Loans are one of the most effective ways to generate revenue for your financial institution, but fraud can quickly erode this revenue source. Unfortunately, loan fraud is on the rise, and small business lending, in particular, poses a risk to banks.
To protect your financial institution, you need to be aware of the risks and implement a strategy to reduce them. Here’s an overview of the essentials.
Types of Loan Fraud
Loan fraud comes in a variety of forms, and the risks vary between online and in-person applications as well as between business and personal loans. Here are the most common types of fraud:
Thieves use stolen identities to take out loans. Then, they take the funds and disappear before the victim reports the issue to the lender. You need robust identity verification methods to minimize this risk.
Additionally, when dealing with loan requests from existing customers, you need to ensure that the request aligns with their usual behavior. For example, if someone with a dormant account contacts you about a loan, you will need to verify their identity more carefully than someone who’s applying for a car loan two months after paying off their last car loan.
There is a lot of overlap with different types of loan fraud. With application fraud, the fraudster may submit an application with a stolen identity. They may use a mixture of real and made-up details, such as putting their real employer but inflating their income. In some cases, they may add a co-signer without their permission.
False Documents or Asset Misrepresentation
Thieves can easily create fake documents when applying for loans. This can include fake business formation documents, falsified bookkeeping records, or a whole host of other documents. In some cases, they may also overstate the value of assets that they want to use as collateral or they may try to take out loans against assets that have liens against them.
To minimize the risks, you need to look over all documents very carefully and take steps to verify them with the entity that issued them. You also need to get proof of assets and insist on independent appraisals as necessary.
This type of lending fraud requires an applicant and a bank employee. The applicant presents inaccurate information on their application, and the employee falsely affirms that they have verified the information. Then, the applicant gets a larger loan than they can afford.
With this type of fraud, the applicant won’t necessarily take the money and run. Instead, they will usually try to make payments. However, they have a higher risk of default, which puts your financial institution at risk. Also, once someone lies once and gets away with it, they may be tempted to do it over and over again. That also makes your bank vulnerable.
To minimize your risk, hire your employees carefully and cultivate a corporate culture of trust. Also segregate duties and audit loan officer activities regularly to look for signs of fraud.
Remember, that seemingly honest people often commit fraud — they only need three things: opportunity, justification, and motivation. The motivation is helping their friend get a loan, and they may even take a kickback if they do this on a regular basis. The justification is that their friend is going to repay the loan so they convince themselves that a “little white lie” on the application won’t hurt. With those two other elements easy to establish, you need to ensure that your employees don’t get the opportunity to commit fraud.
This can happen when a legitimate borrower takes out a loan, but then, a fraudster tricks the bank to direct the money to their account.
To give you an example, imagine that your bank approves Mary Smith for a large business loan. A fraudster sends an email to the loan officer, pretending to be Mary Smith and asking the bank to send the money to a different account. Your employee doesn’t verify the authenticity of the sender, and they send the funds to the wrong account.
Your employees need to be aware of the risk of phishing scams or these types of messages. They should know how to check that an email address is correct. However, this type of education is not foolproof.
If a fraudster hacks Mary Smith’s email and sends a message directly from her account, that is impossible for your employees to detect. To minimize this risk, you need very strict protocols on which communication methods your employees should use with borrowers. You should also have rules about changing the account for loan proceeds.
How to Reduce Your Risk of Loan Fraud
To minimize the risks of loan fraud at your financial institution, keep the following tips in mind:
- Be proactive — It’s cheaper and easier to stop fraud than it is to mitigate losses. This is especially true when you’re dealing with high-balance loan fraud such as mortgage fraud.
- Use robust identity verification tools — For example, when verifying identities online, consider using cameras that match someone’s face to the photo on their ID.
- Invest in signature verification tools — Use automated signature verification tools to compare the signature on the borrower’s loan application with the signature on their ID or in your bank’s database.
- Educate your employees about the risk — Your employees are the first line of defense in your fight against fraud. Make sure they’re aware of this fraud risk and the red flags of loan fraud.
- Monitor all customer interactions with your bank — If someone takes over your customer’s account and then applies for a loan or credit card, the application may seem totally legitimate. To spot the fraud, you can’t just look at the loan application. Instead, you need to be paying attention to the things that happen before the loan gets taken out. In particular, you need to pay attention to strings of actions that seem fine on their own but are suspicious when they occur together. For example, signing into an account from a different IP address and changing the email address on the account.
To get help protecting your financial institution from fraud, contact us today. At SQN Banking Systems, we focus on fraud so that our clients can focus on all of the other aspects of running a successful bank.