Financial Update (April-June 1998)

Fraud's Impact on New Forms
of Retail Payments

F raud involving currency, checks and credit cards is estimated to cost the U.S. economy billions of dollars each year. But for these traditional payments methods, fraud has been kept at a manageable level. To succeed in the marketplace, newer forms of payment like electronic cash and stored-value cards will need to hold fraud risk to similarly low levels.

Will the risk of fraud hinder development of the new electronic payments media? To answer this question, Research Officer William Roberds first considers which features of payments methods are conducive to fraud. In an article in the Atlanta Fed's Economic Review (First Quarter 1998), Roberds explains that fraud is more likely to occur when transactions involve large dollar amounts or are made anonymously or at the point of sale, when verification is costly, and when issuers of payment claims bear the costs of fraudulent transactions.

Payments fraud, Roberds notes, usually consists of one of two types of misrepresentation. The first is an offer to exchange a claim where none exists — for example, a check written on insufficient funds. The second type occurs when a buyer offers to transfer a claim that rightfully belongs to someone else — for example, a forged check or a stolen credit card.

Roberds looks at how certain features of the new forms of payment differ from more traditional forms and whether these features will make the new methods less acceptable in the marketplace. Computer technology could make electronic payments more efficient and cheaper than traditional methods. But, Roberds points out, the natural advantages of electronic systems for storing, copying and manipulating data may be offset by the costs and other disadvantages of the complex security procedures needed to guard against the risk of fraud.

Successful payments systems, Roberds concludes, will have to confront various trade-offs posed by the risk of fraud. These trade-offs include the costs versus the benefits of fraud reduction measures, security procedures for payments systems versus consumers' desire for privacy, and encouraging development of new, more efficient payments systems versus ensuring equitable treatment of participants.

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