First-Party Fraud: How Do We Assess and Stop the Damage?
By Mike Betron, Infoglide VP of Marketing
Note: Today’s post is the second in our four-part series about first-party fraud (FPF). The first part in the series discussed how organized criminals commit first party fraud. In today’s article, we’ll take a look at the high costs of FPF and why it’s so difficult for banks to identify and block.
Feeling the Pain
Just how much damage is being caused by first-party fraud? In short, a great deal. FPF creates a huge financial burden for banks. To put the pain into perspective, consider this: According to the U.S. federal government, charge-off rates are currently at about 10% of all outstanding consumer credit. Most estimates of the amount of charged-off credit attributed to first-party fraud range from somewhere between 10% and 25%. Even at a conservative 15% FPF/charge-off ratio, that means banks lose up to 15 cents of every dollar in receivables to first-party fraud.
The bottom line: Given the relatively thin margins right now on consumer lending, FPF is hurting banks’ profitability and killing their market valuation. The chart below illustrates how much pain the banks are feeling.
Amount of Credit Receivables at Bank
|$100 BN||$50 BN||$10 BN|
|9.95% Charge-off/credit ratio||$ 9.5 Billion||$ 4.8 Billion||$ 1.0 Billion|
|15% FPF/Charge-off ratio||$ 1.4 Billion||$ 700 Million||$ 100 Million|
For example, based on these numbers, a bank with $150 BN in credit receivables can expect that about $2.14 BN will be pillaged by first-party fraud ($150 BN X 9.95% CO ratio X 15% FPF ratio = $2.14 BN).
Unfortunately for banks, most analysts expect FPF to attract even more organized crime in the next few years. Why? Because the rollout of new security measures such as EMV (chip and pin) cards and anti-skimming tactics are going to take away the “low-hanging fruits” known as ounterfeit card fraud and skimming. To get a real payoff, the bad guys are discovering that they have to find new avenues to steal money, such as organized bust-out fraud.
Why is it so hard to detect FPF?
Given the amount of financial pain incurred by bust-out fraud, you might wonder why banks haven’t developed a solution and process for detecting and stopping it.
There are three primary reasons why first-party fraud is so hard to identify and block:
1) The fraudsters look like normal customers
Organized criminals know the ins and outs of banking procedures. They understand what actions and activities would trip the banks’ rules-based and analytics-based anti-fraud systems. By nature of the crime, these fraudsters initially look and act like good customers as they build up credit. The difference between first-party fraud and a normal charge-off is the determination of intent by the consumer. Since the intent is often difficult for banks to determine, most losses from first-party fraud get classified in the charge-off bin.
2) The crime festers in multiple departments
Another problem is that banks often lack the tools to detect activities across different lines of business. For instance, a fraudster may open a charge account and then take out a loan from the retail division to continue cycling their credit card payments. Since most banks’ analytics are focused on specific lines of business, they may not have a complete view of interdepartmental activities. In other words, employees from the loan department wouldn’t necessarily make a connection between the person’s credit card activity and a loan application.
3) The speed of execution is very fast
Once a fraudster reaches a desired bust level or time in the scheme, he or she will rapidly increase spending, “max out” credit card limits and attempt to get additional credit cards, loans or accounts. Since the fraudsters often work together in networks and collaborate with each other, they are able to make sure that they adhere to the rules and thresholds that might otherwise trigger an alarm, making bust-out fraud difficult to detect. Frequently, they will use credit cards and checks to purchase items such as electronics or large household appliances that can be sold quickly after purchase. Because of the speed with which all of this activity happens – usually only a couple of days – banking systems do not detect it fast enough to react and block purchases.
In cases of third-party fraud, such as identity theft or account takeover, there is always a victim; in cases of money laundering, the federal government becomes very interested. However, in first-party fraud, nobody gets hurt – except the bank. Therefore, cases of bust-out fraud don’t garner the attention from the media and general public that the more sensationalist money-laundering and identity theft cases do.
All is not lost, however. There are ways to detect organized bust-out fraud; the banks just have to know where to look and what clues to look for. In the next blog post in our series, we’ll focus on ways to uncover bust-out fraud and we’ll introduce new technology from Infoglide that can help identify tell-tale signs of organized first-party fraud before any damage is done.