Research Paper Impacts of Credit Card Fraud in Banking Service

LONG KimKhorn, PUC, MA. IRs, ID: 61283

Date: March 12th, 2012

Abstract

Credit cards became the very popular means/ instruments to pay services and goods transaction electronically. If recent increase rates continue, credit cards and debit cards will each overtake the number of paid checks certainly and fraud will also grow. Credit card fraud is the misuse of a credit card to make purchases without authorization or counterfeiting a credit card (Balan & Popescu, 2011). The absence of direct or voice communication on the Internet makes scammers more bullying by bestowing them with invisibility. Progressively, scapegoats arent even sensible that their credit cards are being fraudulently accounted until they acquire their monthly statement.

Modern life style, people favor to buy online by credit card because it is spring time and enjoyment. The authors also states that there are many types of credit card fraud layouts such as selling the card to thieves, unauthorized relative users, and deceitfully access a card by using hacked information in banking system or clients email, fake telephone communication as the banker or travel agents to explore for applicant credit card information, and the stolen card to puzzle a new fraud card through many channels such as peel and paste, imprint/resculpt, telephone/mail order fraud, mail theft, false appliances, credit doctors, real name fraud, non-voucher fraud, credit master, penetrating, scooping, excuse calling, and account merger.

Some prevention should be made. The financial institutions/credit card issuer should teach or well train their staff and the investors to be conscious of security factor. And related law enforcement, Personal identification number (PIN) must be required regularly when user arouse their card through phone call, verify caller ID with the customer information in bank, and Smart cards and pin code should be used in order to minimize risk. In conclusion, the usage of credit card will be increase while one card can be used for all type of financial transactions in the future. Nevertheless, fraud rings will reconcile appropriately and new counterfeiting approaches will occur. Therefore, investigators and law enforcers must retain a broad perspective when confronting this kind of fraud.

Introduction

At the beginning of the 20th century, credit cards were first issued by hotels in the United States. By 1914, departmental stores and gas stations also followed the trend of issuing credit cards. In the 1950s, third party cards appeared which acted as entertainment and travel cards. Eventually bankcard appeared. In the 1960s the first bankcard was initiated by BankAmericard, which is now known as Visa card.In order to avoid competition, Master Charge systems and Visa established themselves as the bank's credit card industry in the United States (Garcia, 1980). Changes caused by technological advancements have entered all aspects of human life. Changes caused by technological advancements have entered all aspects of human life. Technological evolutions were introducing to people in daily life is the use of credit cards as a tool for payment.The use of credit cards has increased substantially worldwide in recent years and is replacing currency as a method of payment (EuroJournals, 2008). The credit card business enabled the bank to attract new customers as well as retaining existing customers in order to build a stronger customer base. However, many credit cardholders in Malaysia are non-active cardholders although a significant proportion of them might have more than one bank's credit card. Based on the classification of "light" and "heavy" users for tangible consumer goods (Cook and Mindak, 1984), credit card users can be categorized according to their differences in cardholder usage rates. In another research conducted by Chan (1997), an assistant professor in Hong Kong Polytechnic University, an "active cardholder" in his study refers to those whose card usage rate was at least ten times per month, whereas "inactive cardholder" referred to card usage rate of less than ten times per month. In their recent research (2001), Hamilton and Khan operationalized credit card users into three categories: (i) non-active card holders; (ii) non-interest paying active cardholders; and (iii) interest paying active card holders (Asian Academy of Management Journal, 2002).

