Author: Clari5

Money transfers are one of the most universal cash flow methods. Compared to other cross-border capital flows such as foreign direct investment or official development assistance, cross-border payments form an enormous chunk of transnational cash flow. In fact, the global payments revenue is expected to become a $2 trillion business by 2020.

Money transfer platforms have monetized the exponential growth of internet and mobile technologies and provide flexible and efficient money transfer options to individual and corporate customers who don’t have access to traditional banking or credit options. Given that money is often transferred overseas, cross border payment facilitates a process that was traditionally performed by specific agents or banks.

However, the boon has not been without a bane – the risk of fraud.

Transnational payments expose large financial institutions with global workforce and customer base to a myriad of risks. Fraudsters have been quick to capitalize on the rapid adoption of money transfer technology, exploiting systemic vulnerabilities. Without an iron-clad fraud protection, cross border payments stand to be impacted severely by fraud breaches.

Mergers and acquisitions have also been transforming the global payments landscape over time. For instance, there has been the creation of megabanks such as merger of Bank of America and NationsBank, as well as JP Morgan Chase combining Chase Manhattan Bank, Manufacturers Hanover Bank, Morgan Guaranty Trust and Bank One. In a scale-driven, technology-intensive business such as payments, the emergence of financial monoliths also brings in challenges of a different kind.

Large international banks operate their own internal global payment networks. Through these, they route payments to destinations in different countries. Such internal systems do not always differentiate between domestic and cross-border payments as these flows are within the bank.

Consolidations in the banking sector, both globally and in domestic markets, impacts payment systems. Increased concentration of payment flows has significant credit, liquidity, as well as fraud risk implications.

Global e-commerce is another factor. Nearly half of all e-commerce transactions transcend national boundaries and is the fastest-growing sector in retail. And with the growth of online merchant activity and risk from stolen identities and payment credentials, dubious business entities, cross-border payments are more likely to be suspected as fraudulent transactions.

For merchants expanding their online presence overseas, enabling locally-preferred alternative payment methods and connecting to local acquirers can be a critical success factor. However, without dovetailing a solid fraud management strategy with the payments strategy, insulating cross-border remittances from fraud can be a challenge.

While opening up transactions to new geographies securely, financial institutions must look for providers and merchants who use digital identity-based user verification and assessment solutions to get accurate data on the risks associated with all the entities they transact with.

As payments risks continue to pose a threat, it is imperative that financial institutions use certain technology best practices to insulate themselves from fraud.

Some of the measures that financial institutions can implement have as part of their overall fraud risk and compliance management framework for inward & outward cross-border payments are –

• Advanced watch list screening capabilities to screen various parties against sanctions lists, internal lists & any other custom lists (including remitter, beneficiary, participating institutions).
• KYC due diligence with frequent, periodic customer risk rating
• Intelligent real-time, cross channel transaction monitoring with pre-packaged AML / fraud scenarios and detection models that help identify unusual transaction volumes, risky jurisdictions, mule accounts, transactions inconsistent with customer profile, customers with past STR/SAR marked history and quick drainage after inward remittance.
• Machine learning driven behavioral analytics model to build usual transaction profile (across multiple dimensions such as transaction types, beneficiaries, merchants, transaction purpose)to detect anomalous transaction patterns against customer’s own past transaction history and against peer group.
• Integrated case management fora 360-degree customer view, with built-in customizable work flows and alert assignment policies to accelerate alert investigations and empower fraud investigators to focus on high priority alerts
• Leverage RPA capabilities to eliminate manual searches for internal and third-party data
• Automated reporting capability to generate regulatory filing reports to FIU agency with minimal human inputs
• Entity link analysis tool to discover hidden relationships, based on demographic profiles (to detect seemingly disparate but interrelated parties) and transaction patterns (to detect schemes such as structuring and mule account transfers)

In a heavily regulated industry, where relationships are built on trust, consistent adherence to high security levels and regional financial regulations is paramount. Leveraging advanced analytics, artificial intelligence and machine learning models at an enterprise-wide level, can help financial institutions detect cross-border payments fraud in real-time, reduce false positives and run more efficient investigations.

References

• Remittances, The Flywheel of The Global Economy
• Global Payments: A Dynamic Industry Continues to Break New Ground
• Understanding Cross-Border Remittances
• Inefficiencies of Cross-Border Payments
• Cross-Border eCommerce Expansion: A Fraud Perspective

Increasing instances of related party transactions (RPT) fraud in banks seem to be making the old ‘blood is thicker than water’ sayingtruer by the day.

Several high-profile cases in the recent past seem to be having a common thread–RPT. RPTs have also been a source of concern for regulators because of inappropriate and inadequate monitoring of RPT transactions, besides non-disclosures.

RPTs typically involve an executive who has an undisclosed financial interest in another entity. In one case, the chairman of a state retirement system ensured $65 million in pension funds was invested in a savings and loan company he partially owned. Regulators subsequently seized the S&L company and the investment was lost. The pension fund auditors had no knowledge of the connection.

