Graduated Fraud Policy: The solution to managing fraud
We know that effective fraud prevention solutions can help solve both a regulatory and a risk problem inside of a credit policy. However, we still see a number of retail banks using regulatory compliance as a justification for a constricting fraud policy. Regulatory compliance is very important but shouldn’t completely stagnate your fraud policy.
Equifax appraised one major retail bank’s fraud results and learned that its manual review fallout was more than double what we normally see in the industry. The customer was using a graduated fraud policy, which in theory should have been effective. But there was a compliance bias in their rules that was causing an adverse impact on profitability. This serves as a good discussion point in risk policy configuration from a fraud standpoint.
A sound graduated fraud policy is hinged on attaching business logic to reason codes from a fraud model – the policy uses the score and reason code output of a fraud model to inform its decisions. For this to be effective, business rules need to look at process and profit results and ensure optimized results. Reviewing the correlations of different reason codes produced by the model along with different undesirable outcomes (charge-off, never-pay) better enables an intelligent controlling of credit worthiness.
For example, if a credit analyst finds that applications that return reason codes X, Y and Z represent 30% of the synthetic fraud, new customers getting those reason codes might be declined with minimal review. Many reason codes do usually indicate highly negative scenarios and can help halt the cost of fraud. Alternatively, marginal reason codes with a good fraud score might not need to be reviewed, even though a reason code was returned.
Work to create a fraud score that includes “profit optimization” – that maximizes revenue while minimizing fraud losses and the costs of detecting fraud. Reason codes are good at providing details to a decision, but they need context to ensure that a fraud solution is meeting its business objectives. Regardless of exactly how the graduation is implemented, reason codes presented and leveraged in a compliance framework don’t always equate to a fraud risk.
Risk and compliance can sit next to each other without seriously infringing on profit. Many communications firms are embracing this approach and finding success, and retail banks can leverage their lessons learned. Marrying continual fraud policy review against business targets is a key to helping ensure the right balance is met.
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