Portals and Rails

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Portals and Rails, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Portals and Rails and look forward to collaborating with you.

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December 17, 2012


The Fraud Triangle

The "Rule of 3" is a principle that suggests when things come in threes, they are inherently funnier, more satisfying, or more effective. (I talked about the Rule of 3 in a recent post in which I described my search for the right payment product.) There's even a Latin phrase that generally describes this concept: omne trium perfectum, which means "everything that comes in threes is perfect," or "every set of three is complete."

This rule may apply even to occupational fraud. Long recognized as a predictor of fraudulent actions in the workplace, the Fraud Triangle suggests that three factors must be present for fraud to occur: opportunity, perceived pressure or motivation, and rationalization. But what happens when one of the three members of the trifecta is removed? Will it topple over like a three-legged stool that loses a leg? Will the chance of fraud be decreased?

The Fraud Triangle theory, first described by Donald Cressey in the 1950s, is based on interviews with 200 incarcerated embezzlers, including executives. Not surprisingly, the researchers found that the majority of these embezzlers had committed fraud for financial gain. But what they didn't expect was that most often the perpetrators had no intent to commit the crime.

In workplace fraud, there is the opportunity—say an employer doesn't follow necessary workplace controls and makes one trusted employee singly responsible for all the cash in the business. Then there is the financial trigger, or motivation—the employee experiences a sudden illness, is living beyond his or her means, experiences a loss of spousal income, or has an addiction.

Next, there is the rationalization. Say the employee feels job pressure because of too-high performance standards or unattainable goals, or maybe the employee simply wants to exact revenge on the employer for a missed promotion or reassignment. And voila! You have the Fraud Triangle. The employee has access to cash, needs cash in his or her personal life, and is angry at the employer anyway, so might feel somewhat justified in taking the money.

These situations can occur any time there are weak or missing controls, fast growth in a business, or just lax management, and they usually increase in times of downsizing and layoffs. The crime tends to start small. It may even at first be a true accident. But when it goes undetected, the amounts grow, as does the confidence of the fraudster.

According to the Fraud Triangle theory, then, opportunity, motivation, and rationalization combine to lead to fraud. As an employer, by taking away the opportunity, you can prevent fraud. Make sure you have the proper controls in place in your workplace, even if your workplace is your home, because you hire outside help.

You can protect yourself from fraud as a consumer, too. Make sure you have balance alerts on your accounts, use strong passwords, and undertake other prudent financial account management practices. Let's all keep our holidays safe and secure.

Michelle CastellBy Michelle Castell, senior payments risk analyst in the Retail Payments Risk Forum at the Atlanta Fed

December 17, 2012 in consumer protection, workplace fraud | Permalink

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December 10, 2012


The Interchange Fee Cap: One Year Later

Make no mistake about it, I'm a debit card person, and a PIN debit one at that. So I write this under full disclosure of that bias. I haven't written a check at a retail merchant in more than 10 years and no longer even carry a checkbook. Rarely do I have more than $10 in my pocket—just enough for the purchase of some miscellaneous small-value items. I have always found PIN debit to be a highly convenient form of payment due to its reliability, accuracy, speed, and general acceptance at merchants that I frequent. If I forget or lose a receipt, a quick check of my account online will always show the transaction so I can record it in the balance register.

I know I am in the minority preferring PIN debit, as signature debit has dominated the debit card market both in terms of transaction and sales volume. Consumers like signature debit because of its acceptance at significantly more merchants, and they don't have to worry about remembering a PIN. Pre-Durbin, issuers preferred that their cardholders use signature debit because it generated substantially more point-of-sale (POS) interchange revenue than PIN debit. Some issuers encouraged their cardholders to select “credit” when using their debit card so the transaction would be processed on the signature debit rails and qualify for the higher interchange rate. That was the rub with merchants, especially the larger, high-volume ones. Signature debit was more expensive for them to process. In response, merchants with PIN pads programmed their terminals to encourage PIN usage by designating it as the default debit payment method.

Then came the Durbin Amendment (part of the Dodd-Frank Wall Street Reform and Consumer Protection Act) and the resulting implementation through Regulation II in October 2011 that changed the debit card world forever. The rule set a maximum interchange fee for signature and PIN debit and made no differentiation between the two, despite the overwhelming evidence that fraud losses on signature debit transactions were significantly higher than on PIN debit transactions. Although the final rule raised the interchange cap and reduced the fee-income hit to the issuers, forecasts of a diminished role in the market, especially for signature debit and other core bank products, came quickly from the bankers. A number of issuers that had established rewards programs linked to signature debit transactions (no or lower points for PIN debit transactions) announced plans to discontinue or reduce their debit rewards programs. Some major banks announced they would be imposing a monthly or annual fee for debit cards as a way to partially recover some of the revenue lost by the lower interchange fees. Another expected casualty was the free checking account. The banks said they could not afford to subsidize other account services without the fee income from debit card usage and the revenue loss suffered earlier in the year by the opt-in requirement for overdraft coverage for ATM and POS transactions.

