Credit and fraud losses are two of the most significant credit card-related risks to a financial institution. Credit losses due to contractual delinquency and bankruptcy account for the majority of credit card charge-offs. Fraud includes unauthorized use of lost or stolen cards, fraudulent applications, counterfeit or altered cards, and the unauthorized use of a cardholder's credit card number for card-not-present transactions.
Consumer compliance regulations (Regulation Z and Regulation E) and association operating rules (Visa and MasterCard) provide significant consumer protection for fraudulent transactions. According to Regulation E, if cardholders report timely the loss of their credit cards, they are responsible for no more than $50 of the charges resulting from fraud. Regulation Z provides additional billing error resolution procedures. Visa, MasterCard, Discover, and American Express have zero liability programs, which indemnify card holders for all fraudulent losses in many circumstances. The issuing financial institution or the merchant pays the costs of any fraud involving credit cards. At a minimum, the merchant should obtain an authorization, a cardholder's signature, or an electronic imprint of the card (electronic information on the card) at the POS. The merchant is required by the card companies to cover fraudulent transactions through the chargeback process if it does not follow the minimum procedures. This has become a significant issue for many online retailers processing card-not-present transactions. The major bankcard companies; however, have introduced services to reduce the liability of the merchants. Under one initiative, issuers will assume losses for fraudulent transactions if the payment was authorized using the bankcard company's authentication procedures.
A control method financial institutions use to reduce risk is the authorization process to approve the credit transaction. For example, when the merchant swipes the bankcard, the issuer can deny authorization of the transaction if the consumer is over his or her credit limit, is delinquent, or if the card has been reported as stolen. Financial institutions can also employ the address verification service (AVS) to verify a cardholder's billing address and other pertinent information. AVS is used for mail, telephone, and Internet transactions.
Employing the appropriate underwriting, account management, monitoring, and collection practices can mitigate credit risk. By setting standards that reduce the probability of delinquency and fraud, financial institutions can more effectively control credit losses.
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