For those working in payments and finance, few words can set one’s teeth on edge like “chargeback.”

Trouble with these forced payment reversals is nothing new. Most online merchants expect to see some chargebacks, and when we look at the industry as a whole, we see that sellers lose billions of dollars each year as a result of the practice. However, we tend to pay less attention to the losses incurred by banks as a result of chargebacks.

Let’s assume you’re a consumer. You make a purchase with an online retailer, but then later decide you’re not satisfied with the goods you bought. Maybe they don’t match the description on the seller’s site, or simply don’t fit what you need at the present moment. When you want your money back, the natural assumption is that you should request a refund…right?

Chargeback Costs on the Rise for Financial Institutions

More and more consumers view the chargeback process as a quick, easy alternative to a return. Instead of requesting a refund and returning the goods in question, they simply contact the bank and dispute the charge.

We see these so-called “friendly fraud” chargeback issuances increase by roughly 20% each year. These cardholders are abusing a consumer protection mechanism that was never designed to work this way.

Most of these consumers won’t see a problem with this. In their minds, there’s little difference between contacting the merchant and the bank. Plus, a chargeback saves the hassle of contacting the merchant and sending back the goods in question. So, while cardholders have a responsibility to contact the merchant before requesting a chargeback, it’s not a surprise to learn that only 14% of cardholders actually do this.

Merchants suffer the brunt of these losses. However, financial institutions lose billions of dollars each year as well due to lost processing costs, card network fees, and margin compression. There are other risk factors, too; for instance, if a merchant does not have enough cash in reserve to cover a sudden surge in disputes, as may happen due to the COVID-19 crisis or other unforeseeable circumstances. In this case, the acquirer would end up footing the bill.

The true cost of chargebacks for financial institutions could be several times what we see on the surface. And, if chargeback issuances continue increasing, we could see serious long-term ramifications.

Some merchants could be forced to close their doors, while banks will be constrained by tighter margins. It could stifle innovation in payments and finance, leading to reduced efficiency, higher costs, and a loss of competitive edge. Despite all this, little is being done to really confront the matter in any meaningful way.

A Comprehensive Solution is Key

Chargeback issuances are still mounting. There are several reasons for this; for instance, consumers don’t really have any significant incentive to alter their behavior. They don’t see the broader ramifications of escalating chargeback issuances, so there’s little incentive to change.

At the same time, while payments technology evolves at a rapid pace, the regulations and infrastructure undergirding the transaction process are decades old. This results in inconsistencies, and also creates opportunities for bad actors to engage in fraud.

What we truly need is a comprehensive solution to the chargeback problem. We need consumer education, infrastructure overhaul, and new technologies that can rise to meet the challenge presented by payment chargebacks. Another idea I’ve promoted in the past is the “dispute credit score.” This would make it easier to identify consumers who routinely abuse the chargeback process.

Of course, this is all hypothetical. The card networks like Visa and Mastercard have taken some steps, such as introducing their respective Visa Claims Resolution and Mastercard Dispute Resolution initiatives to try and address shortcomings in the chargeback process. Ultimately, though, these patchwork solutions are not enough to really fix the problem.

Until we have the kind of industry-wide changes outlined above, financial institutions will need to take it upon themselves to defend against chargeback abuse.

AI Could Provide the Answer

The current situation calls for an advanced and adaptive solution that’s driven by artificial intelligence. For acquiring banks, this solution must look at the primary source of their losses (the processing costs and network fees mentioned above), then deploy a solution that targets these pain points.

The dispute process can be protracted and drawn-out, involving lots of back-and-forth exchanges between parties. Any means of automating and speeding up the dispute process would allow financial institutions to free-up resources and reallocate staff. Considering that up to 39,000 fulltime-equivalent employees at financial institutions were occupied with chargeback-related activities in 2018, the savings could be substantial.

An AI strategy for financial institutions could provide a single integration to streamline processes, making for a more efficient and scalable solution. It would provide greater data insight to fill the gap between acquirers and merchants; something that is not currently possible under existing legacy infrastructure. The result would be straightforward chargeback remediation with an easy integration process, giving acquirers the ability to automate disputes, reduce costs, and offer added value to their customers.

The technology should be agnostic and responsive to changes in the industry, such as new preferences in payment method. Alternative options like click-and-collect and mobile wallets have seen explosive growth since the outbreak of COVID-19, and many of these new users intend to stick with the payment model even once the emergency passes. As with disputes at large, COVID-19 merely accentuates an existing shortcoming in the payments space.

Financial institutions must work in close collaboration with merchants, card networks, and government to create a permanent fix to the inconsistencies that enable chargeback abuse. In the meantime, though, automating disputes on the acquirer’s end is the best move possible.

Monica Eaton-Cardone is an entrepreneur and business leader with expertise in technology, e-Commerce, risk relativity and payment-processing solutions. She is COO of Chargebacks911 and CIO of its parent company Global Risk Technologies.