Fraud Risk: Guide to Protect Against Fraud Threats

The importance of fraud risk management can be understood with a cursory glance at the estimated revenue loss of US $5 trillion globally to frauds, according to a report by the Association of Certified Fraud Experts (CFE). This alarming statistic highlights the importance of fraud risk for individuals and organizations that lose over 5% of their revenue to fraud.

The rampant nature of scams has made fraud risk management a critical element to safeguard oneself and businesses from these activities.

Before we discuss how to protect ourselves from fraud threats, let’s first understand fraud risk, its different types, and the risk factors.

What is Fraud Risk?

Fraud, in the simplest possible definition, is any activity that relies on deception to achieve a gain. Fraud Risk is the potential exposure to deceptive or dishonest activities. This could lead to financial damages, reputational harm, legal consequences, or a combination.

‘Fraud risk’ can be applied to all spheres of life—personal or professional, individual or organizational, etc. Understanding fraud risk is pivotal to devising strategies to mitigate its impact through prevention or resolution.

Fraud threats don’t necessarily have to come from external factors such as fraudsters; internal entities, such as disgruntled current employees, agencies or contractors, management, and so on can also cause them.

Now that we have familiarized ourselves with fraud risk let’s explore the types of fraud in depth.

Types of Frauds

According to the Association of Certified Fraud Examiners, fraud can be categorized as individual or organizational. As the names suggest, individual frauds affect a specific person, while organizational frauds affect businesses or large organizations.

Organizational fraud can be further broken down into internal and external frauds. Let’s understand these with examples:

Internal Frauds

In internal fraud, the perpetrator is either an employee of the organization who is the target of the fraudulent activity or somebody associated with it. Internal fraud risks include, but are not limited to:

1.1) Asset Misappropriation: A fraud risk where an employee steals or misuses the organization's assets, such as cash, inventory, or property. For example, an employee creates fake checks or alters amounts and encashes them. Another example could be employees selling office supplies for personal gain.

1.2) Corruption: A fraud risk where an employee exploits their position for personal gain, typically through bribery or kickbacks. A typical example of corruption would be employees accepting bribes or a portion of the deal value to award contracts to a specific vendor or an employee. It also includes an employee with decision-making power to favorably work with a company they have a personal stake in without disclosing conflict of interest.

1.3) Financial Statement Fraud: A fraud threat where employees present a misleading picture of the organization’s financial health by manipulating financial records. Primarily done by senior accountants or people in the management, these could include employees overstating the value of their assets or underreporting the company’s liabilities.

1.4) Data or Intellectual Property Fraud: Stealing of confidential data, trade secrets, or intellectual property to benefit a competitor or personal use. Disclosing or selling of sensitive data such as new product designs or customer lists to a third party is a class case of data or IP fraud.

External Frauds

Any scam committed against an organization by perpetrators from outside its ecosystem is counted as external fraud. These also include frauds done by external individuals or groups with the help of the organization’s employees.

There are various scams and schemes that organizations can fall victim to, such as:

2.1) Payment Fraud: This scam involves deceitful transactions in order to divert funds or acquire goods/services without paying, such as a criminal using stolen credit card details to make fraudulent purchases.

2.2) Identity Fraud: A type of theft where someone uses another’s personal information for financial gain or to access sensitive data. An example of this would be impersonating another individual to make purchases or apply for a loan.

2.3) Vendor Fraud: A fraud risk where the company’s financial department is deceived into making payments without full or any delivery of goods or services. It could include sending incomplete shipments but charging for the whole order.

2.4) Cybercrime and Hacking: Criminal activities carried out digitally, aimed to steal data or cause financial losses. For example fraudsters logging into a company’s system through unauthorized access to gain employees’ sensitive information.

These are just a few examples of fraud threats. Identifying different types of external or internal frauds can help organizations take proactive measures to protect themselves from these risks.

Industries Susceptible To Fraud Risks

Some industries are more susceptible to fraud than others. According to data from ACFE’s report - ‘Occupational Fraud 2024 - A Report to the Nations’, Banking and Financial services is the sector experiencing the highest incidence of frauds.

The financial services industry faces a high risk of fraud due to the nature of its operations and the sensitive information it handles. According to the Association of Certified Fraud Examiners (ACFE), financial institutions account for 16.8% of all reported fraud cases.

