Viewpoint: How to Make Fraud Prevention Cost-Effective

By Trachtman, Jeff | American Banker, February 9, 2007 | Go to article overview

Viewpoint: How to Make Fraud Prevention Cost-Effective


Trachtman, Jeff, American Banker


Fraud issues have taken center stage in the debit industry over the past two years.

Financial institutions have become increasingly sensitive to fraud, pouring money into detection and analysis tools to protect themselves from future losses.

The goal of any fraud strategy should be to minimize losses and maximize profits. However, lost in this rush to prevention is the understanding and data needed to gauge the effectiveness of individual banks' programs, balance risk versus cost, and help debit business managers weigh the effects on profits.

Without this critical understanding, one could imagine an environment where a bank actually spent more on fraud management than it reasonably stood to lose. How can debit business managers strike an appropriate balance? In part by rewriting the traditional debit fraud equation, which measures fraud simply as a percentage of purchase volume.

To appreciate the full scope of fraud in the debit industry, it's important to consider not just actual losses as a percentage of purchase volume, but also the expenses associated with prevention. These include but are not limited to the following:

* Processor-based services such as CVV code authentication, warning bulletin listings, and exception reporting.

* Cardholder identification services such as Verified by Visa, MasterCard Safecode, and PIN checking.

* Neural network fraud detection services, either outsourced or managed in-house.

* Staff dedicated to fraud detection, analysis, and investigation.

* Operational expenses associated with reissuing cards in case of theft or data compromise, including postage, envelopes, and PIN mailers.

Also missing from the historical equation is any consideration of revenue lost (or gained) as a result of fraud management. For instance, if a compromised card is unnecessarily closed and reissued, and the cardholder uses its replacement less frequently (or not at all), the loss of revenue would have to be considered part of the equation.

Additionally, some cardholders may feel more (or less) confident about the safety of their debit card after being contacted by their financial institution about suspicious use. These behaviors can be modeled, and operational strategies can be adapted accordingly -- because they will have an effect on debit profitability.

Any quantifiable approach to fraud would have to consider the effect on debit profits: fraud losses, plus fraud management expenses, plus the effect of fraud detection activities on cardholder behavior (and thus revenue).

In building a quantifiable approach to debit fraud, the next thing you would do is consider more closely the expenses associated with fraud prevention systems -- especially neural network fees. …

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