Is Fraud Really That Bad?

Yes. Fraud is so bad it actually has its own holiday—an entire week. (National Consumer Protection Week this year was February 14-18.) However, you might be surprised that check fraud is much less than credit card fraud, in spite of the fact that many sources suggest otherwise.

Overall Fraud

According to Deborah Williams of Meridien Research, fraud peaked at 1.9% of transactions in 1992 and is now at .9%. While other types of fraud may be continuing to rise, “payments” fraud is under attack by a number of organizations in the U.S., and there are signs of success.

Check Fraud

Figures from TeleCheck state that annual losses from check fraud are more than $6 billion. That figure accounts only for the amount lost, not the amount incurred to thwart check fraud, such as collection fees, processing costs, etc. And, check fraud is continuing to grow; it grew 11% last year. According to the Nilson Report, merchants took in more than $13 billion in bad checks in 1996, which was 18% greater than the year before. According to Ernst & Young, more than 500 million checks are forged annually, with losses totaling more than $10 billion.

The American Bankers Association found that in 1997 one half of all financial institutions suffered financial losses due to check fraud. 289,000 cases of fraud totaled $512 million—that’s 12 times what was lost to bank robberies that year—and that is just the successful fraud. Attempted check fraud at banks in 1997 was $1 billion.

Some are quick to point out that the 289,000 cases in 1997 was a decrease from the 399,300 cases in 1995. However, the reduction may be due to banks reporting “cases” in 1997 vs. “items” in the 1996 survey, but no one is sure. Average gross losses per case rose from $1,220 in 1995 to $1,775 in 1997, according to Dick Clausen, chairman of the ABA Deposit Account Fraud Committee, but the amount passed back to retailers is unclear.

Fraud at large banks grew 38.2% between 1995 and 1997, about 17.5% a year. Seventy-two percent of super regional/money center banks said they spent more than $1 million in 1997 on check fraud related expenses, and that does not include the actual losses. Those expenses range from $10,000 to more than $1 million.

In a presentation at the EC2000 conference in February 2000, Hank Farrar, CEO of SVPCo, stated that bounced checks for 1999 totaled 258 million checks, valued at $18.9 billion. Check fraud losses to banks is estimated to be $1.3 billion for 1999. Losses to payees are approximately $12 billion.

According to a presentation by Carreker-Antinori at the 1998 BAI conference, check fraud is expected to reach $37 billion by 2005. The average loss by a national bank with assets of $150 billion is $10 to $40 million. The average loss by regional banks (those with $30 billion in assets) is between $1 and $6 million.

While many of these points are valid, it is also important to note that while the frequency of fraud, as well as the dollar value, is up, check fraud in relation to the value of checks and the number of checks processed is not. In fact, the overall rate of check fraud loss is less than 2 basis points, or two-hundredths of 1 percent.

In addition, many of the fraud calculations include dishonored checks as part of the “fraud” number, when it should be excluded, or at least reduced, for the collected portion. Annually, slightly more than 1% of all checks are dishonored, but half of these are ultimately recovered, making payments by check one of the nation’s lowest cost payment methods, in spite of fraud.

And finally, for some perspective, bankcard fraud may well be as high as 10 to 20 basis points, 5 to 10 times the level of check fraud.

Credit Card Fraud

By now you have probably heard about the New York department store cashier who used her personal Palm Pilot to swipe customers’ credit cards and steal the numbers. This may be part of the reason that 11% of consumers feel that traditional retail store transactions are risky.

Chain Store Age also reported that Visa and MasterCard suffer approximately $1 billion annually due to fraud. Private label cards experience about $250 million in losses. But, credit card fraud is not just about chargebacks. Credit card fraud of all types adds up to billions of dollars in lost revenue. Specifically, $270 million for lost/stolen cards, $220 million for false applications, and $190 million for cards that were issued but never received.

Online Fraud

The same Chain Store Age survey that found that 11% of consumers feel traditional transactions are risky (see above) found that 34% of consumers consider online transactions “very risky.”

A survey conducted by CyberSource backs up those fears. The survey reported that 4.6 to 7.8% of attempted transactions for physical products are fraudulent, while 14.4 to 23.5% of transactions for digital products are fraudulent (http://currents.net: 80/magazine/national/1803/estp1803.html). In fact, consumers lost over $3.2 million to Internet fraud last year in incident reports to the National Consumers League’s Internet Fraud Watch. The organization reports a 38% increase in Internet fraud complaints in 1999, with an average consumer loss of as much as $580 (www.nclnet.org).

A report released by Gartner Group, Inc. (Limiting Credit Card Fraud and Chargebacks on the Internet) has found that the average chargeback rate for Internet transactions with a credit card is 15%, and can be as high as 30% for merchants delivering digital products immediately at the time of purchase. The rate for POS transactions is about 1% (www.gartner.com). Merchants that do not address the potential growth in costs associated with Internet fraud and chargebacks will face losses that will threaten the viability of their E-business,” observes Gartner Group analyst Ken Kerr. “While a fraud detection system is essential for accurate credit card verification, a high number of chargebacks on Internet purchases are the result of customer disputes, not fraud.”

What Now?

So, fraud is increasing, we’ve established that, and it is likely to be even greater in the eWorld than the physical world. Now what do we do? Well, we can’t stop consumers from purchasing and we can’t get them to change their payment methods of choice, regardless of the security problems with their choice. The Survey of Retail Payment Systems found that consumers expect to increase their use of payment methods. “ . . . 13% expected to write checks more often. . . . 10% of consumers expected credit-card usage to increase in the future.”

It is uncertain whether consumers can be convinced to switch to an alternate payment method that may have better fraud controls. It is even uncertain whether the cost of such a change wouldn’t out-weigh the fraud. Regardless, it is vital that the merchant understand fraud is a dynamic dilemma—there will always be fraud, and criminals are continually creating more advanced techniques to commit fraud. To reduce losses, merchants must be dedicated to continually updating their detection and prevention methods, or trusting a service provider to do it for them. 

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