FedNow Instant Payments Will Not Prevent Fraud

Faster and smoother payment processes may eliminate float for corporate payables teams, but they also provide enormous opportunities to streamline processes and gain much more precise control over cash balances. That’s why most corporate treasurers love the idea of being able to initiate and finalize transactions in seconds, rather than waiting days for them to clear.

Back in August, the U.S. Federal Reserve announced plans to take the first step toward instantaneous payments in the U.S. market. Since then, the Fed has been working to build out a real-time payments settlement system, which will be called the FedNow service. In the announcement, Fed governor Lael Brainard explained this move by saying: “Everyone deserves the same ability to make and receive payments immediately and securely, and every bank deserves the same opportunity to offer that service to its community. FedNow will permit banks of every size, in every community across the country, to provide real-time payments to their customers.”

The Fed describes FedNow as a way to modernize the nation’s payment system. Widespread adoption of FedNow would render obsolete the Automated Clearing House (ACH) framework that currently settles interbank transactions.

The initiative is a response to the express desires of big brands like Amazon.com and Walmart, which have advocated for faster payments resolution. One recent study by Aite Group found that 80 percent of business owners are interested in the possibility of instant funds transfers. Furthermore, 85 percent of respondents to the survey said they would be willing to change to a new acquiring bank if doing so meant having access to instant card receipt funding.

Thus, it should come as no surprise that the announcement of FedNow seems to be drawing overwhelming popular support. The Federal Reserve reported that 90 percent of respondents in the idea’s public comment period were in favor of the initiative. Still, corporate treasury and finance groups should proceed cautiously.

New Processes Create Uncertainty

FedNow adoption is anticipated to begin sometime in 2023 or 2024. According to the Federal Reserve, FedNow will resolve transactions between financial institutions by adjusting the banks’ master accounts at the reserve banks to which the institutions are depositors. In turn, the banks will agree to make transaction funds available to their customers immediately. For companies, this means more prompt resolution of transactions and, as a result, reduced float and more accurate, reconcilable accounting.

In some ways, the service will include natural protections from payment fraud. Faster payments can make it harder for fraudsters to intercept payments. In addition, the Fed intends to promote “resiliency through redundancy,” allowing banks to build backup networks for payments settlement in the event of a disruption.

However, I remain concerned that FedNow will not effectively prevent fraud. In fact, we can reasonably expect fraud to increase after the platform goes live. That is because instantaneous payments do not give financial institutions any time to identify suspicious transactions. In the existing payments environment in the United States, the clearing process involves each institution maintaining its own record of transactions and verifying its record against those of fellow stakeholders. This process calls for considerable back and forth, with different parties communicating and attempting to verify their records, before we ever move to the actual process of debiting and crediting individual accounts.

These due diligence practices are time-consuming and redundant. However, they fill a valuable role in that they weed out fraud and errors. The banks have oversight processes that—while not perfect—at least ensure that individual transactions are probably valid. But when transactions close immediately after they’re initiated, banks simply do not have time to complete this due diligence process. If bad actors are able to intercept a transaction and divert funds, by the time the parties involved notice the fraudulent activity, the company’s money might be impossible to recover.

Concern about fraud in a real-time payment environment is more than idle speculation. We can look to the U.K. as an example; in 2008, the Faster Payments Service (FPS) was adopted, creating an instant payments service similar to FedNow. Since FPS went live, U.K. officials have consistently observed larger losses from online banking fraud. The report Fraud the Facts 2019 report from UK Finance projects that U.K. bankers will prevent £318 million in banking fraud attempts this year. However, £152 million will still go unnoticed.

Process Uncertainty Drives Risk

FedNow is a rebuilding of U.S. payment processes from the ground up. Its adoption will represent a major policy overhaul for the payments space, and it’s going to impact different parties in different ways. For corporate treasuries, fraud will be the primary concern.

The largest impact of the new system for consumers will likely come in the handling of chargebacks. U.S. law guarantees merchants the rights to dispute charges and recover their money in the event of fraud. The process fills an important role in our financial system because it supports cardholder confidence in payment cards. However, the chargeback process is widely abused. Chargebacks cost $31 billion in 2017, and those costs continue to rise each year.

Both payments fraud and chargeback fraud are able to flourish largely because the U.S. financial market lacks standards and consistency of practices across different card schemes (Visa, Mastercard, etc.). Card providers in each scheme have their own process for managing disputes, which creates confusion and unnecessary complexity. At present, each card scheme also has hundreds of pages of rules and procedures for managing the chargeback process, some of which are older than e-commerce itself.

Before we can start talking seriously about instantaneous payments in this country, the financial services sector must develop universally applicable processes for managing fraud and disputes—and consistent, fair guidelines for handling chargebacks. We need simplified, modernized procedures that can be universally applicable across card brands. This will cut down on abuse and enable more consistent dispute outcomes. It won’t be easy to do; developing a modernized chargeback procedure requires coordination and input from merchant representatives, banks, card schemes, consumer groups, and regulators. However, any efforts to improve the payments process that don’t address chargebacks are basically just rearranging deck chairs on the Titanic.

Frontline Dispute Mitigation

In the meantime, merchants will need to take action to mitigate their chargeback risk. Best practices on this front include:

1. Embracing multilayer fraud detection. All chargebacks can be traced to one of three fundamental sources: criminal fraud, friendly fraud, or merchant error. Before addressing the latter two, sellers must eliminate criminal fraud wherever possible. This calls for a multilayer strategy; incorporating redundancies into a strategy with complementary detection tools will help. Back-end fraud detection tools like Address Verification Service (AVS), velocity limits, fraud scoring, and geolocation can identify potential fraud without increasing customer friction. There are also opt-in tools like 3-D Secure, which functions like an online PIN code at checkout.

2. Emphasizing customer service and experience. As merchants take steps to mitigate criminal fraud, they should also review the customer experience from end to end to optimize practices and procedures. Simple steps like providing prompt responses to email, social media, and chatbot inquiries, as well as providing detailed descriptions of products and services, can have a tremendous impact on chargeback issuances.

Merchants should make all policy disclosures easily accessible to customers and should adhere closely to those policies. This establishes clear expectations for buyers and educates them on how best to interact going forward.

3. Being cognizant of friendly fraud. If businesses do everything they can to mitigate the risk of criminal fraud and error, it stands to reason that most of their remaining chargebacks would be cases of friendly fraud. This is a kind of chargeback abuse, and while it can be intentional, it’s often the result of factors like buyer’s remorse, confusion about merchant policies, or a lack of understanding on the customer’s part.

It’s difficult to prevent these problems, given their post-transactional nature; they don’t become fraud until the customer files a chargeback. That said, using delivery confirmation, ensuring all billing descriptors are easy to identify, and monitoring digital goods sales can help merchants curtail friendly fraud.

When a customer manages to file a friendly fraud dispute, it’s important to identify the abuse and engage it through tactical representment. Of course, chargeback representment is an involved and complex process, which is why many opt to seek third-party help from a chargeback management service.

Monica Eaton-Cardone is COO of Chargebacks911 and CIO of its parent company, Global Risk Technologies. She has extensive experience developing agile technologies and products, optimizing e-commerce profitability, analyzing risk relativity, and creating payment processing solutions.