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May 02, 2011

The check's in the mail, but it might be fraudulent

Amid the constant hubbub of emerging fraud schemes, research shows us that criminals are rational consumers of the nth degree. They instinctively move to the path of least resistance. While the exciting and glamorous fraud topics today involve wire fraud, account takeovers, ID theft, and skimming, the results of the Association for Financial Professionals' (AFP) annual corporate fraud survey remind us that the most fraud vulnerable instrument available today is the paper check. Why? Because check fraud is a decidedly low-tech practice whose ingredients include a bit of thievery, a good copying machine, and possibly, but not necessarily, some magnetic ink.

Corporate experiences with check fraud
The AFP's study tabulated survey results from around 400 public, private, nonprofit, and government organizations across a wide range of sizes. Over 70 percent of the respondents reported that they had been the victim of fraud in 2010. Of those, 93 percent reported fraud involving checks, compared to 25 percent with ACH debit fraud and 23 percent with consumer card fraud. Moreover, of the fraudulent methods used, checks also experienced the highest rate of increase, with 30 percent of organizations reporting an increase in check fraud. And check fraud accounted for 53 percent of the reporting organizations’ financial losses. Interestingly, while actual fraud losses were deemed to be modest in total dollar terms, 84 percent of the respondents had made efforts to protect themselves against check fraud by implementing positive pay controls on their corporate accounts; 53 percent had implemented payee positive pay.

Bank experiences with check fraud
The corporate responses synchronized well with the results of the American Bankers Association's (ABA) last deposit account fraud survey in 2009. At that time, 80 percent of respondent banks reported check fraud losses totaling over $1 billion, which is 23 percent higher than losses experienced with debit/ATM cards. Interestingly, there seems to be little evidence in the ABA report or elsewhere to indicate that check fraud stems from abuse of new technology. At the outset of the implementation of the Check 21 legislation, many industry pundits forecasted that losses would climb as a result of widespread implementation of remote deposit capture (RDC) technology, but it appears such has not been the case. In fact, several large banks, emboldened by the experiences of pioneers such as USAA, have even extended remote capture into the homes of their depositors who are armed with the latest in RDC technology—the smart phone.

Yet, there are growing concerns within the industry that the "gild may be off the lily," as the bad guys learn more about the opportunities. A friend and Sunday school classmate of mine who works for a large national bank reported to me that they had been beset over the past few weeks with an interesting scheme involving new account fraud and checks. Individuals have been opening new accounts and obtaining a debit/ATM card at the outset. After making a modest deposit of good funds to open the account, the new customer then used their ATM card to deposit several counterfeit checks at ATM locations. Per the bank’s policy, some or all funds were made available to the customer immediately (depending on the dollar amount of the check). The customer took advantage of that fact, withdrew the maximum amount possible the next day, before the return deadlines, and then walked away (well, one actually complained because not all funds were made available, but that’s another story, involving criminal indignation).

The unit cost of fraud and fee revenue deliberations
The upshot of all this is that there is a lesson to be learned. Just because we see checks as a diminishing-use instrument doesn't mean we should let our guard down whether we are a consumer, a corporation, or a bank. In tough economic times, a billion-dollar loss to the banking industry is still an expensive ticket. Having just wrapped up the Federal Reserve's 2010 Retail Payments Study, I was interested in exploring fraud from a slightly different angle by looking at the average fraud per check written in the United States. While not all industry surveys align perfectly with respect to samples, time frames, response levels, and so forth, they are close enough to produce some interesting observations. Further, such a calculation might help us understand what the actual "fraud tax" is on checks as banks consider future check service fee issues.

The 2009 ABA study estimated that 760,955 cases of check fraud took place in the 2008 reporting year, with actual losses estimated at $1.024 billion. Compare these numbers to 561,306 cases and $969 million in the 2006 study and 616,469 cases and $677 million in the 2003 study. The concurrent Fed payments studies in 2004, 2007, and 2010 estimated the number of checks written in the United States at 37.6, 33.1, and 27.8 billion, respectively. Doing the math reveals that the per-item cost of fraud losses has gone from $.018 to $.029 to $.036 (unadjusted for inflation). Said differently, the unit cost of fraud for every check written has doubled in six years to 3.6 cents per item even as aggregate check volume has fallen by 26 percent. By the way, this figure represents the costs of fraud losses, not the total cost of fraud management for the check world.

In summary, while the industry debates the issue of the cost of fraud management in the Durbin debit card interchange regulation, perhaps similar scrutiny should be applied to the cost of fraud management in the check world as check volume diminishes. Somewhere out there is an opportunity to adopt an overall fraud management fee strategy as yet another arrow in the quiver of strategically leading customers to payments choices that make sense for the bottom line of a bank.

Photo of Rich OliverBy Rich Oliver, executive vice president of the Atlanta Fed and director of the Retail Payments Risk Forum

May 2, 2011 in banks and banking, check fraud, checks | Permalink


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