The past year has brought a wave of federal deregulation across financial services. We have seen a defanged and depopulated Consumer Financial Protection Bureau (CFPB), an executive order curbing state regulation of AI, and the ending of fair lending disparate impact enforcement. This regulatory retreat likely has lowered compliance costs, but it also has increased fraud risks.
Increasing Risk Tolerance leads to greater fraud exposure for financial institutions
We have seen this game played out before.
In the 1980s, states deregulated the savings and loan (“S&L”) industry, allowing thrifts to pursue far riskier activities like commercial real estate lending. With fewer eyes watching the industry, self-dealing and high-risk behavior spiked, eventually costing taxpayers over $160 billion.
Similarly, in the early 2000s, prior to the Great Recession, the mortgage industry operated in a low-regulation environment that enabled rampant fraud. Low-documentation and so-called “liar’s loans” (where originators forged income documents) became common. Suspicious Activity Reports filed by depository institutions, a strong indicator of fraud, more than doubled between 2003 and 2007 (from 288,000 to 649,000). The energy industry told a similar story: deregulation contributed to the Enron scandal.
History suggests that financial deregulation creates a favorable environment for fraud. Deregulation emboldens edge-riders to push the envelope on business practices. Knowing there is no cop on the beat, these players will pursue dicey activities exposing the entire industry to risk. Deregulation also incentivizes companies to deprioritize compliance, leading to greater vulnerability to fraud. Fraudsters thrive in this atmosphere as they know the government is not looking, and companies’ attention is focused elsewhere.
Why financial institutions should invest in fraud detection during deregulation
Today’s lenders should seriously look at their fraud exposure. A period of deregulation is exactly when lenders should increase their investments in anti-fraud tools. Consider the vectors fraudsters could plan to attack your company. If your services are consumer facing, audit every consumer touchpoint for identity theft, forged documents, and third-party fraud.
Maintaining a strong commitment to compliance
Companies seeking to minimize fraud also should continue investing in compliance:
- A strong compliance culture protects against internal fraud risks:
- Training: Mitigates inadvertent legal violations
- Product Feedback: Leads to safer, more resilient product designs
- Monitoring: Acts as a barrier against internal bad actors
- Some regulations help mitigate third-party fraud risk: Rules like KYC, the Red Flag Rule, and the FTC Safeguards Rule aren’t just red tape—they are essential fraud barriers. By following these rules, companies put barriers in front of bad actors.
- Compliance improves operational awareness and early fraud detection: Effective compliance improves a company’s awareness of its own operations and threat landscape. As part of Informed’s model governance, we carefully monitor and track our data and models. Familiarity with data and systems enables earlier detection of anomalies and other indicators of fraud, helping financial institutions reduce fraud damages.
Conclusion
History proves that when regulation thins, fraud thrives. Financial institutions must pivot now—treating robust compliance and fraud detection not as overhead, but as the only thing keeping them off the wrong end of the seesaw.