Now, just over a year after the interchange cap took effect, what has been the result? There clearly has been a decrease in the number of rewards programs tied to debit cards as issuers sought to reduce program costs. Bankrate's 2011 Debit Card Rewards Study reported a 30 percent decline in debit rewards programs, even though the survey was taken before the interchange cap became effective. Not surprisingly, this study found that of the programs still operating, many were still offering reward points only for signature debit transactions.

Efforts by a number of the larger banks to impose a new debit card fee never gained traction. Many of the fee plans were dropped or modified to provide waivers if minimum balances were maintained. Free checking has certainly been a casualty as Bankrate's September 2012 Checking Survey showed that the number of banks offering free checking with no minimum balance requirement dropped from a high of 76 percent in 2009 to 45 percent in 2010, and then declined further, to 39 percent, in 2011.

Clearly, banks have suffered from the impact of Regulation II, with significant reductions in fee-income revenue through the lower interchange rate, especially for signature debit transactions. And consumers have a harder time finding debit rewards programs, and their account maintenance fees may have increased. The big winners have been the large to mid-sized retailers who have been able to renegotiate discount rates with their card processors. The merchant community says that consumers ultimately benefitted from the lower debit card processing expenses because the merchants have lowered or held steady their prices. However, the merchant claims are virtually impossible to validate since the pricing of goods and services is impacted by a large number of different elements, and interchange rates represent only a small one.

On a related note: the $7 billion class-action credit card interchange fee settlement recently received preliminary court approval amid opposition from some of the country's largest retailers and retailer industry groups. The litigation that originated in 2005 has used many of the same arguments that led to the passage of the Durbin Amendment legislation—primarily, that the interchange rates set by two major card issuers were arbitrary and excessive. Another major issue was that the payment card networks' rules prevented a merchant from implementing a surcharge to offset the increased costs claimed by merchants in accepting a credit card.

Clearly, the subject of interchange fees is not going to disappear anytime soon. What will be the longer term impact, if any, of the debit—and possibly credit—card interchange constraints? Will they impact the conversion of debit cards from magnetic-stripe technology to chip? We would like to hear your thoughts on who you believe are the winners and losers from Regulation II as well as its impact on debit and credit cards going forward.

David LottBy David Lott, a retail payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed

December 10, 2012 in cards, chip-and-pin, regulations | Permalink

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December 03, 2012


CFPB Modifies Remittance Disclosure and Error Resolution Rules

According to their congressional mandate, the Consumer Financial Protection Bureau's (CFPB) primary focus is to advocate for consumers when dealing with financial companies. Champions of the CFPB see them as part of the "checks and balances" regulatory environment of all things financial. One of the CFPB's primary activities since being created in mid-2010 has been to work to create disclosures to assist consumers in better understanding their costs, rights, and responsibilities when entering into various financial transactions or agreements. The Dodd-Frank Act, which created the CFPB, also added a new section to the Electronic Funds Transfer Act (EFTA) implemented through Regulation E. The addition requires the CFPB to develop disclosure and error resolution requirements for remittances being sent outside the United States.

In February 2012, the CFPB published rule 1073 dealing with the prepayment disclosure of the total costs of consumer-originated remittances. The rule also imposed liability for errors on the remittance transfer provider (RTP) even if the consumer was the one that provided an incorrect account number or routing information. The rule was originally scheduled to become effective February 7, 2013. More details about the rule can be found in previous Portals and Rails blogs. (Under Categories on the right side of this post, select remittances to get a full listing.)

Responding to input from financial institutions, other governmental regulatory agencies, and the remittance industry groups, the CFPB announced on November 27, 2012, that it plans to issue a proposal to refine specific provisions of the rule and will propose an extension of the effective date until 90 days after the bureau finalizes the proposal. Following are the proposed key changes:

  • One of the key requirements of the rule is that the RTP must disclose the exchange rate and all fees and taxes charged for the remittance so the sender can see the net amount received by the recipient. The CFPB received a number of comments indicating that it would be extremely difficult for RTPs to create and maintain an accurate database of national and local taxes as well as other fees imposed by the disbursement facility. In response, the CFPB's proposal will provide additional flexibility by permitting RTPs to base disclosures on published bank fee schedules and only for taxes levied at the national level.

  • Originally, the rule placed the liability on the RTP for transmittal errors resulting in nondelivery or late delivery resulting from incorrect account numbers. However, the CFPB plans to release the RTP from this responsibility if the RTP can demonstrate that the consumer provided incorrect information. The RTP must still make a good faith effort to recover the funds.

The CFPB will be publishing its proposed modifications in December and will be seeking public comment before issuing a final rule sometime in the spring. While these modifications are termed "limited" by the CFPB, remittance providers must be breathing a measured sigh of relief, especially regarding the shift in liability from consumer-created errors. It will be interesting to monitor the impact of these regulations to determine if there has been any constriction in the number of countries served due to the additional requirements.

David LottBy David Lott, a retail payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed

December 3, 2012 in consumer protection, remittances | Permalink

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