Article: PSD2 and false declines: Turning a downward spiral on its head

by Steve Durney, SVP Innovation & Industry Solutions, Ethoca

What do card issuing banks and eCommerce merchants share in common? The ever-growing burden of card-not-present fraud.

Both sides respond with sophisticated arsenals of multi-layered fraud tools that aim to reduce losses, prevent damage to the customer relationship and control operational expenses. However, when turning down transactions banks often provide merchants with extremely vague “Do Not Honour” instructions. These are intended to protect customer privacy when attributed to insufficient funds or over limit scenarios, but also mask a huge problem: false declines.

False declines – good transactions that are wrongly rejected due to suspicion of fraud – are frustrating for everyone involved. Consider this scenario: a customer is buying a relatively expensive piece of jewellery online. The merchant runs a significant number of fraud checks but is ultimately unable to authenticate the circumstances surrounding the purchase, so they decline the payment. Alternatively, a card issuing bank may interpret the same transaction conditions with suspicion, and decline rather than accept risk of loss. Either way, the customer receives a generic message asking for a different payment card.

Frustrated, the customer tries an alternative card, relegating their previously preferred card to the back of their wallet, where it tends to stay – either permanently or for months at a time.

If you’re looking for a silver lining, there isn’t one – everyone loses out; the customer is insulted when their purchase is obstructed, the merchant loses the sale and the issuer puts their cardholder’s loyalty at risk while incurring the operational costs of dealing with the issue.

So, how big is the false declines problem? In a recent investigation we determined the following:

1) 1.9 billion purchases, representing $145.9 billion in sales, are declined every year.

2) 52% of orders that merchants believed to be fraud were actually good orders they could have successfully fulfilled. We also calculate that up to 475 million cardholders globally are at risk of relegating a preferred card to the back of the wallet after a decline: bad news for issuers.

3) Transactions are declined for a whole host of reasons including insufficient funds or a lost/stolen card, not just those resulting from fraud risk. We found that 44.4% of declines are due to insufficient funds: only 9.4% are actually due to fraud.

The increase in friendly fraud exacerbates the decline spiral even further. This disturbing shift sees cardholders avoid responsibility for a transaction by contacting the bank instead of the merchant and demanding a chargeback. The bank feels obliged to act or depending on the jurisdiction, is forced to as per regulation. The ripple effect is that these ‘good’ transactions are coded as fraud which incorrectly tunes card issuer fraud models, unnecessarily raising suspicion on otherwise harmless transactions. The result? Even more false positives and more cardholders blaming their bank following a decline.

Building a strong customer relationship is high on the agenda of most banks but the fraud and false declines challenge remains one of the most significant obstacles in their path. Breaking this repeat behaviour will require a new approach.

It’s time for a collaborative approach

Banks need to move beyond sole reliance on traditional anti-fraud tools, put aside protracted conflicts with merchants over who owns liability for the transaction and find a more effective way to work together for mutual benefit.  

This is why we built our global collaboration network – to provide banks and merchants with a better way to communicate – one that completely replaces the costly and inefficient chargeback process. With real-time collaboration on confirmed fraud data, both parties can avoid incurring billions trying and failing to prevent, detect and recover fraud. Conflict can be eliminated, and new value unlocked for issuers, merchants and customers.  

Looking to the future

Looking ahead, PSD2 offers unique dynamics that may significantly alter the scope of the problem. Currently we can only speculate on the fall out, but we can be certain of collateral damage and unintended consequences. Although the regulators may expect fraud to dissipate because they’ve enabled the payments system to communicate more effectively, the reality will be quite different. Imagine squeezing a balloon, compressing fraud in one area will only increase pressure in another. There’s just not enough known about the Game Theory in terms of the reaction of the criminal, the counterreaction from the bank and how it will affect real people.

We’re also likely to see a lot of new players who’ve never been involved in the payments ecosystem, yet now see a business opportunity, unintentionally causing false declines. The new actors in the chain are likely to disrupt a finely-tuned system and may cause either issuers or merchants to miss-categorise legitimate transactions.

If there’s one issue that needs to be resolved before we can finally move past the false declines problem, it’s communication. Today, we see the CNP ecosystem functioning in silos, leaving good customers and good banks to fall victim to the system because there’s no reliable way to share intelligence on bad customers. Effective collaboration across the globe is the only way to break the cycle.