What is a Chargeback?

In short

A Chargeback is a mechanism through which a cardholder can dispute a charge by contacting their card issuing bank.  The issuer will request the acquiring bank to reverse the transaction and return the funds to the cardholder.

Unlike the statutory protections provided by section 75 of the Consumer Credit Act 1974, a Chargeback is not a legal right.  The Chargeback system is offered and governed by terms signed up to by Visa, Mastercard and American Express.  Whilst in theory there are no guarantees the cardholder will get their money back, it is a powerful tool for consumers as the scheme effectively pushes the risk of loss onto the acquiring bank rather than the consumer.  ie if there is a problem recovering funds from the merchant, it will be the acquiring bank that loses out rather than the cardholder or issuing bank. 

Here's how it works 

When a cardholder uses a debit, credit or pre-paid card to make a purchase online or in store, the merchant’s acquiring bank will contact the cardholder’s issuing bank to check the cardholder has sufficient funds and to authorise the transaction.  The acquirer then receives funds on behalf of the merchant, deducts processing fees and passes the funds to the merchant’s account.

When a Chargeback occurs, the cardholder contacts their issuing bank who requests the acquirer reverses the transaction.  The acquirer will return funds to the cardholder and attempt to recover those funds from the merchant.  If the acquirer cannot recover those funds from the merchant (eg because the merchant has become insolvent since the original transaction) then it is the acquirer who will be out of pocket. 

Source of risk

Under the Chargeback scheme cardholders have 120 days from the date of purchase to make a claim.  If the purchase relates to a future event such as a future delivery, concert or holiday, then the 120 days start from the date of that future event.  Whilst Chargebacks should be a last resort option, many cardholders will use the Chargeback procedure because it is easier for them and perhaps less confrontational with the original merchant.

From an acquirer’s perspective, Chargebacks can represent a significant area of risk exposure.  If a separate payments processor is involved in addition, then the processor will typically indemnify the acquirer for any loss so responsibility for Chargeback losses will effectively then pass to the processor. 

This assumption of risk is the price acquirers (and processors) pay for processing transactions involving the major credit card companies, without which there would be no transactions in the first place.  However it is still a material risk that needs managing.

For assistance managing merchant default risk contact PureDelta.