Incident Response, TDR

First party fraud

First party fraud is not a new phenomenon. As long as there has been credit granting there have been customers committing first party fraud. However, the technology and automation used today combined with the sub prime mortgage crisis and limited defenses against organized crime makes it easier and easier for fraudsters to slip under the radar.

First party fraud – when a customer applies for and accepts credit with no intention of repayment – is now being recognized across the financial industry and is receiving serious attention and investment by numerous banks. First party fraud applicants can use synthetic identification, or misrepresent their real identity, which is different from third party or identity fraud when the criminal uses another persons identifying information. Most first party fraud is currently written off as a credit loss. The financial industry has historically only recognized fraud when there is a victim. Since the customer commits first party fraud and the only victim is the financial institution, the loss is managed by the collections department and considered a bad debt. First party fraud includes advances fraud, bust out fraud, application fraud, friendly fraud and sleeper fraud.

Automation equals anonymity
Automation of the lending decision primarily through the increased use of lending scores has lead to an increase in first party fraud for a number of reasons. Before the use of lending scores, personal bankers determined credit worthiness and credit was offered as a result of a customer request. In our current market, qualification for loans can occur without any personal contact with the customer. In fact, loans and other lending products are often proactively solicited allowing perpetrators of first party fraud to operate with greater anonymity.

Automated scores are prone to abuse through manipulation. Manipulating lending scores does not require specialized knowledge of banking systems. Increasing your lending score can be as easy as churning transactions through an account. There have been examples of perpetrators depositing funds at a bank branch and withdrawing them at the ATM outside the branch multiple times in a day. In fact, the same perpetrators would periodically ask tellers if they had achieved a lending score high enough for them to qualify for unsecured loans. Although churning is obvious, it is an example of manipulating lending scores allowing anyone with malicious intent to perpetrate first party fraud.  

Capitalizing on a crisis
Significant losses due to first party fraud really started to increase and get the attention of the banking community after the proliferation of programs that target sub prime markets. In general, sub prime markets have thinner and sometimes non-existent credit records. With limited information to authenticate applications, misrepresenting your identity or fabricating a synthetic identity becomes much easier. With the current sub prime mortgage market decline, a large number of consumers are defaulting on secured credit mortgages as well as unsecured loans prior to the mortgage defaults. A larger number of legitimate defaults allow first party fraudsters to hide within the genuine population and get their loans written off.

Attracting organized crime
First party fraud is very lucrative. Many fraud managers that have begun to address the problem indicate that first party fraud can account for approximately 10 times more than all third party fraud losses which include identity theft, counterfeit fraud, lost and stolen fraud and online fraud. The British Bankers Association estimates that, as much as 10-15 percent of bad debt losses suffered by the banking sector may be a result of first party fraud.

With limited defenses (because the problem is largely unrecognized) and lucrative rewards first party fraud is gaining favor with organized crime rings. Specialized criminal gangs now target financial institutions with counterfeit identification and advanced knowledge of lending practices. Once an identity is established at a financial institution, they use the built up credit to apply for multiple products such as credit cards, overdrafts and lines of credit across multiple institutions. Once they have achieved their target value from the identity they bust out. A bust out is a sudden withdrawal of all available funds often accompanied by deposit fraud. Deposit fraud occurs by making fake deposits and withdrawing funds before the deposits are identified as fraudulent. This allows first party fraudsters to extract more funds than they qualify for maximizing the value of the identity before discarding it.

First party fraud prevention

Traditional behavior profiling solutions that work effectively for third party fraud do not identify first party fraud. Behavior profiling works by comparing the current activity on the account with the account history. This is an effective means of addressing third party fraud because the behavior of the fraud activity is different from the customers. Fraud is usually confirmed by contacting the customer to verify the transactions on the account. With first party fraud the customer is committing the fraud and so behavior profiling and verifying activity with the customer only encourage the perpetrator to commit additional claims fraud. A first party fraud perpetrator can claim that transactions on the account are fraudulent, allowing them to get more value from the identity before busting out.

An incident of first party fraud occurs at multiple organizations and across multiple channels within an organization (credit cards, lines of credit, overdraft, online banking). To effectively deal with first party fraud lending organizations need to monitor customers across all channels and consolidate information in order to identify evidence of manipulating lending scores and credit seeking behavior.

First party fraud solutions are now being launched at multiple institutions. Early solution adopters have seen that information sharing within an institution and analytics focused specifically on identifying suspect first party fraud can drastically reduce losses primarily by driving the fraud to the competition. Organized criminal rings quickly adapt to improvements in detecting their activity and the move to the path of least resistance. Lending institutions that are late adopters of first party fraud solutions will suffer growing losses and then face the uphill battle of deterring criminals that perceive them as easy targets.

Jasbir Anand currently manages fraud products for Actimize, Inc. He is a former director of fraud product business development for Fair, Isaac and Company, Inc., where he evaluated business opportunities. Prior to business development, Jasbir worked as a fraud consultant in the financial services industry and has consulted with clients on five continents on risk management, payment card, retail, e commerce, internal fraud, identity fraud and first party fraud/abuse reduction.

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