While in the grocery lane, a person behind you is copying your checking account number; your statement or outgoing mail is stolen from your mailbox; the clerk at the local dry cleaner records your account number after you pick up your clothes; you write a check to a neighborhood teenager for magazines or girl scout cookies. Everyday, consumers provide their transaction account (DDA) number to strangers either willingly or unknowingly. In most instances, nothing bad happens. In fact, more than 99.5 percent of all DDA transactions are legitimate, resulting in a positive payment experience. It is the rare few that result in fraud and subsequent losses that are of the greatest concern.
With only someone’s account number, it is possible to conduct unauthorized transactions against a checking account. In combination with a fake ID, this information can be used to produce counterfeit paper checks that can be presented to retailers in exchange for goods and services. Fraud can even be committed against a compromised account number without leaving the comfort of one’s home. Money is simply transferred electronically into a newly opened checking or brokerage account, used to pay bills, order services or purchase goods over the Internet.
The proverbial Achilles heal in the system is an inability to easily and quickly validate that a person is authorized to transact on a particular account before a fraudulent transaction is initiated.
NACHA’s Proposal
Over the last several months, much has been written about NACHA, the electronic payments association and its proposal to assess fees against Originating Depository Financial Institutions (ODFI) that submit electronic transactions that ultimately result in unauthorized returns. Under existing operating rules, there are no penalties against banks or their originating customers (Originators) for processing items that reject as unauthorized (e.g. an invalid MICR line). The rationale for assessing this fee is to compensate Receiving Depository Financial Institutions (RDFI) for hard and soft dollar costs incurred by processing unauthorized returns. These costs include, but are not limited to, managing customer service complaints, incurring return item fees, conducting fraud/risk investigations and processing Regulation E claims.
While over 50 percent of the voting members were in favor of rules that would impose this fee, it did not receive the required 67 percent to be adopted. NACHA has reviewed the reasons for the “no” vote and will present its recommendations at a future Board meeting.
Regardless of what happens, this proposed fee would only serve to treat the symptoms and not the root cause, which is preventing the unauthorized transactions in the first place. While the fee would provide financial incentives for Originators and their banks to perform additional due diligence, a true solution to the problem would still be lacking.
ACH Return Statistics and Their Consequences
According to NACHA, the number of returns for unauthorized ACH Debits increased over 17 percent annually from Q1 2003 to Q1 2004. During that same period, WEB and TEL volumes increased more than 30 percent to over a billion transactions. Along with this increase comes an absolute rise in returns.
Based on current volumes and projected growth, PPS estimates that the industry will process over five million returns by 2007, costing the industry nearly $100 million. These returns can also have a lasting impact on an RDFI’s relationship with its retail customer...the innocent victim. PPS’ research also indicates a customer attrition rate of between five and 20 percent for all checking accounts where fraud has been perpetrated. Turnover usually occurs within six months of the incident.
So, will a service fee against the originating bank reduce the fraud problem? The answer is “No”. It will merely shift the costs to Originators, who will in turn pass them on to their customers. Additionally, with transactions still posting to corporate and consumer accounts as unauthorized, confidence in the payment system will further erode.
A Proactive Approach
So what should be done to mitigate the risk and reduce this growing cost?
In much the same way that the credit card industry validates bill to/ship to addresses to reduce telephone, mail order and Internet purchase risk, ODFIs and Originators need to also authenticate similar information on checking accounts. With more consumers paying bills online (80 percent of WEB transactions), there is a tremendous need to validate and answer the question, “Is the person transacting authorized to do so?”
Who wins?
- Originators will benefit from reduced fraud and lower collection and processing costs.
- ODFIs will receive a fraud solution to offer customers, potentially rendering proposed penalty fees unnecessary
- RDFIs, both commercial and retail, will benefit from a reduction in customer attrition, operating costs (by reducing the time and dollars spent disputing unauthorized transactions), and costs to process Regulation E claim disputes and return items.
- Customers gain confidence in their institutions’ ability to identify fraudulent transactions and reduce the time and costs to unwind unauthorized transactions.
Who loses?
- Those who commit fraud will find it is much more difficult to originate unauthorized transactions and victimize financial institutions and their customers.
It is important to remember that we are all in this together. Let us not continue down our current path, which involves literally “passing the buck” across the industry. By leveraging our existing infrastructure for sharing and authenticating information, we can significantly reduce fraud and its associated costs before the problem gets any worse.