction a second time based on new evidence, the issuing bank can sue for a second chargeback.
Arbitration
The issuer/cardholder disputes the merchant’s second presentment, and the case goes to the issuer network (Visa, Mastercard, etc.) for arbitration.
At this stage, the parties involved - the bank, the cardholder, or the merchant - cannot resolve the dispute independently. Therefore, they ask the representative of the card scheme/network representative to intervene and decide (Visa, Mastercard, Discover, etc.).

Flow

The chargeback flow includes steps and may vary slightly depending on which banks and card networks are involved. The following parties are involved in the process: the cardholder, the cardholder’s issuing bank, the merchant, and the merchant’s acquiring bank. If the merchant has hired a chargeback representative, they will also be involved. CBHit-1-0.png The chargeback flow begins with the merchant deciding to either accept the chargeback or fight it through, representment - when the issuing bank reviews the merchant’s evidence and either cancels or supports the chargeback.

  • When a cardholder disputes a transaction with their issuing bank, the bank decides whether the customer has grounds to claim a chargeback.
  • If the chargeback request is granted, the bank notifies the acquiring bank, also known as the merchant’s bank, and debits the merchant’s account.
  • The merchant can either accept the chargeback or fight it by resubmitting the payment along with a rebuttal letter and the necessary evidence to rebut the claims (this process is called representment).
  • The issuing bank will review the new evidence and decides. If they decide in favor of the merchants, the funds will be returned.
  • At this stage, any party dissatisfied with the decision can challenge it by initiating pre-arbitration proceedings. Most often, this happens when the issuing bank decides in favor of the merchant, but then receives new evidence that casts doubt on this decision.
  • If neither party admits liability during pre-arbitration, the chargeback will proceed to arbitration. Here, the card network examines the evidence and makes a final decision, which cannot be further appealed. The losing party will be required to pay hundreds of dollars in fees.

By default, merchants are liable for chargebacks. This means that when a chargeback occurs, the funds are withdrawn from the merchant’s account and returned to the cardholder. Although both the merchant and the cardholder may be victims of fraud, the merchant pays for it.
With each chargeback, the merchant loses the transaction amount, as well as all goods and services that have already been provided. In addition, merchants face chargeback fees from their acquirers and processors. The chargeback rate is tracked by the acquirer, and merchants that exceed the allowable threshold may be subject to severe penalties.

If the chargeback rate exceeds certain thresholds set by card networks and other financial institutions they do business with, they may face fines, additional chargeback fees, and even termination of their trading account.

Thresholds

Card schemes (such as Visa and Mastercard) monitor your disputes monthly and compare them to your sales. If the number of disputes (also known as chargebacks) you receive exceeds what the card scheme deem acceptable, you may be placed into their monitoring program.

Once you join a program, the system may charge you monthly fines and additional fees until you decrease the number of disputes to acceptable levels.

Visa

Visa has established two monitoring programs to identify merchants with excessive disputes and/or fraud to promote the use of fraud controls and fair business practices.
Both the Visa Dispute Monitoring Program (VDMP) and the Visa Fraud Monitoring Program (VFMP) run on a monthly cycle within a 12-month timeframe. At the beginning of each month, Visa reviews the previous month’s processing activity and identifies merchants that exceed the program thresholds. Your company must exceed both thresholds to be included in a program.

Visa calculates the ratio of disputes to sales as follows: the number of disputes you received during the month divided by the number of sales you processed during the same month multiplied by one hundred.
For example, if you had 175 disputes in January and made 5,500 sales in January, your dispute-to-sales ratio would be 3.18% (175 / 5500 x 100).
This would place you in the standard level of the VDMP (if you are in a non-high-risk merchant category).
Visa will remove you from the program if your dispute activity falls below the Standard thresholds for three consecutive months.

If your company is accepted into a program, you will be required to submit a recovery plan on a monthly basis starting from the second month. This plan will identify the root cause and describe actions to restore compliance. The plan should include milestones and dates for all remediation actions. Non-compliance fines will be calculated monthly based on the schedule and the month of program participation. To opt out of the program, your company must remain below the standard thresholds for three consecutive months. If your company remains in the program for more than 12 months, you may be disqualified from accepting Visa payments.

