Financial institutions have improved considerably in their ability to detect "real" credit risk, but new research from TowerGroup finds that risk managers often overlook the potential for fraud in areas other than card portfolios.
TowerGroup found that credit risk for financial institutions in the consumer lending space has exponentially increased over recent years due to factors such as identity theft, identity creation and the overall expansion of fraud "footprints" facilitated by the web. That has led financial institutions to get good marks for managing "real" credit risk, such as an individual's ability to repay credit granted or cases of insider loan fraud. Perhaps because of those successes, Tower said fraud activity is expanding into other areas.
"As the frequency and types of consumer loan fraud continue to evolve, we are seeing the emergence of fraud in secured portfolios such as home loans," said Christine Pratt, senior analyst in the Consumer Lending and Bank Cards practice at TowerGroup and author of the research.
Pratt noted that a particularly disturbing trend is the rise in real estate loans initiated by thieves using stolen identities. The dollar damages possible for institutions targeted by thieves for mortgage or home equity loans against property they don't own is staggering. "One takeaway for credit managers from TowerGroup's findings is that organizations marketing those types of products must check and double-check existing procedures and technologies to ensure that they are on alert for this type of activity, so that their customer information does not fall into the wrong hands," said Pratt.
Highlights of the research include:
* Even though fraud generally falls under the category of "operational risk," some fraud is so entwined with credit risk that it is virtually indistinguishable.
* Vigilance in managing credit risk is essential in both servicing and managing portfolios. There is no dearth of risk after the customer's loan has been approved and the information makes its way to the servicing operation. Certainly in a down market, there is a need to manage costs and provide quality processing to retain and cross-sell profitable customers.
* Credit risk in the servicing arena pales in comparison to risk in collections and recovery, where investment in technology lags all other consumer credit processes.
Pratt pointed out that some will say, "a loss is a loss is a loss. So what difference does it make if it is labeled a 'credit loss' or a 'fraud loss'?"
"Widespread misidentified fraud losses cost a financial institution on several fronts. When credit losses inflate, risk ratios grow-since credit losses cannot be insured and fraud losses can. Fraud losses pollute credit models and can inhibit prudent credit decisions by the institution. In addition, operating costs can increase as collectors spend time trying to find people who simply don't exist. This is of growing concern in the secured credit arena," said Pratt. "Knowing the enemy is critically important when it comes to planning to improve your organization's loss exposure and, ultimately, your bottom line."
