Who should pay for scams? Victims or their banks?

Scam call centre on CCTV, via BBC.

Here's a question for you. Should banks be required to reimburse customers who have been scammed?

I was recently reading a CBC article about a 63-year old Toronto man who responded to a phone call from a scammer claiming to be a Bank of Montreal employee, warning him that fraudsters had accessed his bank account. He was soon cajoled into paying out $16,000 to the scammer. Not only did the Bank of Montreal not reimburse the victim the full amount. It continued to charge him interest on the stolen funds.

Which isn't surprising. As the law currently stands, Canadian banks don't have to reimburse their customers who fall prey to authorized push payment (APP) fraud, a range of scams that includes calls from impersonated bank employees, RCMP scams, and fake Revenue Canada refunds.

So why not flip the whole system on its head? Why not require the Bank of Montreal to fully reimburse victims of these sorts of scams? The idea isn't without precedent. In 2024, UK will require that most victims of APP fraud be reimbursed within five business days by their bank.

There are some good arguments in favor of this policy. 

As it currently stands, individuals and their families, friends, and support systems are the main lines of defence for detecting scams. But there are big gaps in these lines of defence. Everyone has vulnerabilities, which scammers skillfully exploit to induce panic. Once in a panic, the victim's ability to think clearly is short-circuited, opening them up to being exploited by the scammer. A victim's second line of defence is to seek a second opinion from a sibling or spouse, but these third-parties may not always be available to help out the scam target.

Banks, by contrast, don't panic. Like scammers, they are cold rational machines. In addition, bank computers never turn off, which means they are available 24/7 to detect fraud. They also have a vast amount of knowledge about their clients' financial lives. Combine this data with technology like AI, and banks are in prime position to intervene in the crucial panic stage of the scam process, thus scuttling the scam.

Banks already do plenty of fraud detection. But imagine how much more vigilant they will be if their profits are at stake because they must reimburse scams.

None of this would be free, though.

Making Canadian banks liable for scams will inevitably mean higher fees and more banking frictions for everyone else. After all, reimbursing victims adds a new cost item to bank operating expenses. To recoup these costs, banks will hike fees on a range of banking products. Bankers will also want to reduce costs by catching scams in progress, which means extra checks when any irregular payment occurs, thus slowing down everyone's economic lives.

While no one likes extra bank fees and delays, think of these burdens as an alternative to the implicit costs that families, friends, communities, and civil society are already absorbing due to APP fraud. For instance, to prevent his elderly parents from being scammed, Jack tries to vet all of his parents' bank transactions. If banks are obliged to reimburse victims, Jack no longer needs to burden himself by monitoring his parents transactions; the bank will now take on that responsibility. The cost of this bank-provided anti-scam insurance comes in the form of Jack, and everyone else, paying higher fees and dealing with the odd delayed transaction.

This isn't a net loss, but a swap of one burden for another. Which is the better option for Jack and his parents? Is it more cost effective for him to monitor his parents transactions, or to pay his bank to do the job?

This gets into the problem of moral hazard. If banks insure customers against scams, then folks like Jack and his parents will become less vigilant, which means the public will be more susceptible to scam calls. However, as long as the additional vigilance brought to bear by banks more than compensates for the lost vigilance of individuals and communities, and does so at lower cost, the policy probably makes sense.

Beware, though. The policy could backfire it it unintentionally unbanks the vulnerable.

Victims of scams are vulnerable. They may be elderly, lonely, have low income, are weighed down by debt, or are working multiple energy-sapping jobs. Requiring Canadian banks to reimburse scams will make it more costly for them to service these groups. In response, banks may close the accounts of those they deem most likely to be tricked by scams. And so one of the unfortunate side effects of trying to protect the vulnerable from scams may be to actually burden them with a worse problem, no bank account.

There may be a fix for to this. Legislators may need to add a companion rule prohibiting banks from discriminating against customers on the basis of "scammability." However, keep in mind that this new rule will go on to have its own round of unintended consequences, which one hopes doesn't necessite a third rule, and a fourth one, and a...

Let's not forget the scammers, by the way, who won't sit idly by. 

Scam call centres will incorporate the new policy as a way to make their attacks even more effective. Imagine a panicked customer who is on the verge of transferring funds to the scammer. She suddenly blurts out loud: "Wait, is this a scam?" The scammer, reading off his script, pounces. "This is not a scam, ma'am, and even if it was, you live in the Canada. Your bank will cover it." The victim's worries allayed, the money is transferred, whereas without a policy of reimbursement the alarm bells in the victim's head might have been sufficient to get her to call a level-headed friend or family member for advice, likely putting an end to the scam.

In response to these tactics, banks will have to roll out their own information campaigns. Thus begins a cat and mouse game, whereby scammers adapt to banks and banks adapt to scammers, who in turn adapt to banks. But this is a cat and mouse game that has always existed, albeit with a different cast of characters, that is, scammers being pitted against individuals and communities. By changing the status quo and pitting scammers against a group that is more well-equipped for the game, bankers, we may all come out ahead.