According to Theory of Planned Behavior (TpB) was introduced to the literature by Ajzen (1988, 1991). A two-period model is constructed to study the interactions among consumers, merchants, and a card issuer. The model yields the following results. First, if the issuers cost of funds is not too high and the merchants profit margin is sufficiently high, in all equilibrium of our model the issuer extends credit to qualified consumers; merchants accept credit cards and consumers face a positive probability of default. Second, the issuers ability to charge higher merchant discount fees depends on the number of customers gained when credit cards are accepted. Thus, credit cards exhibit characteristics of network goods. Third, 3

each merchant faces a prisoners dilemma where each independently chooses to accept credit cards, however all merchants two-period profits are reduced because of inter-temporal business stealing across industries (Sujit, 2006).According to TpB model, human action is guided by three kinds of consideration. These are behavioral beliefs, normative beliefs and control beliefs. Behavioral beliefs are beliefs about the likely results of the behavior and evaluations of them, normative beliefs are the beliefs about the normative expectations of other people and motivation to comply with them, and control beliefs are beliefs about the existence of factors that may affect the performance of the behavior (Ajzen, 2006). Furthermore, the equilibrium interaction between the merchant discount and the accessibility of credit has network effects. If the card issuer makes credit more widely available, the merchant increases its sales to illiquid customers. This in turn allows the card issuer to increase the discount the merchant is charged. In other words, merchants are willing to pay higher merchant discounts if credit cards generate greater sales. That is, credit card services exhibit network effects (Sujit, 2006).Since socioeconomic consequences of credit card debt have become one of the most common problems in the world, the problem has received widespread attention of media, public policy makers, card issuers and holders and consumer protection agencies. Within this context, it is important to know which factors have impact on the probability of default and intention of credit use as a financial solution during economic hardship. As credit card and other debt spirals at a society level, it brings with it many socioeconomic problems such as divorcing, filing for bankruptcy, committing suicide and killings of family members (International Research Journal of Finance and Economics, 2008). These attributes include acceptance level, credit limit, interest-free repayment period, annual fee, application approval period, ancillary functions, handling of cardholders' complaints, issuing bank image, gift/bonus to new applicants, card design, leaflet to describe the card, and advertising by the issuing bank (Asian Academy of Management Journal,2002). The model provides a benchmark for policymakers to consider when setting policies regarding credit card networks. We consider a credit card market where consumers are given rebates in the form of an interest-free short-term loan and merchants do not impose surcharges on credit card purchases. We also consider a monopolistic issuer and merchants that are monopolists but no single merchant has any bargaining power with the issuer. Under these conditions, we find under what conditions credit card equilibrium exists and which participants benefit (Sujit, 2006).

Meanwhile, credit cards became the very popular means/ instruments to pay services and goods transaction electronically. And if recent increase rates continue, credit cards and debit cards will each overtake the number of paid checks certainly and fraud will also grow. Credit card fraud is the misuse of a credit card to make purchases without authorization or counterfeiting a credit card (Balan & Popescu, 2011). The American Institute of Certified Public Accountants has released a Statement on Auditing Standards(SAS) No. 99 Consideration of Fraud in a Financial Statement Audit - that highlights the importance of fraud detection. This statement claims the auditor to specifically evaluate the risk of material misstatement due to fraud and it allows auditors with operational guidance on considering fraud when conducting a financial statement audit. SAS 99s approach is also necessity for other types of audits.Occupational Fraud is defined by the ACFE as:The use of ones occupation for personal enrichment through the deliberate misuse or misapplication of the employing organizations resources or assets.Fraud encompasses an array of abnormalities and illegal acts characterized by intentional deception. The five elements of fraud are: A representation about a material fact, which is false; and made intentionally, knowingly, or recklessly; which is believed; and acted upon by the victim; to the victims damage. Fraud, like other crime, can best be explained by three factors: (1) A supply of motivated offenders; (2) The availability of suitable targets; (3) The absence of capable guardians or a control system to mind the store. There are four elements that must be present for a person or employee to commit fraud: Opportunity, Low chance of getting caught, Rationalization in the fraudsters mind, and Justification that results from the rationalization.The absence of direct face-to-face or voice communication on the Internet makes scammers more bullying by bestowing them with invisibility. This challenge was happening every where around the world both in developing and developed countries. Progressively, scapegoats arent even sensible that their credit cards are being fraudulently accounted until they acquire their monthly statement. Modern life style, people favor to buy online by credit card because it is spring time and enjoyment. Thomas suggests thatfactors contributing to fraud include the following: Poor internal controls, Management override of internal controls, Collusion between employees, Collusion between employees and third parties. And there are many types of credit card fraud layouts such as selling the card to thieves, unauthorized relative users, and deceitfully access a card by using hacked information in banking system or clients email, fake telephone communication as the banker or travel agents to explore for applicant credit card information, and the stolen card to puzzle a new fraud card through many channels such as peel and paste, imprint/re-sculpt, telephone/mail order fraud, mail theft, false 5

