Understanding the total cost of fraud
Scams are becoming increasingly sophisticated. The industry may be making strides in dealing with this challenge, but there is evidently still a long way to go.
As new rules from the UK’s Payment Systems Regulator (PSR) are likely to raise the potential costs for dealing with fraud, should payment services providers (PSPs) prioritise deploying new solutions to prevent fraud at source or reimbursing customers after the event?
The total cost of fraud encompasses more than just the direct financial losses from fraudulent transactions: it includes operational costs, such as the resources needed to investigate fraud cases, handle customer complaints, as well as the reputational damage that can result from fraud incidents. When complaints escalate, the costs incurred by customer service teams and potentially fines from Financial Ombudsman Services also need to be factored in.
These costs can scale quickly. Just a small increase in the proportion of an organisation’s customers who fall victim to fraud can have a fundamental impact on overall fraud costs. While capital will need to be set aside to support fraud reimbursements in most business models, firms need to carefully assess their appetite for risk and where investment in fraud prevention measures is likely to drive a higher saving in their wider fraud costs.
Adopting a fraud prevention-led approach
It may sound obvious, but fraud prevention refers to a proactive approach that aims to stop fraud before it occurs. Over the past few years, fraudsters have become increasingly sophisticated, leveraging generative AI and getting more effective in persuasive techniques. For every action there is an equal and opposite reaction though, and fraud prevention tactics have also become exponentially more sophisticated to deal with the new challenges.
This can involve investing in measures like overlaying shared cross-industry fraud intelligence over customer accounts, identifying suspicious activity early and stopping payments before they are sent. Levelling up fraud prevention measures typically requires investment as well as operational changes, but the long-term benefits often dramatically outweigh the costs.
For example, if a bank invests £250,000 in fraud prevention technologies and this investment reduces fraud losses by £1,000,000, the bank effectively gains a £750,000 return on investment through reduced direct losses. This is before the wider benefits from reduced operational costs and improved customer satisfaction are even factored in. Additionally, by preventing fraud, the bank can maintain a positive reputation and reduce customer attrition, resulting in significant long-term benefits.
The importance of customer trust and future-proofing
In an industry where customer trust is paramount, but sometimes overlooked with such a focus on the negative side of criminal enterprises, being known for robust fraud prevention measures can help differentiate a bank from its competitors. Customers are more likely to stay with a bank that they perceive as safe and secure, leading to higher customer retention rates, increased share of wallet and a stronger brand reputation.
Moreover, as regulatory requirements around fraud prevention continue to evolve, having a strong prevention strategy in place can help financial institutions stay ahead of compliance mandates and avoid potential fines and penalties.
Adopting a reimbursement-led approach
Fraud reimbursement is often seen as a more reactive approach. It involves compensating customers after they have fallen victim to fraud and absorbing the reimbursement costs rather than investing in measures to help avoid the fraudulent activity in the first place.
While this approach requires less investment and operational change in the short term, it has several drawbacks. Namely, the direct financial cost of reimbursing customers can be substantial. Additionally, there are indirect costs, such as the operational burden on fraud investigation teams and the potential for increased customer attrition due to dissatisfaction with the bank’s handling of fraud incidents.
Doing the right thing vs doing the legal thing
Putting a price on fraud based on the impact to balance sheets negates the incalculable human cost paid by the victims. People that fall prey to scams often have their lives turned upside down resulting in a potentially profound hit on their wellbeing and mental health.
Measures like the PSR’s split reimbursement model for APP fraud was designed to safeguard consumers by incentivising PSPs to protect their customers. Ignoring the human factor and absorbing fraud reimbursement costs may be legal, but it would seem to go against the intention of the regulations.
Helping someone when they are struggling clearly feels like the ‘right’ thing to do and organisations need to carefully consider where they stand on ethical grounds, particularly in a world where a growing number of organisations seek to become more purpose-driven and rules like the FCA’s Consumer Duty increasingly seeks to make ethical principles like this a legal requirement.
Why do so some organisations use a reimbursement-led model?
Despite the clear advantages of fraud prevention in the long term, some smaller banks and payment companies struggle to put a prevention-led approach into action. In many cases, it represents a fundamental change of approach.
Consider for example a scaling fintech organisation. Their success may be built on innovation and customer experience, with a lean business model focused on product development that has helped enable rapid growth. They are unlikely to have the level of internal expertise related to fraud prevention or the investment budget of a Tier 1 bank.
There is often a substantial skills, cultural and infrastructural gap which needs to be filled, but this typically means a sizable transformation project. Preventing fraud is hard, the expertise and need for continuous investment of time and dynamic nature of fraudsters shifting attack patterns is all consuming. A reimbursement-led model is often therefore the only viable option in the short term, but it becomes increasingly costly to maintain the more time passes.
An industry shift towards fraud prevention
Regulations and regulatory standards can often be a catalyst for innovation and change. While larger organisations have historically been better placed to invest more resources into fraud prevention, the PSR rules are set to buck this trend and incentivise affected organisations of all sizes to put their fraud strategy under the microscope.
Fraud costs are expected to become exponentially higher for financial institutions relying solely on reimbursement as it can make them an attractive target for fraudsters. If fraudsters know that a bank has a lenient reimbursement policy twinned with weak fraud security measures, they may have good reason to target that bank leading to a vicious cycle of spiralling fraud incidents and rising reimbursement costs.
Minimising the opportunity costs of fraud prevention measures
As organisations look to evolve from a reimbursement to a prevention-driven approach, many face the issue that investing time into building measures internally means taking resources away from areas such as product development, innovation and enhancing the customer experience which are key to business growth. This is most commonly seen in tech-first companies whose success has been partially driven by a culture of building things internally rather than outsourcing.
The business case for outsourcing parts of fraud prevention is becoming increasingly compelling though making robust fraud prevention more accessible. Third party providers can bring specific anti-fraud expertise, free up internal teams to focus on business growth areas and harness solutions which simply are not possible with in-house resources. For example leveraging externally shared intelligence can help identify high-risk accounts before they have even conducted any suspicious activity.
In a similar vein, orchestration platforms that allow organisations to plug different systems into one platform can provide a 360-degree view of customers and make it easy to adapt to fraud, enhance customer experience and innovate easily without needing to take on massive IT transformation projects. Third party solutions like these can help relieve the opportunity costs associated with fraud prevention while providing a return on investment in a short space of time.
Read the original article here.
