Fraud is a reality of the times in the financial world. All of us have been victims of fraud or know someone who has been. Traditional fraud—where an unauthorized party obtains one’s financial information—is havoc. However, most banks have safeguarding measures to minimize the damage. But what if fraud is from an unknown source and is unwitting? This is where friendly fraud comes into play—a deceitful practice that is difficult to identify and even harder to combat.
What Is Friendly Fraud?
Friendly fraud refers to a case where one opposes a valid transaction that has been done on their account, resulting in an unfair refund. Unlike traditional fraud, where a third party gains access to an account without permission, friendly fraud is actually caused by the cardholders themselves, knowingly or unknowingly. In most cases, the “victim” had prior knowledge of the transaction but claimed that it was unauthorized.
This deceitful act typically occurs when a cardholder requests a chargeback with their bank, stating that they never bought anything or did not receive the merchandise or services. If the fraudster’s demand is granted, they receive a full refund and keep the product they purchased or benefit from the service—something for nothing.
How Does Friendly Fraud Happen?
Friendly fraud is unintentional, though at times, it can be purposeful. In most cases, there are simple misunderstandings, such as:
- A family member, typically a child, uses the cardholder unbeknownst to them.
- Someone forgets they made a subscription or web purchase and calls the chargeback.
- A shopper thinks returning something automatically earns a refund but does not utilize the merchant’s return procedure.
- A person misinterprets a description of a transaction on their banking statement and believes it is an act of fraud.
Regardless of whether or not friendly fraud occurs by accident or deliberately, the outcome is one and the same—companies and financial institutions suffer financially, and thieves, either involuntarily or willingly, obtain refunds that they are not, in fact, entitled to.
The Effect of Friendly Fraud
At first glance, the immediate victim of friendly fraud appears to be the bank issuing the refund. However, the impact of this type of fraud extends far beyond banks. Merchants, particularly small businesses, are the hardest hit by these chargebacks in a variety of damaging ways:
Financial Losses for Merchants
Friendly fraud is not about losing a sale—it is about merchants handing their goods or services away for free. When merchants succeed at a chargeback, it is not just the price of the product they lose—the chargeback and administrative fees come on top, too.
Disrupted Cash Flow
For small as well as bigger merchants, chargebacks can drain their cash and cause financial troubles. Merchants rely on periodic revenue, and when chargebacks withdraw funds from their accounts, it can impede their ability to operate successfully.
High Fees and Fines
Credit card networks and payment processors track chargeback ratios, and high chargebacks will result in increased fees or even account termination. If a company goes above the chargeback threshold that exists in the industry, it will be put on a high-risk list, and it will be more difficult and costly to process transactions in the future.
Challenges in Establishing Innocence
Unlike traditional fraud, in which strong evidence (such as stolen credit card information or unauthorized purchases) can readily make a case, friendly fraud leaves merchants with very little room for recourse. Since claims through chargebacks are often made weeks or months after the initial transaction, it will be nearly impossible to gather sufficient evidence to dispute such a claim.
Combating Friendly Fraud: What is Being Done?
The silver lining is that banks and businesses are not totally helpless in the face of friendly fraud. Companies like Ethoca and Verifi are working to prevent fraudulent chargebacks by increasing interaction among banks and merchants. Here is how financial institutions and businesses can address friendly fraud:
Real-Time Communication
Some financial institutions will now cooperate with merchants in real time to verify transactions before issuing a chargeback. This can help clear up miscommunication before refunding.
Detailed Transaction Histories
Having detailed records of transactions, including customer communications, shipping history, and proof of service delivery, can allow merchants to dispute suspicious chargebacks more effectively.
Enhanced Authentication Procedures
Requiring two-factor authentication (2FA) for online purchases can help verify that transactions are being authorized by the actual cardholder.
Enhanced Billing Descriptions
Another top reason for accidental friendly fraud is unclear transaction descriptions. By ensuring that billing statements clearly display a recognizable merchant name and product description, companies prevent confusion, leading to chargeback disputes.
Customer Education
Friendly fraud also happens sometimes through inadvertent mistakes. Issuing guidelines to customers on proper refund policies, subscription management, and billing is probably going to save the company from accidental chargebacks.
Chargeback Prevention Alerts
Some merchants do have chargeback alert systems that alert them whenever a chargeback has been made so they can resolve the issue before the automatic refund occurs.
The Bottom Line
Friendly fraud is not always as blatant as traditional fraud, but it is just as destructive—if not more so. Businesses lose money, banks lose money, and even consumers contribute to the environment in which fraudsters are able to take advantage of loopholes in the system.
By raising the level of awareness about this rising issue, improving communication between businesses and financial institutions, and implementing better fraud prevention strategies, we can work toward reducing friendly fraud and protecting businesses from unnecessary losses.