as seen in The Paypers

by Keith Briscoe, Chief Marketing Officer, Ethoca

CNP fraud is a downward spiral of diminishing value and rising cost for all parties in the payments ecosystem. While card issuers and merchants both suffer acutely, it is cardholders who pay the ultimate price by enduring not only the painful chargeback and recovery process, but also the increasing likelihood of false declines.

The shift in fraud from card-present to card-not-present (CNP) channels is one part of this dangerous equation. Aite Group estimates that between 2014 and 2018, card issuer CNP losses will balloon from USD 2.8 billion to USD 6.4 billion. In the UK, despite the significant adoption of 3DS, CNP fraud is up 46% in the first half of 2016 (Financial Fraud Action UK, 2016) and case volume is up 53%. These are troubling indicators that despite the increasing range of fraud tools available for both card issuers and merchants, fraudsters continue to find vulnerabilities in defences and exploit them.

Rising friendly fraud compounds the problem

Compounding this mounting fraud problem is the encroaching spectre of friendly fraud, now hitting alarmingly high values across a range of merchant categories, particularly for digital goods where some of Ethoca’s customers have reported levels that range between 60 and 90%. What is especially disturbing here is the shift in customer behaviour: some merchants are now characterizing this trend not as a ‘fraud’ problem, but as a ‘liar’ problem. In part fuelled by the global regulatory environment (Regulations E & Z in the U.S., Financial Ombudsman Service in UK and Payment Services Directive in Europe, to name just three), cardholders have learned it is easier to contact the bank first and avoid responsibility for the transaction – without penalty
or consequences.

Whether fraud is ‘friendly’ (innocent or hostile), or criminal in nature, the combined impact is fuelling dramatic increases in false declines. Javelin research (Future Proofing Card Authorization, August 2015) suggests that in 2014 U.S. card issuers falsely rejected USD 118 billion in transactions due to suspicion of fraud, compared to USD 9 billion in actual fraud – that’s a ratio of 13 to one. In direct response, 39% of cardholders will abandon a card post decline, and 25% will move a declined card to the back of the wallet.

With the increase in friendly fraud, this decline spiral is exacerbated even further. These transactions are routinely coded as fraud – an outcome that has a negative ripple effect on card issuer authorization strategies. To cope with the increasing demand, card issuers are compelled to decline more, but this defensive strategy is based on inaccurate and incomplete data. These are essentially ‘good’ transactions recorded as fraud, ultimately used to tune card issuer fraud models. The inevitable result is higher false positives – more good cardholders getting turned away.

The dark irony of consumer protection

What we are witnessing is a dark irony: the very laws designed to protect cardholders are being abused by them for perceived gain. Yet it is these same cardholders who will bear the brunt of the false decline problem as they struggle to transact with trusted merchant and banking brands. Perhaps most damaging is the impact on banks’ highest value cardholders, who are victimized by criminal and friendly fraudsters alike. At a time when banks are more focused than ever on the customer relationship, the fraud and false declines challenge is among the most difficult to disentangle and overcome.

The reality behind the ‘Do Not Honour’ reason code Ethoca research has pulled back the covers on the decline problem and revealed that there are many reasons why cardholders are declined – many of which are often buried in the generic ‘Do Not Honour’ category. This lack of transparency fuels many merchants’ belief that fraud-based declines are the largest slice of the declines pie, when in fact the true picture is considerably more nuanced. Our findings indicate that ‘fraud’ accounts for just 9% of those declines, while ‘insufficient funds’ accounts for 44%, followed by ‘lost/stolen’ at 26%. This is often an untold chapter of the declines story, long masked by the lack of clarity in decline reason codes.

Merchant decline challenges

The challenge to balance a frictionless transaction experience with effective fraud prevention measures obviously also affects merchants’ authorization strategies, and overcompensation for fraud is just as pronounced. Ethoca’s research reveals that merchants in our study experienced a false positive rate of 52% – more than half the time, transactions they declined (or were in manual review) were actually good orders they could have fulfilled. Once again, that is a staggering amount of lost revenue and irreparably damaged customer relationships.

The time for collaboration has come

Stopping the downward spiral is going to take more than tools and a layered approach to fight fraud. It is going to take more than protracted conflict over who ultimately owns liability for the transaction. It is going to take a fundamental shift in the way each party in the CNP transaction communicates and collaborates.

The system we have built to manage this process today – the chargeback process – is ill equipped to facilitate this real-time collaboration. As a result, card issuers and merchants are incurring billions to prevent, detect and recover fraud, while forgoing billions in revenue – much of which is entirely avoidable.

Ethoca believes that ecommerce should simply be about commerce. Let’s stop being witnesses to the damage. Collaboration is the key to eliminating the conflict – and unlocking the value – for every party with a stake in the transaction. Join Ethoca on January 25th, 2017 at the Paris Fintech Forum for an invitation-only Collaboration Working Group with the country’s leading card issuers and ecommerce merchants.