550 – Risk Estimation
Cluster Analysis of Financial Institution Fraud: The Role of Civil Money Penalties
Sharon B. Pedersen
Niels Brock International
This paper explores risk mitigation strategy in the supervision and regulation of financial institutions. As a result of the depth and breadth of financial fraud that characterized the financial crisis, and in terms of both institutions and individuals involved, this research assesses what supervisors-regulators have learned and what their response has been to this massive disruption in both the financial and real economies.
Using a dataset compiled from the Federal Reserve's enforcement actions, we examine supervisory-regulatory typology, but focus on civil money penalties, in particular. Civil money penalties entail more than the transactions costs of additional audits; they also affect banks income statements and balance sheets, as well as financial market prices, which in turn, affect us all. We attempt to discover patterns in enforcement based on hierarchical clustering of financial institutions by type of fraudulent behavior. The resulting classification reveals two main, stable clusters: Institutions with long histories of fraud and criminal violations and large, global financial institutions across a wide range of financial activities that have high incidences of losses.