The most affected industries as per the ACFE report are:

1. Banking and financial services
2. Manufacturing
3. Government and public administration
4. Healthcare

Fraud Risk Management - A Complete Guide

The process of fraud risk management includes identifying, understanding, and responding to fraud risks in an organization. A comprehensive fraud risk management program for businesses involves detection of frauds and preventing both external as well as internal frauds.

The five principles of fraud risk management provide structure in an organization’s fight against frauds and safeguard itself from them. These are:

1. Fraud Risk Governance

Fraud risk governance encompasses an entire structure of best practices and processes to manage frauds in a company. Each element of fraud risk governance policies needs to be well documented and easily accessible.

Fraud risk governance includes increasing fraud awareness among employees, ensuring following best practices, continuous risk monitoring, research on fraud prevention, and detailed fraud investigation processes.

2. Fraud Risk Assessment

The process of identifying risks and their impact is the basis of fraud risk assessment. It can be done by implementing the following steps:

• Understand the organization’s top risks
• Reviewing existing risk control measures to ensure their efficacy
• Identification of risks and vulnerabilities including frauds that could be potentially harmful in the future
• Integrating fraud risk strategy across all departments by driving coordination and transparency

3. Fraud Risk Prevention

Fraud prevention can be done after devising the governance policy and assessment strategy. Implementing procedures, policies, and control measures help organizations to reduce the chance or completely preventing frauds. Focus needs to be given to mitigate all aspects of the fraud triangle:

• Motivation - Understanding the incentives that encourage people to commit fraud
• Rationalization - Knowing how fraudsters justify committing scams against businesses
• Opportunity - Analyzing the ease of committing fraud without getting caught

4. Fraud Risk Detection

While fully preventing frauds is nearly impossible, ensuring proper mechanisms are in place to detect frauds helps an organization reduce its exposure. Data analysis, mining, monitoring anomalies, etc. are common processes to detect risks. Tips, however, are the most common method as per ACFE, with around 42% of the frauds being detected by this method.

5. Fraud Risk Monitoring and Reporting

Organizations that deploy a robust mechanism to report frauds such as anonymous channels, encouraging a culture of transparency, and fraud education are ones that are able to mitigate risks of deception in the best possible manner. Regular monitoring of existing processes and consistently improving on them in the rapidly changing world ensures businesses safeguard themselves by staying on top of fraudsters.

How Artificial Intelligence (AI) Can Help Mitigate Fraud Risks

Organizations, especially big companies, deal with huge volumes of data, which may not be possible for humans to monitor, analyze, and identify anomalies constantly. Sophisticated artificial intelligence (AI) systems can help businesses mitigate fraud in a fraction of the time and cost.

AI fraud risk prevention is using a group of algorithms to identify and prevent fraud through real-time data analysis, detecting anomalies or unusual patterns, and predicting threats. Implementing AI fraud prevention techniques can help detect various fraud types, such as card fraud, identity fraud, and illegal access.

Benefits Of Using AI In Fraud Risk Management

Using artificial intelligence to manage fraud risks can be hugely beneficial for organizations as it helps with:

1. Real-time detection through its dynamic nature and speed
2. Continuous improvement through data analysis and communication with systems
3. Opening up employee bandwidth to focus on strategic decisions, leaving cumbersome tasks to algo-based analysis

Risks Of Using AI In Fraud Risk Management

Like all techniques, while Artificial Intelligence has huge benefits, there are certain risks associated with using it:

1. As AI examines huge amounts of data, it creates a black box situation where understanding how it works can be difficult
2. It is impossible to eliminate false positives, even with the most robust AI software
3. Detection of manual threats such as social fraud, phishing, etc., from internal and external sources

How Arya AI Can Help With Fraud Risk Management

Arya AI is focused on managing fraud risks at a granular level. Our AI-driven solutions are especially tailored for banking, insurance, and financial services.

Arya AI offers the Smart Onboarding feature, which frees organizations’ bandwidth to focus on driving revenue growth and strategic initiatives. It also helps optimize the customer conversion funnel and guard businesses against fraud.

Our robust machine learning and AI algorithms help us identify deepfakes. The dedicated deepfake detection API allows one to combat identity fraud and counter disinformation and fake news.

One of the biggest challenges in the financial industry is detecting document fraud. Leveraging advanced AI, our intelligent document processing solutions can effectively identify forgeries, enabling companies to prevent fraud and safeguard their operations.