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Payment reversals are a concern for merchants of all sizes. It means sending funds back to a customer, costing your valuable time and effort on top of the lost funds. It may take the form of a refund (which is a type of payment reversal) carried out to keep a customer loyal, honor your legal obligations, and preserve your business's reputation.
Each type of payment reversal is different. Knowing more about them will help to manage costs and strengthen customer trust.
In this article we describe the three main types of payment reversal and the steps a merchant can take to minimize them.
What does payment reversal mean?
The term payment reversal applies to any transaction when payment funds are returned to a cardholder’s bank. A payment reversal can be initiated by the cardholder, merchant, issuing bank, acquiring bank, or card network.
There are lots of reasons why a payment reversal may take place, such as:
- product is no longer in stock
- product does not meet the expectations of the customer
- customer changes their mind about the purchase
- incorrect amount of money was taken
- purchase was fraudulent
A payment reversal may point to operational failings, substandard products, or an inadequate approach to fraud prevention. The consequences of a high payment reversal rate go beyond the money being paid back out. Depending on the cause, payment reversals can harm customer trust or attract stricter anti-fraud controls from banks and card issuers. As such, understanding more about payment reversals is key to building a more profitable business.
What types of payment reversals are there?
There are three main categories of payment reversals: authorization reversal, refund reversal, and chargeback reversal.
Authorization reversal
Authorization reversals take place before a payment has been completed. This is possible because card payments can take days or even weeks for the funds to be transferred from the customer’s bank to the merchant's bank. Authorization means the customer’s bank validates that the payment can take place, and the transaction amount is ringfenced. It provides a window of opportunity to withdraw the authorization before the funds have left the customer’s account.
The trigger is often someone spotting an issue as the transaction is being processed. It could be that the merchant notices they have keyed in the wrong amount, or the customer wants to pay with a different card. Depending on the payment software, there will usually be a mechanism to stop the transaction, such as a cancel button. In technical terms, an electronic communication is sent to the issuing bank through the merchant’s payment processing system, instructing them to reverse a transaction that was just authorized.
Other times, a merchant requests that a customer payment is pre-authorized prior to them consuming the product or service. This is sometimes referred to as a security payment, and is common with the hotel and car rental businesses. If the customer does not spend the authorized amount, the merchant will then need to reverse this authorization, either fully or partially.
The longer the authorization takes, the more complicated the reversal becomes as the payment passes through various stages, from issuing bank to card network and acquiring bank. In an efficient authorization reversal, the funds should never leave the customer’s bank, and the merchant can avoid interchange fees that are usually levied at the point of settlement.
If the reason for the reversal is due to an error on the part of the merchant, the reversal can be completed without the customer even being aware. Another benefit of a fast authorization reversal is that the merchant does not have to account for the arrival and return of revenue on its balance sheet. This accounting exercise becomes complex when merchants are processing high volumes of transactions.
As such, authorization reversal is the cheapest, fastest and most customer-centric way of cancelling a payment.
Refund reversal
Once a payment has settled (and so the opportunity for an authorization reversal has passed) the next best option is a refund reversal. In a refund reversal, the merchant returns funds to the customer’s bank. In purely transactional terms, a refund reversal is a completely separate activity to the original customer payment, although typically they are for the same amount of money. As such, the refund reversal will be subject to normal fees and settlement times. But in that time, a customer should be able to see a pending credit item on their bank statement. This should appease any measures the customer may take to contact their bank to get their money back.
It is for the merchant to decide when to initiate a refund, and for what reasons. That said, without a generous refund policy the customer may initiate a chargeback request.
Chargeback reversal
Chargeback reversals are the worst case scenario for merchants. A chargeback occurs when the customer’s issuing bank refunds the customer and then seeks to reclaim the money from the merchant. If the merchant does not dispute the chargeback, it will need to refund the customer plus an additional penalty fee to the issuing bank.
Fighting the chargeback will require the merchant to provide evidence, and the process can take weeks, even months, of additional administrative burden. Even if the merchant wins, a high volume of chargeback requests can result in the bank or card networks classifying the merchant as high risk, and applying stricter security thresholds on it. In turn, a merchant’s payment acceptance rates can fall. In extreme cases, a merchant with an excessive chargeback rate can have their account suspended by the card networks, leaving them unable to trade.
Payment reversal vs returned payment
Although they sound very similar, a payment reversal is entirely distinct from a returned payment. A payment reversal undoes a completed transaction, while a returned payment indicates the transaction failed before completion.
You can think of a returned payment as a bounced payment: the transaction did not go through. Common reasons for a returned payment include insufficient funds, incorrect account details (similar to how an email fails to send to an email address containing a typo), or the bank placing a hold on the account. While a payment reversal takes place after a transaction has already settled, a returned payment signifies a transaction never completed in the first place.
How long do payment reversals take?
How long a payment reversal takes depends on the type of reversal it is. An authorization reversal can be immediate, and often without the customer even being aware it has happened.
Refund and chargeback reversals take longer because funds have to be returned to the customer’s bank account. Of those, a refund reversal will be faster, but dependent on how the refund is processed (i.e as a transfer to the customer’s bank account, or credit added to the card used in the initial payment.) Settlement can take between one and five days.
