US consumers lost a whopping 5.8 billion USD in 2021 compared to USD 3.4 billion in 2020, according to a February 2022 report by the US Federal Trade Commission. In 2021 the agency received fraud reports from around 2.8 million consumers. A similar report by TransUnion, an American consumer credit reporting agency, shows that financial services is the industry most affected by financial fraud.
Pandemic-induced lockdowns and more people working from home spurred digital payment growth and borrowing from app-based fintech companies, providing scammers and fraudsters new avenues from which to defraud consumers – be it by stealing data from social media sites, through social engineering, or infecting devices with malware. These developments affect banks, financial institutions, regulators, and ACHs due to potential losses for their customers and themselves.
Additional challenges for real-time payments
Uptake of The Clearing House’s RTP, the increasing use of Zelle, and the upcoming launch of FedNow call for implementing robust fraud prevention and detection mechanisms in the US. Real-time payments can be scary because fraudsters can also move funds in real-time. Best practices in fraud management shift the emphasis to preventing fraud rather than recovering fraudulently obtained funds after the fact. Data privacy concerns, the 24/7/365 nature of real-time payments, and the transaction speed all mean that fraud detection has become more difficult. With real-time payments, preventing fraud is more difficult because of the need to meet demanding service level agreements (SLAs) as part of real-time scheme rules (whereby financial institutions only have a few seconds before they have to submit the payment message to the infrastructure and receiving FIs only have a few seconds before they need to make funds available to beneficiaries) as well as the informational asymmetries between the sending and receiving financial institutions.
How to detect and prevent financial fraud
Modern problems require modern solutions– scammers rely on technology, but technology can also be used to thwart them. Actors in the payment space are becoming increasingly aware that no one player can fully protect consumers and businesses. This has resulted in more cross-party fraud prevention initiatives that involve regulators, banks, ACHs, consumer groups, industry associations, etc.
Financial institutions and banks
Financial institutions and their customers are particularly vulnerable to fraud because of the large variety of financial services provided, the number of channels these services are offered on, and changing end-user expectations. Common fraud prevention techniques include multi-factor authentication (such as biometrics), device and geolocation identification, artificial intelligence and automation, behavioural analytics, and risk-based authentication.
Clearinghouses and payment infrastructure providers
Clearing houses can provide insights into certain kinds of payment transactions more accurately than banks due to their central position in the payments value chain. They are increasingly implementing new solutions for fraud prevention such as confirmation-of-payee, facilitating information-sharing between participants, centralized fraud monitoring and risk-scoring, and money-mule detection, but these are not enough to prevent all types of fraud. Rather, these should be seen as supplements to the regulator and financial institution-led fraud prevention tools. Concerns around liability, data privacy, and impacting the end-user experience pose challenges as to how far clearing houses will be willing to go to combat fraud.
Regulators and other industry bodies
Regulators in several geographies are implementing many techniques against fraud such as requiring multi-factor authentication to initiate real-time transactions (EU), implementing confirmation-of-payee (UK), setting guidelines for data security (EU), imposing transaction value limits during the night (Brazil), creating accountability and fraud-loss recovery frameworks (Japan, UK), and developing regulatory sandboxes where solutions for fraud prevention can be tested (India). Regulators and industry associations have also worked together to develop successful fraud awareness campaigns that target specific populations or groups on the latest fraud tactics and how not to fall prey to them.
While there is no one bulletproof solution, taking a holistic approach covering regulatory, technological, and rule-based initiatives is the way to go. Each market is different, so local payment behaviours and the domestic financial and payments ecosystem could make fraud prevention solutions successful in certain markets and unsuccessful in others.
Financial fraud is dynamic. As technology and how transactions are initiated change, fraudsters are constantly searching for new ways of defrauding consumers and their financial institutions. It is an ever-ending game of cat and mouse in which regulators, financial institutions, banks, and others need to continuously innovate to try to stay a step ahead of fraudsters. The financial industry needs to stay vigilant, update policies and technologies, and adopt newer capabilities to be ahead of scammers and fraudsters.
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