hargebacks are one of the most misunderstood components of the bankcard industry. A common misconception is that chargebacks are synonymous with fraudulent or 'bad' merchants. While that is a good rule of thumb to follow, the reality is that perfectly legitimate and sincere businesses can be plagued by unfounded chargebacks.

The purpose of this article is to provide you with a better understanding of a merchant, cardholder, processor and bank's perspective on chargebacks. (The word "processor" will have a dual use for any entity ISO/MSP or processor that holds the risk and liability on a merchant account.)

As most of you are aware, Visa and MasterCard have always favored their issuing banks, which, in turn, creates favoritism for their cardholders. The April 2004 interchange increase is a classic example of this. I believe the motivation for the latest increase is entirely issuer-focused. We can also apply that same logic to cardholder and merchant disputes.

The Associations will typically favor cardholders over merchants on disputed transactions. Of course, we all want to see consumers protected from unfair and deceptive business practices, unfulfilled purchases or gross misrepresentation. But who protects the merchants? Merchants can do everything correctly and still lose chargebacks. This leaves them little recourse through costly collections outside of the Associations' control.

From a processor's perspective, chargebacks have more than one face, but the biggest concern is with the bad merchants. These are the merchants that set up "bust-out" accounts and run stolen credit cards, use card skimmers, sell a misrepresented product, engage in deceptive business practices or simply just don't fulfill a product or service that was promised.

The environment these merchants create will result in chargebacks and an increased liability to their processor. This is where risk management would get involved and help minimize the exposure.

Processors are responsible for paying all chargebacks if the merchant is unable to pay. This concept alone is the basis for all underwriting and risk management criteria adopted by this industry. The merchant agreement and the Associations' rules and regulations have provided the framework for controlling the processors' inherent exposure.

From the perspective of most processors, chargebacks bring something more serious than monetary losses; chargebacks bring Visa's and MasterCard's Chargeback Monitoring Program. Previously, the Chargeback Monitoring Program was brought in with a 2% exception (chargeback/retrieval) rate or excessive refunds. That limit was lowered to 1% as of October 2003.

The monitoring program extends over 12 months, but almost never exceeds the third month. The reason for this is a barrage of fines from Visa and/or MasterCard to the amount of $50 per chargeback in addition to a $5,000 review fee and a possible audit by the Associations. No processor or bank welcomes the fines or audit, so they will almost always terminate a merchant account before they complete the third month of the monitoring program.

With the understanding of chargebacks as they relate to bad merchants, the monetary losses for which processors are liable and the consequences from the Associations, the other side of dealing with chargebacks is 'What about the good merchants?' Is it possible for good merchants to have chargebacks? Is it possible for good merchants to wind up on the chargeback monitoring program? Absolutely. There are certainly plenty of good merchants out there that are unfairly taken advantage of by cardholders.

Without a doubt there is a percentage of cardholders who understand how to work the system. Knowledgeable cardholders can bend the chargeback rules in their favor quite easily. Unfortunately, there are industries that are targeted for this and have ultimately wound up on most processors' list of unacceptable merchants.

Are travel agents considered bad merchants? Not necessarily, but why are they always on unacceptable merchant lists? Travel agents can do everything correctly: swipe the card, get an imprint and a signed invoice. But they can still lose a chargeback. The cardholder goes on a vacation and plays the 'services not rendered as described' game or another chargeback reason code-and most likely wins.

There are several examples of this including e-commerce, service industries, businesses involved with futures or memberships, etc. These businesses can play by the rules exactly and still lose chargebacks. As a result the processors must protect themselves from the monetary liability and the involvement of Visa and MasterCard by preventing both good and bad merchants from becoming chargeback problems.

This has been hammered out over the years through unacceptable merchant lists and risk management flags geared toward historically problematic SIC codes.

While processors, merchants and cardholders are exposed to both perspectives of a chargeback, banks are often only concerned with Visa and MasterCard. Unless banks are actively involved with the transaction processing, their only responsibility is to their membership with the Visa and MasterCard Associations. The fines, audits and phone calls from Visa and MasterCard all hit the banks first. The banks, therefore, are most concerned with their reputation and positive standing within the Associations.

A sponsoring bank will almost always side and push in favor of the Associations. This is perhaps one of the biggest dilemmas of the industry. The acquiring banks and the issuing banks have their distinctive roles with the purpose of creating a balance.

As it pertains to chargebacks, the reality is that the issuers have the most clout while the sponsoring members usually assume an attitude of "not rocking the boat." That leaves processors in a very difficult situation-but not so unusual that the same model above applies to multiple aspects of the bankcard industry.

In the big picture, chargebacks have only negative ramifications for merchants, processors and banks. Although there is certainly a percentage of legitimate merchants unnecessarily caught up in the process, the system does far more good than bad. On all levels, understanding the different perspectives of chargebacks is critical for communication and risk management.

While some good may be caught up in the bad we are an industry of averages and percentages. The actions of all parties involved are based on the averages in which the bad outweighs the good. Hence, the common misconception is that chargebacks are synonymous with bad merchants.

Jared Isaacman is Director of Operations for United Bank Card, Inc. Reach him by calling 908-638-5326 ext. 120 or email him at jared@unitedbankcard.com