From False Identities To Phony Companies To ...

By Ray Birch

BOSTON—As credit unions compete more aggressively for small business loans, one expert believes many are moving too quickly and not paying attention to risk from fraudsters who are increasing their attacks in the space.

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He said crooks are creating false identities and phony companies to secure loans from lenders without ever intending to make even one payment.

“Small business lending is an emerging target for crooks,” said David O’Connell, senior analyst at Aite Group.

O’Connell told there has been limited data related to small business lending fraud, which is why he recently completed a study on the subject in partnership with the Small Business Financial Exchange.

A Knowledge Gap

“There really has been a knowledge gap here, within financial services, regarding small business fraud,” he said.

O’Connell said the study of 42 financial institutions revealed 33% of respondents said more than 1% of their small business loans were connected to fraudulent activity.

“While that finding, at first glance, may not seem like a super sexy headline, when you reflect upon it is actually kind of a big deal,” he said. “It’s an issue for two reasons. First, all of a sudden you have discovered a new source of loss, and it’s hitting 1% of your portfolio. That is a big deal in banking, because you have to set aside capital for it.”

The second big problem: the loan loss here is 100%.

“It’s not like a loss due to a borrower defaulting on a car or mortgage loan, for example,” explained O’Connell. “In those cases there is collateral that can soften the blow, and likely several payments have been received. But here the crook gets the loan and runs off with it all.”

Going to Get Worse

O’Connell said another reason for concern is crime within commercial lending is growing in good economic times.

“If financial institutions are telling me they are getting this much of this type of fraud in a good economic environment, it means we're going to see much more of this fraud shifting to small business if the economy starts turning downward,” he said. “If people are telling me that 1% of their losses are happening during sunny days, it's going to get a lot worse on rainy days.”

Contributing to the Risk

The growth in small business loan fraud is happening, asserted O’Connell, as lenders race to speed their approval processes, potentially taking shortcuts, in a business line that requires a great deal of borrower scrutiny.

“Small business lending is a growing area. We have too many institutions chasing too few deals, and the way to get the deals, many lenders believe, is to minimize friction for the borrower,” said O’Connell, who added criminals are very aware of this trend.

Lenders are under pressure, O’Connell asserted, to close more small business loan deals.

“They are under pressure to underwrite them more quickly and crooks know that often fairly junior underwriters are involved and not enough time is being spent on these loans,” he said. “They know their fraud tactics will often get past these lenders that are hell-bent on process friction reduction.”

Fraud Strategies

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David O’Connell

Criminals are taking a number of approaches to commit their small business lending crimes, explained O’Connell.

“About 35% of this fraud looks like it's attributable to what I call bogus businesses,” he explained. “A bogus business is a criminal enterprise that possesses legitimate articles of incorporation but whose sole purpose is committing lending fraud. Think of it being like a synthetic identity for people, but it's actually not synthetic because a synthetic ID is not associated with an actual being. These bogus businesses actually have legitimate paper—they actually exist technically, even though they do not operate as a business.”

Masquerade Game

The next biggest tactic, according to O’Connell’s study, is criminals masquerading as a guarantor or principal of a legitimate business for the purpose of committing fraud.

“That’s 26%,” he said. “And then 20% of respondents said they have seen loan stacking. Loan stacking is when a criminal enterprise, on behalf of a business, applies for credit multiple times with multiple lenders, nearly simultaneously. So within 15 minutes they submit multiple loan apps.”

O’Connell explained when fraudsters commit their crimes they falsify bank statements they submit which reflect the performance of their company.

“Creating an entirely counterfeit bank statement is one approach,” said O’Connell. “You deposit $50 in a bank just to get an account and a statement, and then once you receive your first bank statement you know how to recreate a phony one. It’s like a kid creating a fake ID in college, they get a legitimate ID and work from there.”

Tampering With Statements

What is also happening, said O’Connell, is legitimate businesses under stress are tampering with portions of bank statements to hide problems within the company.

“They can change revenue numbers to make the company appear bigger than it is,” he said. “There are also crimes of omission. Let's say your business is having some kind of operational problems, and it’s reflected by customer returns on the bank statement. All of your returns, which are reversals of revenue, you intentionally book in the third week of the month. Then what you do is submit the bank statement with the credit application and leave out the single page that contains all of the reversals.”

What credit unions and all lenders need must do to address the growing threat, said O’Connell, is slow down their small business lending process and conduct additional due diligence.

Do the Basics

“Do the basics that you have always done when evaluating a small business. Underwrite carefully. And at the same time be on the lookout for signs the borrower could be a criminal,” he said.

That might mean paying closer attention to the borrower’s website, their email addresses, and more.

“Bottom line, crooks will tend not to look and behave like regular, legitimate people and businesses,” he said. “It’s hard to create a good fake website, so look there. It’s harder to fake a website than it is a false bank statement. And pay attention to email addresses. Real people use real email addresses like Criminals use kind of sexy email addresses. Real people have email addresses that have been in place 15 years. Criminals tend to use email addresses that have not been open for that long.”

O’Connell said lenders can also use vendors, such as Microbilt and Ocrolus, which can closely examine bank statements and bank data to make sure information is legitimate.

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Copyright Year: 2019
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