RPTs often elude easy detection. In certain cases, one can cross-reference the client’s key personnel to corporate records maintained by the state in which the company was formed. If a client’s officers are also listed as officers of another corporation, a detailed check may probably reveal an RPT.

Not very long ago, an Irish bank was fined €1.4 million for issuing loans to related parties. The bank had failed to obtain necessary approvals from its related party lending committee before granting loans to related parties and extended the maturity on 12 separate occasions for 5 existing loans.

To avoid restrictions from central and federal authorities, certain financial institutions are tempted to ‘creatively’ structure entities and transactions. There are also situations where banks have to combata perception of nepotism, given high profile corporate entities and stakeholders involved.

Despite the intent to maintain clean books, certain banks hesitate to disclose RPTs partly to avoid the time and effort of regulatory scrutiny. As a result, they end up using‘innovative’ practices to keep certain RPTs off the radar.

RPTs generally tend to be higher in corporate accounts of family-run businesses. Ties are closer between the financial institution and family run businesses, but there are several instances where banks have failed to draw the line between policy/process adherence and customer relations. Also, large family-run business houses are already vulnerable to perceptions of preferential treatment by financial institutions.

The onus of not allowing conflicts of interest impair the bank’s contracts and overall governance is on the bank’s management and auditors.

Most of the admired and well-run financial institutions have a strict policy for disclosure of RPTs, are transparent about exposures and publish declarations in public domain. Proxy statements, disclosures, tax filings, insurance policies, and contracts/agreements are some of the sources which auditors use to find evidence of undisclosed related parties. Failure to disclose RPTs is actually a misstatement that should be highlighted in audit reports.

When it comes to collusion and willful economic offence, it is essential to first examine the bank’s risk management and governance framework, the nature and quantum of RPTs and indicators that differentiate genuine RPTs from potentially fraudulent ones.

Some common related party fraud examples in banks are:

1. Lending at an interest rate that is significantly below market rate
2. Granting loans with no scheduled terms of repayment
3. Non-recourse advances to shareholders
4. Issuing lines of credit to borrowers who cannot repay
5. Hastily writing off loans as uncollectible

There are more sophisticated ways of circumventing processes and controls and large frauds can lie undetected for years together in certain well-concealed scams.

Being the custodians of ‘trust’, the primary responsibility for preventing financial fraud in banks lies with the banks. While internal auditors identify potential red flags, the bank’s fraud risk assessment must include closer examination of RPTs.

Dispassionate reviews must also weigh evaluations of unusual financial trends and relationships identified from analytical procedures and techniques, keeping in mind the risk of management’s override of controls.

Banks can do more to further fortify existing processes and control for prevention and timely detection of RPT fraud. Controls should be internal, external, as well technology-based. Integrating an intelligent anti-fraud technology solution in the overall risk management framework and process helps banks monitor RPTs to detect anomalies.

A key feature of smart AI-based anti-fraud technology solutions is early warning signals, but then no one signal must be seen in isolation. It must be seen contextually with insights from across all channels across the banking enterprise. Also, the presence of signals does not necessarily mean that there actually is an incidence fraud. In the event of fraud, multiple signals appear together.

An AI-based anti-fraud technology solution already has cross-channel coverage across online, mobile, branches, alternate delivery channels and business products; real-time transaction monitoring to detect fraud during transaction authorization within the transaction window itself; entity link analysis to analyze relationships between internal and/or external attributes to detect collusive activities or misuse.

AI-based fraud detection solutions also help banks conduct fund flow analytics in real-time to detect inappropriate loan arrangements. These solutions also have sophisticated algorithms that routinely and automatically review account activities and continuously update changing customer data.

These solutions usually use a blend of AI/ML, Real-time Decisions and Automation technologies for detecting RPT fraud, namely –

• Machine Learning powered Intelligence: Predictive scoring using trained ML models, scenario/pattern discovery, pattern intelligence from cross-institutional analysis, machine intelligence from low-data density environments.
• Real-time Decisions: Real-time decisions of transactions using ML fueled intelligence and known patterns, decisions that are explainable and traceable.
• Investigation Automation: Red-flags & specific additional due diligence processes are automated using RPA, especially for decisions that need more information beyond the enterprise boundaries.

By regularly monitoring transactions, alerting suspect or anomalous transactions, and seeking timely justification for RPTs, financial institutions can control potentially massive damage. Ultimately, beyond all the audits and advanced technology, prompt and diligent scrutiny of early warning signals by the bank and acting decisively on them is by far the best deterrent for RPT fraud.

References

• Role of Related Party Transactions in Fraudulent Financial Reporting – University of Miami
• Related-Party Transactions: Think like an Auditor – OnTarget CPA
• Fraud and Related Party Transactions – Jonathan T. Marks