A curious tale is unfolding in Nigeria’s fintech scene.

It all began on an eventful Friday, April 28, 2023, when Payday, a well-known startup offering virtual card services, sent out an email to its users. The message carried a mix of reassurance and caution, informing customers of upcoming changes to their card services. While promising a swift resolution, Payday advised users to ensure they had enough money in their accounts to cover their card transactions.

Meanwhile, Chipper Cash, another prominent player in the Nigerian fintech arena, faced its own challenges. The company announced a non-refundable fee of ₦‎500 for transactions declined due to insufficient funds. Payday and Chipper Cash were not alone in their struggles, as several other card providers grappled with the complexities of the landscape, leading some to temporarily suspend their card-issuing services.

The main culprit here is Nigeria’s turbulent economy. Everyone agrees: making international payments in Nigeria and other parts of Africa is a real hassle. The Central Bank of Nigeria (CBN) created its own problem by putting monthly limits on international payments, so naira card users can only spend $20 per month. But people need to spend much more than that. So, it opened up an opportunity for fintech companies to offer virtual cards that allow unlimited international payments.

Virtual cards are attractive because they make foreign exchange payments easy and help people avoid the bank fees associated with domiciliary accounts. For fintech startups, it’s a straightforward decision. Virtual cards are an easy win and a good way to attract customers. Most of the work involved in issuing virtual cards is handled by partnering with established card issuers like Visa.

But running a virtual card business is not without its challenges. Occasionally, we catch a glimpse of some of the more difficult aspects of providing what seems like a simple service. Since many Nigerian fintechs rely on foreign card issuers, they are at their mercy. As a result, service disruptions and shutdowns are common, and issues with customers requesting refunds, known as chargebacks, are also frequent.

Chargebacks: the elephant in the room

Chargebacks create significant problems for fintechs. They occur when customers ask for their money back after completing a transaction, usually because they couldn’t access the product or service they paid for. However, there are also fraudulent individuals who try to get their money back even after using the service, causing headaches for fintech companies.

In March, the CEO of Union54, a fintech startup that provides APIs to other companies for issuing physical and virtual dollar debit cards, gave a surprisingly honest interview to TechCrunch. He revealed: “We noticed a lot of fraud attempts on our platform, which we detected and stopped. People were trying to use funds they didn’t have… they were attempting over $1.2 billion in fraudulent transactions.” As a result, Union54 had to temporarily pause its card issuance business, leaving many other fintechs that relied on them in a difficult position.

Mastercard has a policy (PDF) that requires issuers (in this case, African fintechs) to limit chargeback rates to 1%. But the high volume of fraudulent transactions makes it hard to stay in that bracket. Meanwhile, these startups have to pay chargeback and card decline fees to the card schemes — whether Mastercard or Visa — out-of-pocket. It doesn’t matter whether the transactions in question came from a wrong customer claim; someone has to pay for them. Notably, sometimes, it’s not even the customers’ fault as service providers can also cause failed transactions.

Nevertheless, fintechs want that burden off their shoulders. So, they’re passing the cost to the customers. This move is supposed to help cut down on fraudulent transactions. However, regular customers, who outnumber the bad actors, are getting the short end of the stick.

This also points to how fintechs are gradually moving away from the “freebie” model that became popular in recent years. The race to acquire users made several startups offer no-cost banking services, but now, the game is changing, and survival matters more. Venture Capital funding is not as cheap as it used to be, so businesses have to be as financially efficient as possible.

However, chargebacks are clearly a problem fintechs will need to think harder about. For now, it might be enough to simply charge the customers for failed transactions. But frauds get smarter, and service providers haven’t budged on efficiency.