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As more people embrace online banking, fraudulent actors have created new ways to breach security measures. Fraudulent schemes evolve as fintech improves. Among these challenges is first-party fraud, which is a prevalent threat to both companies and their customers.
In this blog, we’ll explain first-party fraud in the context of fintech, its evolving forms, and mitigation strategies.
What is First-Party Fraud in Fintech?
First-party fraud occurs when a legitimate customer or account holder intentionally misrepresents or deceives a financial institution or fintech company for personal gain.
Unlike other types of fraud that external actors perpetrate, first-party fraud originates from within the customer base itself. This can include various deceptive activities, from fraudulent applications to exploiting loopholes in system design for personal gains.
The key characteristic of first-party fraud is that it is executed by legitimate customers or account holders. Fraud executed by an organization’s business partner or affiliate is considered second-party fraud. Meanwhile, the most well-known type of fraud is third-party fraud or those that involve external actors, such as hackers, who steal a company’s or its customers’ data.
First-party fraud can have a significant and detrimental impact on fintech, banking, and insurance companies. This type of fraud can lead to financial losses and reduce the company’s profitability. Furthermore, the costs associated with fraud prevention and detection, including investments in technology, personnel, and investigative resources, can significantly increase operational expenses.
Fintech fraud may also erode customer trust. They may lose trust in the company’s ability to protect their information and provide secure services if they fall victim or experience difficulties due to fraudulent activities. This can lead to customer churn, negative reviews, and reputational damage, ultimately impacting the company’s brand image and long-term success.
Here are examples of 1st party fraud:
Fraudulent Applications
Misrepresentation of Income: Applicants may inflate their income or provide false employment information to qualify for loans, credit cards, or other financial products.
Identity Theft: Individuals may use stolen identities to create fraudulent accounts, often to obtain loans or credit cards.
Synthetic Identity Fraud: This involves creating a completely fabricated identity using a combination of real and fake information.
Account Abuse
Friendly Fraud: Customers may dispute legitimate transactions, claiming they were unauthorized.
Account Takeover (ATO): While technically a form of account abuse, customers may exploit vulnerabilities in authentication processes to gain unauthorized access to their own or others' accounts.
Abuse of Promotions and Rewards: Customers may engage in activities like churning (rapidly opening and closing accounts) or manipulating loyalty programs to maximize rewards.
Insurance Fraud
False Claims: Policyholders may file false claims for events that never occurred or exaggerate the extent of losses.
Premium Fraud: Individuals may provide false information to obtain lower premiums or avoid paying premiums altogether.
How First-Party Fraud in Banking Has Changed
In the past, an individual may need to physically steal another person’s IDs in order to use their identity to access their accounts. Nowadays, with the rise of fintech, first-party fraud has also evolved.
First, the finance world has undergone a digital transformation, with banks and businesses shifting to digital banking. Over half of the population is poised to use digital banking by 2026, meaning these individuals have their banking information in their gadgets. This shift created new vulnerabilities for fraudsters to exploit.
The rise of new technologies also led to the emergence of fintech players like lending platforms, giving fraudsters new institutions to target. Fintech has also disrupted laws and regulations surrounding finance and banking. Fraudsters take advantage of loopholes in the regulations to execute their schemes.
Of course, with new technologies, fraud techniques have also become more sophisticated.
• Digital Transformation: The shift to digital banking has increased the avenues for fraud. Online applications, mobile banking, and remote customer interactions create new vulnerabilities that fraudsters can exploit.
• Sophistication of Techniques: Fraudsters are becoming increasingly sophisticated, employing advanced techniques like social engineering, deepfakes, and AI-powered tools to deceive systems and evade detection.
• Rise of FinTech: The emergence of new fintech players, such as lending platforms and cryptocurrency exchanges, has introduced new fraud vectors and regulatory challenges.
How to Mitigate First-Party Fraud in Fintech
First-party fraud detection and mitigation require a multi-layered approach combining robust technology with strong internal controls.
Enhanced Customer Due Diligence (CDD) and Customer Acceptance Policy (CAP)
CDD and CAP are foundational to any effective fraud prevention strategy. By rigorously vetting customers during the onboarding process and continuously monitoring their activity, fintech companies can significantly reduce their exposure to first-party fraud.
Thorough Application Screening: Implement rigorous checks on application data, including income verification, employment history, and identity verification.
Risk-Based Approach: Develop a risk-based framework for customer onboarding and ongoing monitoring, prioritizing high-risk customers and transactions.
Leverage Technology: Utilize advanced technologies like machine learning, artificial intelligence, and biometrics to automate and improve the accuracy of CDD processes.
Strong Authentication and Access Controls
Strong authentication and access controls are crucial for safeguarding customer accounts and preventing unauthorized access to sensitive data, a key factor in mitigating first-party fraud such as account takeovers and fraudulent transactions.
Multi-Factor Authentication (MFA): Implement strong MFA solutions, such as biometrics, one-time passwords (OTPs), and device fingerprinting, to enhance account security.
Behavioral Analytics: Monitor customer behavior patterns for anomalies, such as unusual login times, locations, or transaction amounts.
Account Lockout Policies: Implement robust account lockout policies to prevent unauthorized access attempts.
Fraud Monitoring and Detection Systems
Financial institutions need to establish a strong monitoring and detection system so they can immediately detect and respond to potential fraud. This can be done in a few ways:
Real-time Transaction Monitoring: Implement fund disbursement solutions that allow real-time transaction monitoring to detect suspicious activities, such as large or unusual transactions, and alert relevant personnel.
Rule-Based Systems: Develop and maintain a robust set of rules and alerts within your fintech ecosystem to flag potential fraud indicators.
Leverage AI and Machine Learning: Utilize AI and machine learning algorithms to identify complex and evolving fraud patterns.
Fraud Prevention Education and Training
Banks and financial institutions cannot leave their customers and employees behind. Customers and employees must hold their own fort. However, organizations must make sure that they are equipped to protect themselves from various types of fraud. Here’s how:
Customer Education: Educate customers about common fraud risks and best practices for protecting their accounts.
Employee Training: Train employees on fraud awareness, detection, and reporting procedures.
Regularly Update Procedures: Regularly review and update fraud prevention policies and procedures to adapt to the evolving threat landscape.
Building Strong Customer Relationships
Strong customer relationships can indirectly help strengthen your protection against first-party fraud.
Open Communication: Maintain open and transparent communication channels with customers to build trust and address concerns promptly.
Prompt Resolution of Disputes: Investigate and resolve customer disputes efficiently and fairly.
Customer Feedback Mechanisms: Encourage customer feedback to identify potential fraud risks and areas for improvement.
Build Your Security with Brankas
First-party fraud poses a significant and evolving threat to fintech companies. By implementing a comprehensive fraud prevention strategy that combines robust technology, strong internal controls, and a focus on customer education, businesses can effectively mitigate these risks and protect their customers and their bottom line.
Brankas offers a comprehensive open finance platform that provides secure and convenient fintech lending and direct payment solutions to help you manage security risks and simultaneously improve your services.