SMB lending fraud keeps growing – how can lenders protect themselves?
- Lenders of all kinds, from large banks to small community banks, credit unions, and fintechs, are hemmed in by the pressing issue of SMB lending fraud -- with fintechs continuing to experience the highest hit.
- Convenience is a staple of digital lending. And while this is valued by borrowers looking for a quick and easy application process, it also opens the door for fraud.
Lending money involves risk. And it gets even riskier when fraudsters are involved. SMB lenders experienced as high as 14.5% loan fraud between 2021 and 2022, that’s up from a 6.9% increase experienced the year prior – seeping down into their bottom lines, according to a new study by LexisNexis Risk Solutions.
Source: LexisNexis Risk Solutions
Fraud losses could make up to 15% of overall losses for the institutions surveyed. And 72% of FIs reckon that lending fraud may continue to increase over the span of the next 12 months.
The digital lending market size was valued at $10.7 billion in 2021 and is projected to reach $20.5 billion by 2026 – lending is one of the largest growing sectors within financial services. However, both consumer and business lending fraud continues to be a significant challenge facing the sector. Lenders of all kinds, from large banks to small community banks, credit unions, and fintechs, are hemmed in by this pressing issue.
Smaller banks/credit unions and fintechs in particular are easy prey for fraudulent activities stemming from their SMB lending businesses. The average value of SMB lending fraud losses as a percent of annual revenues remains higher than before the pandemic (5.5% overall), with fintechs continuing to experience the highest hit.
For startups, small businesses, and entrepreneurs, borrowing from banks hasn’t always been a smooth road. On the other hand, fintechs unbundle financial products and services, which allows fintech lenders to compete with traditional banks and other lenders in providing a range of online lending products to their customers. This is one of the reasons businesses are increasingly turning to fintech firms for loan options. The survey indicates slight increases in in-person fraud attempts but online and mobile channels are where lenders should likely be extra careful about their strategic investments for fraud screening – as fraudsters tend to gravitate toward mobile channels and online channels.
Moreover, convenience is a staple of digital lending. And fintechs often advertise their fast digital decision-making capabilities that are atypical of those of a bank. This explains why most digital lenders try to keep KYC verification checks as painless as possible. And while this is valued by borrowers looking for a quick and easy application process, it also opens the door for fraud, enabling bad actors to exploit tech susceptibilities and steal data through biometric hacking, deepfakes, and other data breaches to evade KYC checks.
However, this is an area where fintech lenders are investing and pushing the envelope as they seek more fraud screening capabilities and expertise for developing a strategy to better identify potential threats during the loan application stage. FIs that are making the grade in mitigating fraud have generally already made the required investments in multi-layered screening approaches that are adaptable among various systems and provide comprehensive risk insights, according to the report.
Identifying SMB lending fraud
Historically, lenders considered fraud as a cost of doing business and found it difficult to tell apart from credit losses. Often miscategorized as credit loss and crossed out as bad debt, this type of fraud occurs when a person misrepresents and counterfeits their identity, salary, and employment, or their financial standing on purpose just to provide false information for financial gain.
“The effort to curb SMB fraud increases with a greater understanding of what SMB fraud looks like, how fraudsters attack, how differentiated and more complex SMB fraud is than credit fraud and what it is costing them [lenders],” said Tom Hunt, director of business risk strategy at LexisNexis Risk Solutions.
SMB lending fraud v/s consumer lending fraud – which is more complicated and why?
The paucity of information makes it difficult for lenders to identify the types of business fraud they may face. Small business loan frauds are less obvious compared to consumer loan frauds because consumers generally capture the headlines of becoming fraud victims more than businesses.
But because businesses are not perceived as soft targets in the same way consumers are, does it make consumer loan fraud more complex than business loan fraud or vice versa?
Source: LexisNexis Risk Solutions
“I don’t think it [consumer lending fraud] is more complex. Consumer lending fraud has more research behind it and therefore combating it has received more investment and attention. As we develop more insights, an appreciation for the complexity of the problem grows along with it, which does not mean that the problem is more complex. We simply understand it [consumer lending fraud] better and as a result it’s perceived as more complex,” added Hunt.
On the whole, nearly 40% of FIs find SMB lending fraud more complicated than consumer lending fraud. With small business fraud, the lender is often dealing with two or more entities, the business itself and its owner(s). Each additional entity adds a layer of evaluation and complexity, according to Hunt. In addition, often small businesses do not have comprehensive profiles available in traditional commercial credit bureau sources, providing a limited background to the lender – which may add to the lending fraud complexity.
While fraud will likely continue to exist, it can be scaled down by internal controls and tools that can help FIs identify red flags and adopt strategies to tackle them to the best of their abilities.
Additionally, Hunt is of the view that sophisticated workflows that include anti-fraud tools fueled by analytics, algorithms, and artificial intelligence at every customer touchpoint including during the initial onboarding process are now widely implemented. Lenders can evaluate the business, device, behavior while on the device, people behind the business, location, documents provided, and more by using these tools during the application process.
“The final step entails applying the right analysis to those insights on an ongoing basis, which sums up the formula to enable a sophisticated workflow; workflow = tools + expertise + insights/analysis + monitoring,” he added.