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The Consumer Financial Protection Bureau will appeal to the U.S. Supreme Court over the Fifth Circuit’s ruling that their funding structure is unconstitutional, with an initial hearing set for Jan. 6. Should the Supreme Court uphold the decision in April, it could lead to a rollback of many regulations imposed by the financial watchdog agency.
Merchants and financial institutions need to work together by utilizing end-to-end data sharing and automated technology to provide a more accurate picture of how fraud occurs and protect consumers, banks and businesses, especially if the Consumer Financial Protection Bureau (CFPB) finds itself in legal turmoil.
While payment disputes can arise between cardholders and merchants, how best to handle these disputes is controversial.
The problem is framed as a zero-sum contest where the needs of retailers must be weighed against the rights of cardholders. Conventional wisdom says that anything benefitting merchants must do so at the expense of cardholders and vice versa.
Regulatory pressures from agencies like the CFPB have largely ignored the merchant perspective in favor of expanding cardholder protections. Unfortunately, this focus has consequences that continue to drive increased costs for merchants and financial institutions caught in the middle.
Fortunately, technology allows us to build a collaborative solution that benefits all parties in the transaction process without prioritizing the needs of one over another. With the Supreme Court set to consider the CFPB’s certiorari petition regarding the Fifth Circuit Court of Appeals deeming their funding structure unconstitutional, the possibility looms that the Supreme Court could uphold the Fifth Circuit’s ruling, leading to a rollback of regulations imposed by the financial watchdog agency and a big disruption for banks and businesses.
The need for cardholder protections
Obviously, there’s a solid case to be made for prioritizing consumer protection.
When the CFPB was established in 2011, its express purpose was safeguarding consumers against abusive and predatory financial practices. This was seen as a necessary repercussion in a post-2008 environment.
Protecting consumers against fraud and abuse is the right thing to do. It also helps to provide a solid bedrock for the market at large. If consumers have confidence in their protection, they’ll be more willing to transact online.
Cardholders have the right to ask their issuing bank to intervene by filing a chargeback, essentially a forced refund. This fundamental guarantee underpins much of the growth in the online market over the last two decades. Without it, one could argue that far fewer people would confidently shop online.
For instances of true fraud, payment disputes should be easy to resolve and require minimal effort by cardholders. Adding excessive friction or burdensome obstacles would have downstream consequences for the entire ecommerce industry.
The problem is that cardholders have become more comfortable with the dispute process and learned ways to abuse the system.
The problem of chargeback abuse
Many of the chargebacks filed by cardholders this year will be based on invalid claims.
Consumers increasingly see chargebacks as the first course of action when resolving any issue with an online merchant. Card issuers have made it very easy to dispute a charge, so it’s often faster for consumers to contact their bank than the merchant when they are unhappy. It’s so easy, in fact, that many chargebacks are accidentally initiated by cardholders simply seeking information about a transaction.
This has led to a boom in friendly fraud cases that cost merchants billions of dollars annually. One recent study found that friendly fraud was the most prevalent fraud attack method confronting merchants in 2021, rising from fifth place in 2019.
The current system also puts a lot of burden on merchants who wish to defend themselves against friendly fraud. The lack of standardization and cumbersome requirements of many acquirers is designed, in part, to dissuade merchants from responding to disputes.
The LexisNexis True Cost of Fraud study estimates merchants ultimately lose $3.60 for every dollar in direct fraud costs. This multiplier is partially due to the resources required for merchants to manage chargebacks effectively.
The need for merchant rights
The current chargeback system was codified long before ecommerce or online banking was a concern. While there have been several updates to the chargeback process in recent years, the underlying logic has remained largely unchanged.
Under the present system, the burden of disputes falls overwhelmingly on merchants, and filing a response is typically difficult. Most banks still require paper documents and provide very little guidance on the format or other requirements. This may be, at least to some degree, by design.
When a merchant provides compelling evidence that the transaction was legitimate, both banks must review and process the case. If the case is decided in the merchant’s favor, the cardholder can escalate the dispute. This is a manual, time-consuming process. The current system would break down if most merchants responded to most cases.
This “strategic dysfunction” has dissuaded many merchants from defending themselves against illegitimate disputes, but it cannot be the final solution. As friendly fraud becomes more common, it should be easier, not harder, for merchants to fight back.
The “merchant vs. cardholder” fallacy
Common wisdom states that by placing too much emphasis on consumer protection, we ask merchants to accept chargebacks and friendly fraud as a cost of doing business. This puts a financial burden on merchants that is invariably passed onto customers.
In contrast, trying to empower merchants without reexamining the foundations of the dispute process could put consumers at risk. The system could be overloaded, and dishonest merchants could re-victimize cardholders with legitimate claims.
The path forward isn’t to try and protect one party at the expense of another. Instead, it’s to develop strategies that serve the needs of merchants, cardholders and banks.
A technological roadmap
Modern banks are behaving more and more like software companies, but payment disputes are still largely handled on rails built in the twentieth century. Collaborative solutions and end-to-end data sharing can better inform chargeback decisions, streamline operational bottlenecks, reduce friendly fraud and protect cardholders.
Here’s an example: as artificial intelligence and machine learning play a larger role in fraud prevention, accurate data to train these systems is becoming increasingly valuable. By discouraging merchants from responding to disputes, institutions are forfeiting critical data that could be used to prevent fraud.
If acquiring banks encouraged their merchants to respond to all cases, even just to confirm actual fraud, it would provide the institutions with a much more accurate picture of the actual fraud. The current solution relies heavily on raw chargeback data, including “criminal” third-party and “friendly” first-party fraud.
If more merchants responded to payment disputes, banks would be much better at identifying and preventing fraudulent transactions. There would be fewer instances of criminal fraud and fewer false declines, which would benefit everyone.
The added caseload could be streamlined through modernization. Instead of relying on disparate, non-standard, paper-based documents, technology could allow merchants to transmit raw data in a globally standardized format. This would empower all parties to utilize automation, minimize mistakes, and reduce the number of employees required to process disputes.
Additionally, chargebacks could be further reduced by increasing the data available to issuing banks when processing disputes. A significant number of chargebacks are filed by mistake. Cardholders call their bank to inquire about a charge, and with little to no information about the transaction, the bank’s only option is to initiate a chargeback.
Currently, two technologies — Verifi Order Insight and Ethoca Consumer Clarity — allow merchants to share data with banks in case of a cardholder inquiry. They have proven the benefits of data, but the programs are costly and difficult for merchants to implement.
Increased data sharing, by default, should be the goal.
Out with the old, in with the new
Striking a balance through technology is a “win-win” that benefits cardholders, banks and merchants alike. It should be the objective of all parties, including regulators like CFPB, to advocate for technological solutions to our present-day problems.
The change will not be easy, and we won’t see results overnight, but the value of building a better, more viable system outweighs any costs. The more focus we put towards solutions that align with the needs of merchants, banks and consumers, the easier it will be to solve the remaining conflicts.
The current system is not sustainable. It’s time to try new ideas.