Chargeback reversals will be longer again, especially if the merchant disputes the claim. Although disputes can take weeks, even months to resolve, a customer may expect their bank or card issuer to provide the refund while the dispute is ongoing.
How can merchants prevent payment reversals?
While every merchant will face some level of payment reversals, they should not be passive bystanders. There are plenty of things they can do to minimize payment reversals, or mitigate the disruption when they do happen.
In this section we will revisit some of the reasons why a payment reversal is initiated, and what a merchant can do in each situation.
Merchant error
If the merchant has made a mistake, such as processing the wrong value or requesting a single transaction twice, then speed is the key. In an online transaction, a speedy authorization reversal means the customer does not need to be made aware that a mistake has taken place.
Unavailable product
Whereas some customers may be willing to be patient to receive their purchase, others will not be. By integrating the systems used for taking payments and stock control, a customer can be told at the point of transaction if the product is unavailable, and when new stock will arrive. The customer can then make an informed decision about whether to go ahead with the transaction, and be less inclined to change their minds later.
Payment data is incomplete
A single payment includes a lot of data. Alongside personal and banking information about the customer, a payment transaction includes a transaction identifier (TID), a retrieval reference number, a surface trace audit number, and payment authorization code.
If any of this data is missing or in an unfamiliar format, the payment may be blocked between authorization and settlement, and the customer’s money will need to be refunded. A payment processing gateway, typically offered by a third party, will ensure that payment requests are sent with all the necessary data.
The customer doesn’t recognize a payment
Customers who do not recognize a transaction will sometimes jump straight to requesting a chargeback from their bank. Processing a payment quickly will help the transaction be familiar with the customer.
A merchant should also regularly communicate with customers about their purchase, from the point of payment through to delivery (if that applies). Clearly identifying the payment on a bill or bank statement (known as ‘deflection’) also leaves the customer more knowledgeable. The more a customer is kept up to date, the less they will query the payment and seek a refund.
Learn more: What is an ARN?
Recurring payments are being reversed
For businesses where the customer experience is drawn out over days or weeks (think hotels, car rental, tool hire), merchants can submit a single authorization request for multiple payments that accumulate over a set period of time.
By enabling all the payments under a single authorization, it means the merchant only needs to get a payment request right once. It also means that the customer is made aware of funds that are expected to be paid out, and so will be less likely to challenge them.
Learn more: Recurring payments explained
Refund reversals initiated by customer complaints
A refund reversal initiated by a customer complaint is also a learning opportunity. Systematically recording and analysing the reasons why customers are unsatisfied can surface commonalities and provide lessons to reduce future complaints.
These can include sourcing better quality products to sell; providing more accurate product descriptions so customer expectations are more realistic; or investing in after-sales support services. Merchants can collect this feedback in numerous ways, such as directly asking the customer or through social media listening tools.
Fraudulent payments are causing refund reversals
A fraudulent payment can often go undetected until the customer initiates a chargeback. By that point, the damage for the merchant has already been done. So merchants should aim to stop fraudulent payments at the point of transaction.
Today there are a range of software solutions available that are designed to manage a merchant’s risk appetite to fraud, while identifying and processing genuine transactions. As well as leveraging this software, merchants should also use payment technology that allows them to easily store and retrieve data that evidences a genuine transaction, in order to combat friendly fraud.
Learn more: 10 ways to prevent chargebacks
Which payment types can be reversed?
The possibility of payment reversal depends on the payment method used. Since transactions can take place in different ways, there isn't always a direct way to initiate a reversal through the financial institution which facilitated it. Credit card payments can be reversed thanks to chargeback legislation which protects customers from financial loss in the event of fraud or poor business practices. Usually this applies to debit card payments, as well. Banks are obliged to refund unauthorized transactions, so a customer who claims they did not authorize a payment may have their funds returned by their issuer.
Payment app reversal
Certain alternative payment methods, such as PayPal, Cash App and AliPay, have payment dispute processes which can result in payment reversals. Each app has its own terms and conditions, so the timeframes and requirements for returning customer funds differ accordingly. However, the process typically involves raising a payment dispute, submitting evidence to the app, and awaiting a resolution from their dispute team.
ACH reversal
You can reverse an ACH payment under certain circumstances. Say, for instance, a transfer went to the wrong account, the payment was duplicated or the wrong payment amount was deposited. The sender would contact their bank to initiate a direct deposit reversal, and the ACH operator would notify the recipient's bank of the reversal request. The transaction can be reversed if the account contains sufficient funds. In certain circumstances, the recipient must consent to the reversal.
Bank transfers
Bank transfers, wire transfers, SEPA Direct Debit, money orders, and blockchain payments are generally irreversible, so they should only be used when there's complete trust between payer and payee.
Reduce payment reversals with Checkout.com
Checkout.com has a range of solutions that can help businesses minimize the disruption and revenue lost to payment reversals. For example, with Fraud Detection Pro merchants can better identify and stop suspicious payments, and so reduce the risk of chargebacks. More generally, Checkout.com’s unified payment platform has sophisticated authorization processing capabilities, which nullifies the risk of human or data errors; and a customer experience engine that allows merchants to keep their customers up to date when refunds are activated. When a refund is initiated, Checkout.com’s integrated payouts solution ensures a fast refund.
As such, Checkout.com can support merchants with all three types of payment reversals we have explored in this article.
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