appliances, credit doctors, real name fraud, non-voucher fraud, credit master, penetrating, scooping, excuse calling, and account merger. There is no pending legislation that specifically addresses frauds in connectionwith online banking. The Internet provides fertile ground for those intending todefraud financial institutions. Because the online customer is anonymous, therisk of fraud is greater.

And now some prevention measures should be made. The financial institutions/credit card issuer should teach or well train their staff and the investors to be conscious of security factor. And related law enforcement, Personal identification number (PIN) must be required regularly when user arouse their card through phone call, verify caller ID with the customer information in bank, and Smart cards and pin code should be used in order to minimize risk. In conclusion, the usage of credit card will be increase while one card can be used for all type of financial transactions in the future. Nevertheless, fraud rings will reconcile appropriately and new counterfeiting approaches will occur technologically in this 21st century, epoch of cutting-edge-revolutionized technology. The question is that the present efforts are capable enough to handle cyberspace evils. And if this problem wont be complied accordingly, how does it impact to all banking services operation. In todays environment, it is essential that local governments have policies and procedures in place forreporting irregularities and/or suspected fraud. These policies and procedures need to be clearlycommunicated internally and externally to all employees and reviewed periodically to ensure that they still make sense.In addition to having policies and procedures in place, employees should be able to communicate red flagswith the appropriate personnel without being concerned for their jobs or some type of retaliation. Ifpossible, some type of anonymous form should be developed for employees to fill out. Just remember, theACFEs 2006 Survey disclosed that approximately 34.2 percent of frauds were detected through tips.

Critiques

The identified and defined theft as the most common type of identity theft is credit card fraud of various kinds and there is evidence that the numerous of credit card fraud on the internet (and by telephone) has increased because of the opportunities provided by the Internet environment so If without Internet evolution, there is no cyber crime anyway. However, some prefer not to include credit card fraud as true identity theft, since it may occur only once, and be discovered quickly by the credit card issuing company, often before even the 6

individual card holder knows it. Other types of identity theft such as account takeover are more involved and take a longer time to complete.They classify theft identification into three stages. Stage 1: Acquisition of the identity through theft, computer hacking, fraud, trickery, force, re-directing or intercepting mail, or even by legal means (e.g. purchase information on the Internet).Stage 2: The use of the identity for financial gain or to avoid arrest or otherwise hide ones identity from law enforcement or other authorities (such as bill collectors). Crimes in this stage may include account takeover, opening of new accounts, extensive use of debit or credit card, sale of the identity information on the street or black market, acquisition (breeding) of additional identity related documents such as drivers license, passport, visas, health cards etc.), filing tax returns for large refunds, insurance fraud, stealing rental cars, and many more. Stage 3: Discovery. While many misuses of credit cards are discovered quickly, the classic identity theft involves a long period of time to discovery, typically from 6 months to as long as several years. Evidence suggests that the time it takes to discovery is related to the amount of loss incurred by the victim. At this point the criminal justice system may or may not be involved and it is here that considerable research is needed. And the question is why they only determine three stages of theft identification. There could be more stages to prevent such crimes.According to the FTC research, there are differences in the extent to which individuals report their victimization (older persons and the less educated are likely to take longer to report the crime and are less likely to report the crime at all). It also suggests that the longer it takes to discovery and therefore reporting of the crime to the relevant authority, the greater the loss and suffering of the victim, and from the criminal justice perspective, the poorer the chance of successful disposal of the case. Furthermore, the recording and reporting of identity theft as a crime by criminal justice authorities, especially local police has been thwarted by three significant issues: (1) The difficulty of defining identity theft because of its extensive involvement in other crimes. Most police departments lack any established mechanism to record identity theft related incidents as separate crimes. This is exacerbated by the lack of training of police officers to identify and record information concerning regular crimes that also involve identity theft. (2) The cross-jurisdictional character of identity theft which over the course of its commission may span many jurisdictions that may be geographically far apart. This has led to jurisdictional confusion as to whose responsibility it is to record the crime. Although efforts have been made by the IACP to resolve this issue, there are still significant hurdles to be over come.

