AML/CFT Financial Crime Fraud Prevention Fraud Trends

The true cost of fraud

Terri Luttrell, CAMS-Audit, CFCS

November 17, 2023

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Measuring the cost of fraud losses.

The true cost of fraud goes beyond the initial reported fraud losses

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Fraud losses

Financial institutions have been inundated with fraud losses for the past several years and the COVID-19 pandemic and the overall downturn in the economy have only made things worse. The Federal Bureau of Investigations (FBI) reports that natural disaster has historically brought fraudsters out of the woodwork, pouncing on a pool of vulnerable victims: the more catastrophic the event, the more active the fraudsters. The COVID-19 pandemic was arguably the worst worldwide disaster in decades, and an increase in fraud has been detected on a wide scale. While some of the recent trending fraud schemes are not new, they have been transformed to prey on communities already dealing with unprecedented times.

The downturn in the economy has undoubtedly affected fraud statistics as well. According to PWC, rising prices can have substantial implications on fraud risks. Inflationary periods are likely to exacerbate all three components of the fraud triangle, those being incentive, opportunity, and rationalization. With surging costs of living and financial hardships, individuals will potentially have added incentives to carry out fraud. They will likely consider the economic problems faced to be a rationalization of their actions.

Fraud losses

The factors mentioned above created abundant opportunities for fraudsters, and financial institutions and consumers must stay one step ahead to protect themselves from falling victim to a myriad of fraud schemes. According to the Federal Trade Commission (FTC), consumers lost $8.8 billion to fraud in 2022, a 44% increase over the prior year and a trend that has continued into 2023. That equates to $35 billion annually. This, of course, doesn’t include fraud losses that were not filed due to the victim's embarrassment or lack of knowledge on how to report. The FTC further addresses the highest losses by type of fraud scheme. Social media scams account for the highest losses and are higher than any other fraud typology, at a reported half-billion total loss. Phone calls report the highest per-person loss, at a $1,400 median loss per victim. No matter the medium used, it is clear fraud continues to grow and cannot be ignored.

Fraud risk

Leaders within financial institutions are frequently tasked with understanding the full scope of fraud's impact. It extends far beyond the potential monetary losses associated with each fraudulent transaction. To fully appreciate the actual cost of fraud, the complex nature of fraud and its repercussions should be explored.

In assessing the true cost of fraud, Gartner, the respected technological research and consulting firm, has coined three distinct pillars of fraud costs. The first pillar is the overall hard dollar loss rate experienced from illicit transactions. This is the immediate financial hit that impacts the bottom line. It encompasses not only the amount of funds extracted by fraudulent means but also the ancillary financial repercussions, such as transaction reversal costs and compensation paid to affected clients. This tangible loss is often the easiest to quantify, yet it is merely the tip of the iceberg in fraud-related costs.

The second pillar concerns the cost of technical and human resources dedicated to fraud prevention, detection, and remediation. The race against fraudsters involves a continuous outlay of cutting-edge technologies designed to safeguard against intrusion and theft. Additionally, the human capital investment—in terms of both hiring fraud prevention experts and training existing staff—represents a significant operational expense. These costs are necessary and ongoing, forming a crucial barrier against fraud scams.

The third pillar, the client value impact, is associated with attrition rates following fraud incidents. The erosion of trust caused by incidents of fraud can lead to a decline in client retention, which is a critical issue for financial institutions. Each client lost to fraud represents future revenue streams that are now gone. The relationship between fraud incidents and client departure is a serious concern, as the institution not only loses the lifetime value of the client but also incurs higher costs in attempting to acquire new clients to fill the void.

More than just fraud losses

Reputational Risk

Separate from these pillars, financial institutions suffer reputational risk whenever a client falls victim to fraud scams. The damage inflicted on an institution’s reputation after a fraud incident can have extensive ramifications. A tarnished reputation can deter potential clients and negatively affect existing relationships, as trust is critical in a financial relationship. According to research by Javelin Strategy & Research, 31% of clients are more likely to leave the financial institution after a fraud event, even when the bank or credit union is not at fault. Remember, media attention is not always positive or wanted.

Regulatory risk

Regulatory risk is yet another significant concern. As overseers tighten the leash with stringent regulations aimed at protecting consumers, the cost of compliance grows. Failure to meet these standards can result in regulatory sanctions, fines, and a mandate for expensive corrective measures. Moreover, non-compliance can lead to enhanced scrutiny by regulators and the possibility of heightened requirements in the future.

The Financial Crimes Enforcement Network (FinCEN) has listed fraud and cybercrime as two of their National AML/CFT Priorities. FinCEN states, fraud is believed to represent the largest share of illicit proceeds in the United States. Further saying, cybercrime, specifically, is one of the most significant threats posed to financial institutions. This is the first-time fraud has been addressed at a high level as part of AML compliance, but it makes sense. Proceeds from fraudulent activity must be laundered, so there is a direct correlation. Now is the time to be sure that your fraud, AML, and IT security teams collaborate and keep each other informed on illicit trends they are detecting.

With fraud now considered an AML/CFT priority, regulatory penalties and fines around fraud may be something to consider in future exams. Regulators are expecting financial institutions to address each of the priorities in their AML/CFT program, and when there are deficiencies, you can expect criticism and possibly monetary penalties.

Fraud Risk Management

Financial institutions must approach fraud with a comprehensive strategy that accounts for direct financial loss, resource allocation, and the broader implications on client value, reputation, and regulatory standing. It is a continual battle requiring vigilance, innovation, and a commitment to safeguarding all stakeholders. Things to consider include:

Hardware: Is your business data safe, and are updates and patches applied timely? They should always be.
Software: Do you have adequate detection and fraud management software? Are you able to detect various types of illicit activity, such as check, wire, and ACH fraud?
People: Do your investigators receive proper training? Do they have the correct skill set to detect complex patterns of fraudulent activity?
Client education: Does your institution have avenues for client education, such as written materials, online warnings, or in-person seminars for clients and prospects? If not, this is a great way to foster community goodwill and deter fraud at the same time.

Understanding fraud

Understanding and addressing the nature of fraud is paramount for financial institutions in today's complex economic landscape. The surge in fraudulent activities demands a robust and dynamic approach to deterrence and detection. Institutions must invest not only in advanced security measures and skilled personnel but also in client education and community engagement to combat fraud effectively. The true cost of fraud extends far beyond direct financial losses, and the commitment to combating fraud is not just a regulatory necessity. It is a critical aspect of maintaining the integrity and sustainability of the U.S. financial system.

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About the Author

Terri Luttrell, CAMS-Audit, CFCS

Compliance and Engagement Director

Terri Luttrell is a seasoned AML professional and former director and AML/OFAC officer with over 20 years in the banking industry, working both in medium and large community and commercial banks ranging from $2 billion to $330 billion in asset size.

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The true cost of fraud

Measuring the cost of fraud losses.

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