Understanding 1st-party fraud: Risks and resolutions

Know your customer (KYC) procedures during onboarding and throughout the life of the client relationship are important to mitigating 1st-party fraud. Effective KYC starts with identifying the typical demographic associated with 1st-party fraud. Often, perpetrators of this type of fraud are younger males with a strong understanding of technology, residing in cities and usually not financially well-off. While these traits alone don't necessarily identify someone as a fraudster, they could be important markers to consider during onboarding.

Careful new account procedures, background checks, and ongoing monitoring can help spot individuals who have the potential to commit fraud against your financial institution. The goal is to eliminate the threat before any inside fraudulent transactions occur. Develop a consumer risk rating process encompassing the possibility of 1st-party fraud on consumer accounts. 

Common models for 1st-party fraud

Here are some examples of common 1st-party scams that financial institutions should be looking for: 

1. Kiting: Kiting occurs when an account holder knowingly writes a check from their account without sufficient funds, exploiting the float time. The fraudster typically attempts to siphon the funds before the check is presented for payment. This differs from 2nd or 3rd-party check fraud, where external entities forge or tamper with checks. 
2. Paper hanging: Paper hanging is when fraudsters write checks on known closed accounts, relying on institutional inefficiencies to cash in. 
3. Application fraud: Application fraud happens when an accountholder misrepresents their personal or identifiable credentials or uses false information or supporting documentation to get more favorable terms on a loan or line of credit.  
4. Government loan fraud: First-party fraudsters may misrepresent information about themselves to benefit from government loans or stimulus programs. This abuse was frequent with the Paycheck Protection Program (PPP) set up during the Covid-19 pandemic. 
5. 1st-party debit or credit card fraud: Card fraud causes financial institutions significant monetary losses. Several types of card fraud should be understood:
   • Chargeback fraud: A customer buys something with a credit or debit card and then claims to their card company that the payment was fraudulent to get back the funds fraudulently. Chargeback misuse costs both financial institutions and their clients significantly.  

   • Cyber shoplifting: This type of 1st-party fraud involves a cardholder filing an invalid dispute against a credit card transaction, usually after a significant purchase. The transaction is effectively valid until the cardholder initiates a dispute. 

   • Friendly fraud: When a cardholder initiates a chargeback on a purchase without a legitimate basis. Unlike cyber shoplifting, which is usually intentional, friendly fraud may not be malicious and is usually inadvertent. Regardless of the motive, the outcome is the same: the cardholder has merchandise they haven't paid for. 
   • Goods Lost in Transit Fraud (GLIT): GLIT occurs when a person orders goods online and falsely claims they were never delivered or damaged on arrival. Sometimes, fraudsters return empty boxes to get a refund and vanish before the refund can be reversed.