Can We Do Better?

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With the new year here, I figured it was a good time to step back and take stock of our progress – as an industry – in the ongoing battle against fraud. A frank assessment: we could be doing a lot better.

Sure, there are always improvements that can be made to the organizations, processes and technologies that must come together to solve a complex issue like fraud management. But I think the more important barriers our industry faces are more fundamental and structural in nature. Specifically, I see the following:

The Boiling Frog
Our industry’s slow reaction to the growing, morphing fraud problem makes me think of the boiling frog phenomenon. If you haven’t heard of it, here’s a version taken from Daniel Quinn's novel, The Story of B:

        If you drop a frog in a pot of boiling water, it will of course frantically try to clamber out. 
        But if you place it gently in a pot of tepid water and turn the heat on low, it will float there 
        quite placidly. As the water gradually heats up, the frog will sink into a tranquil stupor, 
        exactly like one of us in a hot bath, and before long, with a smile on its face, it will 
        unresistingly allow itself to be boiled to death.

Apply this phenomenon to the way the financial services industry often deals with fraud threats. It starts with denial that a real problem exists: “it’s not really a big problem.” This thinking enables the problem to fester and grow, along with our risk exposure: “maybe there’s a problem, but it’s just a cost of doing business”. Eventually enough financial institutions (or their customers) get hit with big losses, and the lawsuits follow: “uh oh, we better do something, but we’re not sure what”. And then the government steps in with rules and regulations that drive up the cost and complexity of managing the risk and keeping track of our efforts: “darn, now we have to do something we weren’t planning for.” As with the frog, it’s a slow, degree-by-degree dive into a really bad place.

The Value Paradox
Investments in fraud prevention suffer from what I call “The Value Paradox”. The paradox is that success in the fight against fraud results in less fraud, which eventually produces an investment with a negative return (see illustration below).



Put another way: if you’re good at preventing fraud, you suffer very few fraud losses. If you suffer very few fraud losses, it’s hard to justify continued investment in fraud prevention. Using traditional value measures like ROI don’t work with fraud prevention because it’s hard (impossible?) to quantify the value of stopping something before it happens.

They’re Innovating, We’re Not
For most financial institutions, fraud prevention is still a cost – a cost center, a cost of doing business, a cost of compliance or all of the above. On the other hand, the fraudsters are innovating like crazy. For them, fraud is a growth business. They’re specializing, experimenting, and collaborating in order to keep the balance of power in their favor and preserve their growth business. For the FIs, treating fraud prevention as a cost center has its consequences, one of which is stifled innovation. With a few exceptions, I think it’s fair to say that fraud prevention in financial services – at a macro level – hasn’t seen a high level of innovation in years.

Innovation doesn’t just happen. It is borne out of an ecosystem that nurtures and rewards different thinking, new players and unique approaches to creating value. Think back to the boiling frog and the Value Paradox: risk-averse, in-the-box thinking, and certainly not innovation-inducing. So as long as financial institutions view fraud control as a cost of doing business, with a traditional, ROI-driven view of value, then the innovation war will continue to be won by the bad guys.

What do you think? Am I too pessimistic? Or do I have it right? What’s the key to breaking the cycle and moving fraud prevention to the next level of success and innovation?

Posted in: New Account Fraud Internal Fraud Deposit Account Fraud Debit Card Fraud Credit Card Fraud Collusive Networks Check Fraud Account Takeover Identity Theft ACH and Wire Fraud