(3) Depending on the type of identity theft, individuals are more likely to report their victimization to other agencies instead of the police, such as their bank, credit card issuing agency etc. Thus, there is a genuine issue as to the extent to which police are the appropriate agency to deal with this type of victimization, when in fact it is the many financial agencies that are in a position to attend to the victims problems and even to investigate the crimes (which many do). Therefore there is strong motivation for police agencies to avoid taking on the added responsibility for dealing with this crime (Graeme& Megan, 2005).

Methods In doing this term paper about 10 pages of impacts of credit card fraud on banking services, I collected many literature reviews, journals, researches, financial reports, and so on from various sources such as universities, research institutes, governmental agencies and banking firms virtually and then I extract all those main ideas into synthesis matrix and wrote it down into literature review and also use problem-solution approach with data/ figures to support my proposition in the paper. Results/ Findings

According to Meridien Research, estimated fraud loss for the credit card industry amount to $1.5 billion annually, of which $230 million is estimated to result from online transactions. MasterCard reported a 33.7% increase in worldwide fraud from 1998 to 1999. During the first quarter of 2000, fraud losses increased 35.3% over the last quarter in 1999. VISA reports similar trends. It is estimated that fraud losses for online transactions may exceed $500 million in 2000fraudulent credit card activities include the use of counterfeit, stolen, and never-receivedcards, as well as account takeover, mail order and Internet card-notpresenttransactions (National Fraud Center, 2000).Most types of fraudulent activity can be categorized as employee andmanagement red flags. Before we give you examples of employee and management red flags, it is important to understand more about employee and organizational profiles of fraud perpetrators. According to the 2006 ACFE survey of more than 1,100 occupational fraud cases, perpetrators have the following characteristics: Fraud Perpetrator Profile: The majority of occupational fraud cases (41.2 percent) are committed by employees. However, the median loss for fraud committed by managers was $218,000, which is almost three times greater than the loss resulting from an employee scheme. 8

Approximately 61 percent of the fraud cases were committed by men. The median loss resulting from fraud by males was $250,000, which is more than twice the median loss attributable to women.

Most fraud perpetrators (87.9 percent) have never been charged or convicted of a crime. This supports previous research which has found that those who commit occupational fraud are not career criminals.

Nearly 40 percent of all fraud cases are committed by two or more individuals. The median loss in these cases is $485,000, which is almost five times greater than the median loss in fraud cases involving one person.The median loss attributable to fraud by older employees is greater than that of their younger counterparts.

The median loss by employees over the age of 60 was $713,000. However, for employees 25 or younger, the median loss was $25,000.

