Safety: Should Payment Schemes Rules Protect Consumers from Counter-Party Fraud Liability?

Consumer protection against fraud, predatory practices, and other criminal activities is a priority for regulators in all countries. In this section we look specifically at consumer protections related to payments transactions. There are two levels of protections to consider. The first is protecting a consumer against unauthorized use of their accounts and funds. This is primarily an issue of authentication of the consumer, and in general regulators consider this to be the obligation of the consumer’s own service provider. Obviously, there are important issues of consumer education here, but there are clear best practices: a consumer is expected to maintain the secrecy of any PIN or other identity token. Provisions need to be made to ensure that a consumer who believes their account to have been fraudulently used can report and resolve this issue as required by regulation and/or operating rules of the payments scheme.

A second question is more complex, and more debatable. Should the payment scheme rules (and/or regulation) protect the consumer from counterparty fraud, and enable the consumer to get their money back from their counterparty in certain situations? Looking at established payments systems around the world, the most common practice is “no” – the consumer has no right to a refund, in most ACH or checking systems, if their counterparty has committed fraud: the consumer can, of course, use normal court procedures to attempt to redress the problem. In other systems, notably card systems in many countries, the operating rules of the system require that funds be returned (“charged back”) to a consumer in certain situations. In open-loop systems, this is an obligation on the part of the service provider (normally a bank), who is responsible for returning the money. The bank, of course, has a contract with their customer allowing them to get the money back– but if their customer has gone away, or is insolvent, the risk remains with the bank. For this reason, the bank often charges a fee for the payment service sufficient to cover their risks under these rules.

Option “A”: Payment scheme rules should protect consumers from counter-party fraud

This mechanism not only protects consumers but builds consumer trust in using the payment system. Poor consumers are unlikely to be able to use courts to pursue fraudulent counter-parties and may turn away from using digital financial services if they feel unprotected.
Arguments against this approach are that it adds significant cost to the payments system, which can only be recouped through pricing to consumers and merchants. There are two elements of the increased cost. One is the cost of protecting the counterparty’s provider against its liability – since this liability is related to the value of the payment, it forces the provider to assess a “percent of value” fee for all transactions. The other is the cost to the scheme and the providers of administering the liability transfer mechanism, the cost of which would be passed on in service fees to providers and to end users.

Option “B”: No – payment scheme rules should not protect consumers from counterparty fraud

Arguments in favor and against this are the opposite of those for option A. This is the best approach for ensuring a low cost payment system, which can be usable by poor people as a cash replacement. Since the underlying payments are “push”, and not “pull” payments, the primary risk – of unauthorized access to the consumer’s account – can be managed by placing obligations on the consumer’s provider, without the need for the liability transfer mechanism. However, consumers have no systematic way of protecting themselves from payments-related counterparty fraud.

The Financial Inclusion Perspective: Option “B” is preferred.

The benefits of achieving a low-cost payment scheme outweigh the arguments in favor of liability transfer for consumer protection. Consumer education programs (by providers, the scheme itself, and, hopefully, the national government) can help alert consumers to risks in dealing with questionable counter-parties.