VDMP

  • 75 or more disputes, and 0.65% ratio of disputes to sales transactions
  • 100 disputes, and 0.9% ratio of disputes to sales transactions
  • 1000 disputes, and 1.8% ratio of disputes to sales transactions
  • 100 disputes, and 0.9% ratio of chargeback to sales transactions and
  • One of the following:
    • Merchant outlet moved from Visa standard threshold to High-Risk threshold based on a review of merchant performance and inappropriate business practices (e.g., use of abusive free trial policies, negative renewal options, etc.), or
    • The Merchant exceeds the standard program thresholds and is categorized or should be categorized by a high-brand risk MCC, as specified in Section 10.4.6.1, High-Brand Risk MCCs (MCC 5962, 5966, 5967, 7995, 5912, 5122, 5993), or
    • Met or exceeded the program’s Excessive threshold

VFMP

  • US $50,000 or more in fraud dollar amount, and 0.65% or higher ratio of fraud to sales dollar amount
  • US $75,000 in fraud amount, and 0.9% ratio of fraud to sales dollar amount
  • US $250,000 in fraud amount, and 1.8% ratio of fraud to sales dollar amount
  • US $75,000 in fraud dollar amount, and 0.9% ratio of fraud to sales dollar amount, and
  • One of the following:
    • Merchant outlet moved from Visa standard threshold to High Risk threshold based on a review of merchant performance and inappropriate business practices (e.g., use of abusive free trial policies, negative renewal options, etc.), or
    • The Merchant exceeds the standard program thresholds and is categorized or should be categorized by a high-brand risk MCC, as specified in Section 10.4.6.1, High-Brand Risk MCCs (MCC 5962, 5966, 5967, 7995, 5912, 5122, 5993), or
    • Met or exceeded the program Excessive threshold

Mastercard

Mastercard’s Acquirer Chargeback Monitoring Program (ACMP) has two levels: Excessive Chargeback Merchant (ECM) and High Excessive Chargeback Merchant (HECM). The total number of chargebacks you have in a month and your ratio of chargebacks to sales in that month will determine which tier you are placed in. We will notify you if you are accepted into the program.

Mastercard measures your chargeback rate in “basis points” and uses the number to determine which tier of the program you fall into.
These basis points are calculated as follows: the number of chargebacks in that month is divided by the number of Mastercard transactions you processed in the previous month and multiplied by 10,000.
For example, if you had 185 chargebacks in February and processed 7,500 payments in January, you would have a chargeback rate of 247 basis points (185 / 7500 x 10,000 = 246.66, rounded up to 247). This would place you in the Excessive Chargeback Merchant (ECM) tier of the program.
Mastercard will remove you from the program if your dispute activity falls below the ECM thresholds for three consecutive months.

The ECM program aims to simplify enforcement and enable faster communication between acquirers and the card network. The goal is to make merchant compliance a more accurate process with greater accountability. The ECM program is a chargeback compliance program created by Mastercard. The purpose of the program is to monitor the activities of eCommerce merchants and prevent excessive chargebacks on the Mastercard network. This is achieved by imposing penalties on merchants for non-compliance.
The EFM program aims to simplify enforcement and enables faster communication between acquirers and the card network. The goal is to make merchant compliance a more accurate process with greater accountability.

ECM

  • A count of at least 100 to 299 chargebacks, and
  • A chargeback to transaction ratio (CTR) = 1.5% to 2.99%
  • A count of at least 300 chargebacks, and
  • A chargeback to transaction ratio (CTR) = > 3%

EFM

  • 1,000 or more eCommerce transactions and
  • The total dollar amount (or local currency equivalent) of fraud related chargebacks in a given month equals or exceeds USD 50,000, and
  • The total number of fraud chargeback basis points is equal or more than 50, and
  • The percentage of monthly clearing volume processed using 3DS (including Data Only transactions) or Digital Secure Remote Payment (DSRP) is less than 10 percent in nonregulated countries or less than 50 percent in regulated countries.

Representment

The cardholder is entitled to object to the invalid payment, and the merchant is entitled to object to the illegal refund. This process is called chargeback representment: CBHit-1-1.png If you need to prevent a chargeback, follow these rules:

You have a timeframe to respond to a chargeback before it is accepted by default, typically 7-30 days.
This is a short (one-page) letter outlining your counterarguments to the cardholder’s claims.
You must have documents that relate to the claim and prove that you are right. Each chargeback reason code has certain standards as to what evidence can be used against it, so always look at the reason code to determine what you need.



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