How to Do Fraud Detection in Merchant Accounts

Overview

Fraud is a major concern for businesses handling online payments. Merchant accounts, which allow businesses to process credit card transactions, are prime targets for fraudsters. Without proper fraud detection measures, businesses risk financial losses, chargebacks, and even legal consequences. In this guide, we’ll explain how to detect fraud in merchant accounts using simple strategies, tools, and best practices. This article by Academic Block will help merchants safeguard their transactions and protect their businesses from fraudulent activities.

What is Fraud in Merchant Accounts?

Merchant account fraud occurs when criminals use stolen or fake payment details to make unauthorized transactions. This can lead to chargebacks, revenue loss, and potential account termination.

Common fraud types in merchant accounts include:

Detecting these fraud types early is crucial for business security.

Why Fraud Detection is Important for Merchant Accounts

Fraud detection is essential for:

Now, let’s explore the best ways to detect and prevent fraud in merchant accounts.

How to Detect Fraud in Merchant Accounts?

1. Monitor Unusual Transaction Patterns : Fraudsters often make transactions that don’t match regular customer behavior. Look for:-

Aspects
Description
Unusually large orders
Fraudsters may attempt high-value purchases with stolen cards.
Multiple transactions in a short time
A sudden spike in purchases from the same user can signal fraud.
Mismatched billing and shipping addresses
If a buyer uses different locations for payment and delivery, it may be suspicious.



Use AI-powered fraud detection tools to flag these activities for review.

2. Use Address Verification System (AVS) & CVV Checks : AVS and CVV checks help verify the legitimacy of a transaction.

Aspects
Description
AVS (Address Verification System)
Compares the billing address entered by the customer with the one on file with the bank. Mismatched addresses may indicate fraud.
CVV (Card Verification Value)
The 3-digit or 4-digit code on the back of credit cards. Since fraudsters may steal card numbers but not the CVV, requiring this code helps reduce fraud.



Most payment gateways offer AVS and CVV checks as security features.

3. Implement Multi-Factor Authentication (MFA) : MFA adds an extra security layer to prevent unauthorized access. It requires users to verify their identity using:-

1. A password (something they know)

2. A mobile OTP or authentication app (something they have)

3. Biometric verification (something they are, like fingerprints)

This prevents fraudsters from accessing merchant accounts even if they steal login credentials.

4. Enable Device Fingerprinting : Device fingerprinting helps detect fraudulent activities by tracking device attributes such as:-

1. IP address
2. Browser type
3. Operating system
4. Geolocation

If multiple suspicious transactions come from the same device or location, the system can block them automatically.

5. Set Velocity Limits for Transactions : Velocity limits control the number of transactions a user can make in a given period. For example:-

1. Block transactions if a customer makes more than 5 purchases in 10 minutes from the same card.

2. Limit the total value of transactions allowed per customer within a day.

These limits prevent fraudsters from making rapid, high-value purchases with stolen cards.

6. Use AI and Machine Learning-Based Fraud Detection : AI-powered fraud detection tools analyze transaction patterns and identify unusual behaviors. These tools provide:-

Aspects
Description
Real-time fraud scoring
Assigns a risk score to each transaction.
Behavioral analysis
Detects sudden changes in buying patterns.
Automated fraud alerts
Notifies merchants of suspicious transactions instantly.



Popular fraud detection software includes Signifyd, Riskified, Kount, and Sift.

7. Monitor Chargeback Ratios : High chargeback ratios indicate fraud issues. Keep your chargeback ratio below 1% to avoid penalties from payment processors.

To minimize chargebacks:

1. Use clear billing descriptors to prevent customers from misunderstanding charges.

2. Provide responsive customer support to resolve disputes before they escalate.

3. Keep proof of delivery to counter false chargeback claims.

8. Monitor and Block High-Risk Countries : Some regions have a high rate of online payment fraud. If your business doesn’t operate in these areas, consider blocking transactions from:-

1. Nigeria, Russia, Vietnam, Brazil, Indonesia, Romania, and Venezuela (historically high fraud risk).

2. Use geolocation-based restrictions to allow transactions only from trusted regions.

This reduces exposure to international fraud attacks.

9. Implement Tokenization & Encryption : Tokenization replaces sensitive card data with unique tokens, reducing the risk of data breaches. Encryption ensures that transaction data is secure from cybercriminals.

1. Use PCI-compliant payment processors like Stripe, PayPal, or Authorize.net for secure transactions.

2. Never store raw card data to prevent hacking risks.

10. Conduct Regular Fraud Audits & Staff Training : Regular audits help detect security gaps in payment processing. Train your team to:-

1. Recognize phishing scams targeting merchant accounts.
2. Identify suspicious customer behavior.
3. Report fraud attempts immediately.

Fraud prevention is a continuous process that requires vigilance and proactive monitoring.

How Does Merchant Fraud Work?

Merchant fraud involves deceptive tactics used by fraudsters or dishonest merchants to exploit payment systems, financial institutions, and customers. Here’s how it works:

1. Fake Merchant Accounts : Fraudsters set up fake businesses to process fraudulent transactions. These accounts operate for a short time before disappearing, leaving banks and customers at a loss.

2. Transaction Laundering : Criminals use seemingly legitimate merchant accounts to process illegal payments. They create fake websites to disguise their true nature, making it difficult for financial institutions to detect fraud.

3. Chargeback Fraud (Friendly Fraud) : Merchants or customers falsely claim that a legitimate transaction was unauthorized. This results in chargebacks, where funds are refunded, but businesses face financial losses and penalties.

4. Card Testing Fraud : Fraudsters use stolen credit card details to make small purchases. If the transaction succeeds, they proceed with larger fraudulent transactions, leading to financial damage.

5. Overcharging & Hidden Fees : Some merchants add undisclosed charges to transactions, misleading customers. Victims often notice the excess charges only after reviewing their bank statements.

6. Affiliate Fraud : Dishonest merchants manipulate affiliate programs by generating fake sales or clicks. This results in unjustified commissions and losses for businesses running these programs.

7. Synthetic Identity Fraud : Fraudsters create fake merchant profiles using a mix of real and fake details. These fraudulent accounts operate temporarily before getting flagged and shut down.

Businesses Affected by Merchant Fraud

Merchant fraud impacts various industries, leading to financial losses, reputational damage, and legal complications. Below is a table outlining the most affected businesses and the specific fraud risks they face.

Final Words

Detecting fraud in merchant accounts is essential for protecting revenue, maintaining customer trust, and ensuring compliance with payment regulations. By using AVS, CVV, MFA, AI-powered fraud detection, velocity limits, and device fingerprinting, businesses can significantly reduce the risk of fraud. Hope you liked this article by Academic Block, please share your thoughts below in the comment section to make this article better. Thanks For Reading!

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