Organizational Profile:Most costly abuses occur within organizations with less than 100 employees; Government and Not-for-Profit organizations have experienced the lowest median losses; Management ignores irregularities; High turnover with low morale; Staff lacks training. Merchants or business owners also can identify their employees behaviors: Employee lifestyle changes: expensive cars, jewelry, homes, clothes; Significant personal debt and credit problems; Behavioral changes: these may be an indication of drugs, alcohol, gambling, or just fear of losingthe job; High employee turnover, especially in those areas which are more vulnerable to fraud; Refusal to take vacation or sick leave; Lack of segregation of duties in the vulnerable area. Furthermore, they can keep their eyes on management characteristics, especially, on: Reluctance to provide information to auditors; Managers engage in frequent disputes with auditors; Management decisions are dominated by an individual or small group; Managers display significant disrespect for regulatory bodies; There is a weak internal control environment; Accounting personnel are lax or inexperienced in their duties; Decentralization without adequate monitoring; Excessive number of checking accounts; Frequent changes in banking accounts; Frequent changes in external auditors; Company assets sold under market value; Significant downsizing in a healthy market; Continuous rollover of loans; Excessive number of year end transactions; High employee turnover rate; Unexpected overdrafts or declines in cash balances; Refusal by company or division to use serial numbered documents (receipts); Compensation program that is out of proportion; Any financial transaction that doesnt make sense - either common or business; Service Contracts result in no product; Photocopied or missing documents.

Changes in Behavior of Employees about to commit fraudsas the following can be uses in combating fraud crimes:Borrowing money from co-workers; Creditors or collectors appearing at the workplace; Gambling beyond the ability to stand the loss; Excessive drinking or other personal habits; Easily annoyed at reasonable questioning; Providing unreasonable responses to questions; Refusing vacations or promotions for fear of detection; Bragging about significant new purchases; Carrying unusually large sums of money; Rewriting records under the guise of neatness in presentation. Some research study found Possibility of Fraud in Cash/Accounts Receivablesince cash is the asset most often misappropriated and local government officials and auditors should payclose attention to any of these warning signs by looking at these related factors: Excessive number of voids, discounts and returns; unauthorized bank accounts ; Sudden activity in a dormant banking accounts; Taxpayer complaints that they are receiving non-payment notices; Discrepancies between bank deposits and posting; Abnormal number of expense items, supplies, or reimbursement to the employee; Presence of employee checks in the petty cash for the employee in charge of petty cash; Excessive or unjustified cash transactions; Large number of write-offs of accounts; Bank accounts that are not reconciled on a timely basis. Some findings are in Payroll, it is a vulnerable area, especially if collusion is involved: Inconsistent overtime hours for a cost center; Overtime charged during a slack period; Overtime charged for employees who normally would not have overtime wages; Budget variations for payroll by cost center; Employees with duplicate Social Security numbers, names, and addresses; Employees with few or no payroll deductions. There also fraud in purchasing/ inventory: Increasing number of complaints about products or service; Increase in purchasing inventory but no increase in sales; Abnormal inventory shrinkage; Lack of physical security over assets/inventory; Charges without shipping documents; Payments to vendors who arent on an approved vendor list; High volume of purchases from new vendors; Purchases that bypass the normal procedures; Vendors without physical addresses; Vendor addresses matching employee addresses; Excess inventory and inventory that is slow to turnover; Purchasing agents that pick up vendor payments rather than have it mailed. Beside these findings, there are general types of fraud in: Lifestyle Fraud is often committed by trusted employees whom management know well, so it isimportant to be on the look out for employee lifestyle issues that may be red flags indicating afraud risk; Some embezzlers are secretive. They dont want to be caught and will stash stolen fundsand be extremely careful with their spending; other aspiring embezzlers want to use, enjoy, share,

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and show off their fraudulentlygained money. And the factin many cases of fraud, perpetrators openly live beyond their means. Time to time in doing businesses and when there were frauds happened, investors or bankers can observe a few patterns in looking for fraud in their organization through: Absenteeism; Regular ill health or shaky appearance; Easily making and breaking promises and commitments; Series of creative explanations; High level of self absorption; Inconsistent or illogical behavior; Forgetfulness or memory loss; Family problems; Evidence of deceit (small or large). By the way, financial pressures can lead to frauds by contributing factors such as: Medical bills; Family responsibilities; a spouse losing a job; Divorce; Debt requirements; maintaining a current lifestyle; Car repairs etc.

