How your bank can prevent commercial lending fraud in COVID-19 relief programs

Topics: Compliance, Criminal Enforcement, Financial Crime, Fraud, Government, Government Accountability Office, Government Fraud, Risk Management

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Gina Jurva of Thomson Reuters contributed to this article.

The impact of the COVID-19 pandemic on the nation’s health, economy, and even psyche has been severe. In response, the U.S. government sought to avoid further catastrophic job losses — by passing the Paycheck Protection Program (PPP) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act — as COVID-19 spread throughout the country.

Unfortunately, when large amounts of money are infused into the economy, nefarious actors are usually waiting in the wings, hoping to seize upon these opportunities. The Department of Justice (DOJ) recently announced that it had charged 57 people with trying to steal more than $175 million in PPP funds — and that is only the tip of the iceberg.

Commercial lending fraud grows

As the pandemic rages on, crime and money laundering risks continue to evolve at a rapid pace in the commercial lending space, placing the financial sector at an interesting crossroads.

The need for banks to expand their business is as much a driver for economic success as ever, while marketplace risk typologies appear to have increased exponentially. Conversely, regulatory expectations for financial institutions have become more complex and simultaneously more ambiguous as new guidance is issued for emerging risks.

Commercial lending has now been moved forward into the spotlight as one of the convergence points of credit, reputational, and financial crime risk.

How banks can prevent lending fraud

In a recent webinar, Deceptive Due Diligence: Identifying Risk in Commercial Lending, hosted by Thomson Reuters and the Association of Certified Financial Crime Specialists (ACFCS), as panelists Amanda DuPont, a public records product expert for Thomson Reuters, and Michael Schidlow, a financial crime compliance and training expert, discussed how knowing your customer can significantly reduce the risk for banks of fraud in commercial lending. The panel was moderated by Gina Jurva, Manager of Market Insights and Thought Leadership with Thomson Reuters.

Knowing your customer

Bank robbers these days are more likely to be wearing “really nice suits,” said DuPont, adding that today, sophisticated fraudsters use “fake identities and fictitious companies” and “accounting-based fraud” in order to illicitly receive millions of dollars in loans from lenders that may not be conducting adequate due diligence on borrowers.

Unfortunately, making loans to these fraudsters defeats the goal of commercial lenders to develop a “long-term and sustainable return on investment,” explained Schidlow.

DuPont agreed, saying that quite simply, “fraud cuts into profits.”

Schidlow cautioned commercial lenders that efforts to create a “pleasant onboarding experience” for the borrower and “streamline compliance” can sometimes “smooth over” problems with the borrower or the business, resulting in bad loans. Compliance should be viewed as a way to make sure business “sustainability is viable,” he added.

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Although new customers may be asked to provide collateral to secure their loans, lenders still do not always conduct adequate due diligence. However, when the lender hasn’t “fully researched what that collateral is, it’s virtually valueless,” Schidlow said.

Using technology to find red flags

In order to prevent borrowers from misrepresenting their assets as well as their businesses and personal history, banks need to have access to “source records” in real-time, said DuPont. Technology can provide lenders with the ability to verify payroll, receivables, and bills of lading rather than relying upon only customer-produced documents. Of particular importance can be simply verifying that their records “prove this company is a business,” she said, adding that many fraudsters are now “resurrecting” lapsed companies to give the appearance that the business has been active longer.

In those cases where there is no ongoing relationship with the customer, a borrower can easily overstate their worth, falsify records, understate obligations, omit critical information, or submit multiple applications as seen in the recent PPP fraud arrests. The ability for commercial lenders to readily identify these red flags in loan applications is critical to preventing fraud in lending programs such as the PPP.

The panelists highlighted several other examples of red flags, including:

  • disqualifying factors such as bankruptcy, felony convictions, or exclusions for government programs;
  • using a synthetic or fake identity when applying to hide the borrower’s background or the business’s history;
  • assuming the name of a lapsed business;
  • failing to maintain active corporate registrations with the secretary of state of in whichever state the company is incorporated;
  • interlocking connections to other questionable individuals or businesses; or
  • applying for multiple loans with multiple lenders.

Lenders can use certain technology tools to conduct “instantaneous analysis, day one,” DuPont noted, describing a recent search she conducted where her analytics uncovered a “hidden principal” who had a prior conviction for tax fraud. In this case, this due diligence helped avoid a bad loan.

In order to prevent fraud and abuse in government lending programs, lenders making commercial loans must have access to the data that will allow them to verify and assess risks from the front end of the lending process through the disbursement of funds. Without the ability to conduct verification, however, it is clear that fraudsters and schemers will take advantage of the system, resulting in millions, if not billions, of dollars that were intended to support small businesses being lost to fraud.