How much does fraud really cost my institution?

Fraud hurts. It damages your institution's profitability and bottom line. It compromises the relationships you've built with customers and the reputation you have in the industry. Understanding the full impact of fraud on your organization can help build a business case for investment and get the executive buy-in you need. But as I've discussed in other posts, quantifying the complete impact of fraud can be difficult. Here I propose a top-down approach, using loss estimates from the TowerGroup. What's wrong with current approaches? Typical estimates of fraud loss use the number of cases and the loss amounts associated with each case. This approach provides a base level of understanding but falls short of capturing the real cost of fraud. Many fraud incidents either go undetected or unreported. Here are just a few examples:

• A customer falls victim to a 419 scam but is too embarrassed to report it.
• Withdrawals from a dormant account are not flagged or reported.
• A new account opened with a synthetic ID is used to deposit stolen checks. Fraudsters withdraw funds quickly and the account goes dormant.
• Accounts used fraudulently are closed due to a negative balance and are written off as bad debt.

In these examples, there is no fraud loss associated with the event. Failing to account for these types of events underestimates the full impact of fraud loss on your organization. Consider an alternative. A top-down approach can make quantifying fraud losses easier. The TowerGroup estimates that 20-35% of operational losses are due to fraud.

This data provides a nice jumping off point for a top-down estimate one that eliminates the inherent inaccuracies of trying to account for all fraud types.I spent some time with a few annual reports this afternoon and found the following:

• For a large Top 5 bank, operational risk is 8% of $11.5B in economic capital. This equates to total fraud loss of $184 - $323M.
• For a Top 10 bank, operational loss is estimated at $354M resulting in fraud losses of $71M - $124M.
• For a top thirty bank, operational loss is estimated at $298 Million with fraud losses between $60M and $104M

What has your experience been when calculating the full impact of fraud loss on your institution? Have you ever used a top-down approach? Do my fraud loss estimates seem too large, too small or just right?

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