Discussion and Conclusion

As card business transactions increase, so too do frauds. Clearly, global networking presents as many new opportunities for criminals as it does for businesses. While offeringnumerous advantages and opening up new channels for transaction business, theinternet has also brought in increased probability of fraud in credit card transactions.The good news is that technology for preventing credit card frauds is also improvingmany folds with passage of time. Reducing cost of computing is helping in introducingcomplex systems, which can analyze a fraudulent transaction in a matter of fraction of asecond.It is equally important to identify the right segment of transactions, which should be subject to review, as every transaction does not have the same amount of risk associatedwith it. Finding the optimally balanced total cost of fraud and other measures outlined inthis article can assist acquiring and issuing banks in combating frauds more efficiently.Auditors, employees, and management need to be aware of red flags in order to monitor the situation and then take corrective action as needed. Employees who notice that red flags are ignored may mistakenly believe that it is okay to game the system or that they wont get caught. A little fraud soon becomes a large one if left to grow.According to the National White Collar Crime Centers National Public Survey onWhite Collar Crime, FBI statistics indicate that, for the period from 1988 to 1997, arrests for violent crimes decreased, but the arrest rate for crimes having to dowith fraud and embezzlement increased dramatically.47 as is evident from thisstudy, this trend is sure to continue, and to grow, as technology facilitates theemergence of cyber crime. As a result of the burgeoning of e-commerce, cybercrime has become prevalent, and it will soon be difficult to differentiate amongtraditional economic and cyber 11

crimes.Preventing, detecting, investigating, and prosecuting economic crimes mustbecome a priority, in order to lessen their impact on the economy and the publicsconfidence. Law enforcement, as it stands now, is in danger of slipping furtherbehind the highly sophisticated criminals. New resources, support for existingorganizations, e.g. The National Fraud Center, The National White Collar CrimeCenter, The Internet Fraud Council, and The Economic Crime InvestigationInstitute, and innovative solutions are needed to control this growing problem inAmerica and the world.

Acknowledgement

By March 2012, I would like to say thanks to Dr. Ms. TING Layheng who taught and guided me through this term paper. And I would like to show respect to all scholars and researchers works which uploaded virtually that it was importance and very useful for my research in doing this term paper. Anyway this term paper, it is a little contribution of my academic life by concerning the widespread of cyber crimes, frauds, in banking services that can result in big challenges for bankers or investors at anywhere around the world, especially, in Cambodia, at-least developing country (LDC) with weak technology practices in every sectors, particularly in financial sector. But however it might be the lead, by some degree, for other researchers, scholars, and students who love doing researches, specifically in financial and banking sector.

References

Balan, L., & Popescu, M. (2011)Credit Card Fraud, 11(1), 81,84.

Ramayah, T., Noor, N., Narsudin, M. A.,& Choo, H. L. (2002).Asian Academy of Management Journal:CARDHOLDERS' ATTITUDE AND BANK CREDIT CARD USAGE IN MALAYSIA: AN EXPLORATORY STUDY, 7(1),

International Research Journal of Finance and Economics (2008), ISSN 1450-2887 Issue 18 EuroJournals Publishing, Inc.

Ted To, C. S., (2006).A Theory of Credit Cards 12

Canadian Bankers Association (2010).Credit Card Fraud Statistics, Public

Curry, S. (2000).An Inside Look at E-Commerce Fraud: Prevention and Solution

ACL Services Ltd. (2010).Fraud Detection Using Data Analytics in the Banking Industry

National Fraud Center, Inc. (2000).The Growing Global Threat ofEconomic and Cyber Crime

Newman, R. G., McNally, M. M. (2005).The U.S. Department of Justice: Identity Theft Literature Review, p. VI

DiNapoli, P. T.,& Hancox, J. S. (2001). Office of the States Comptroller: Red Flags for Fraud

Bhatla, P. T., Prabhu, V., & Dua, M. (2003). Cards Business Review # 01: Understanding Credit Card Frauds

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