Key Steps to Prevent Commercial Lending Fraud

10/31/2019
Commercial Credit, Small Business Credit, Commercial Fraud Solutions

Commercial lending fraud is on the rise, and both online and traditional banks as well as credit unions are challenged with identifying, weeding out and tracking suspicious activity. As technology creates increased convenience and accessibility for customers, it also creates opportunity for criminals.

Why is this? In an effort to make SMB lending as seamless as possible, many lenders are in an all-out race to streamline and expedite the loan application process from months to days. At the same time, current procedures to check suspicious activity are often conducted manually through phone calls or site visits, which can slow down the underwriting process. 

According to a recent Aite Group report, 33% of SMB lenders estimated that more than 1% of their loans were connected to fraudulent activity. 19% identified this rate as more than 2%. Given that financial stress in the SMB lending market remains historically low, one can expect that – if financial stress rises – fraudulent activity could increase even more. 

Financial Institution Fraud Defined

Financial institution fraud is the use of illegal means to obtain money, assets, or other property owned or held by a financial institution. Different kinds of fraud include: 

  1. Known Fraud – wrongful or criminal deception intended to result in financial or personal gain.
  2. Suspicious Fraud – forms of first payment default, whether over a defined time period, such as 30 or 60 days, or a default with a material amount of loan principal unrepaid. 
  3. Suspicious Activity – an indication of activity based on various variables that is highly correlated with known or suspicious fraud. 

Fraudsters are constantly evolving their tactics to defraud banks, but some of the most common examples of irresponsible borrowing activity include:

  • Bogus businesses – loan applications from criminal organizations masking as legitimate business. According to the Aite report, bogus businesses accounted for 35% of all fraudulent activity. Such organizations have legitimate articles of incorporation or LLCs and leverage fake websites, counterfeit bank statements, and the presence of fake identities on their articles of formation. Some might even have physical locations to mask their criminal nature. As they possess legitimately obtained documentation, they can be extremely hard to identify. 
  • Fraudulent identities – different from bogus businesses, this is when criminals present themselves as the guarantor of a legitimate business under a fake or stolen identity. According to Aite, 26% of fraud was comprised of fraudulent identities. 
  • Loan stacking activity – taking out multiple loans from different online lenders simultaneously in violation of agreement terms. This accounted for 20% of fraudulent activity. The ability of criminals to commit this kind of fraud is reflective of the fact that reporting among agencies is not yet standardized and lags behind the approval process.
  • Fraudulent bank statements – again, because of the lack of a formal, governed and comprehensive reporting system – similar to that of consumer lending – SMB lenders often are reliant upon a business’s existing bank statement when performing underwriting. This gives rise to bank statement fraud.

Organizations at Risk

It’s not just traditional banks and credit unions at risk. Online lenders are particularly vulnerable to credit loss as fraudsters abuse the anonymity of the internet and customer-not-present credit processes to engage in irresponsible borrowing activity. Fraud left unchecked can impact the quality of loans provided by online lenders. Excessive fraud also could drive away providers of high-quality loans, leaving only low-quality small business credit lenders. 

And, based on the Aite report, financial institutions indicate that trends in SMB lending fraud are worsening, with 56% of institutions seeing increases in the leading kinds of fraud – those committed via bogus businesses and fraudulent identities. 

Industry-Wide Data as a Deterrent

To combat this growing issue, an industry-wide initiative is required. Lenders would benefit by pooling their data in order to learn from their collective experience about the many variations of suspicious activity. By banding together, lenders can identify and weed out constantly evolving fraudulent tactics.

Suspicious activity indicators can measure the probability of immediate loss, but to create those indicators, you need a large data set. No one lender likely has enough examples of suspicious activity in its various forms to create a robust indicator. The data needs to be collected from across the industry to create statistically valid indicators. 

PayNet, an Equifax company, has committed to developing and maintaining a robust fraud suite, which will continue to evolve based on the ever-changing landscape. PayNet has access to data from 32 million private businesses and 117 financial contracts totaling $3.8 trillion. Within that database are approximately 38,000 known frauds, suspicious frauds or suspicious activity events. More than 900 commercial credit providers contribute to the database. Additionally, PayNet has been collecting known frauds to be used for future modeling purposes. Finally, to preserve the anonymity of both those inquiring and those reporting, the sources of activities are fully masked. 

Become Part of the Collective Solution

With the right data and tools, commercial lenders can reduce and prevent loan fraud. In order to participate in our database consortium, lenders must: 

  1. Give to Get – to gain access to the tools, lenders must contribute known and suspicious frauds to the database on an ongoing basis. 
  2. Permitted Use – the suspicious activity indicator and known fraud database are to be used solely to detect suspicious activity in the originations or portfolio management processes of the lender’s operations.
  3. Data Ownership – lenders retain the ownership of their reported known and suspicious frauds data. 
  4. Proper Vetting – before any business is identified as being suspected of fraud, there will be a series of verification steps to validate accuracy of entry. 

To learn more about proactive steps you can take to become a part of the fraud data consortium, please visit PayNet at https://paynet.com/