This is the second part of a series that discusses financial fraud.
Fraud risk is a form of operational risk and can cause an organization financial and reputational damage, which could lead to regulatory action. Consequences of fraud include:
- Financial Impact: Fraud can result in monetary losses which could affect the organization’s health.
- Reputational Damage: Fraud events can lead to loss of customer trust and loyalty and rebuilding that trust would require significant effort and investment.
- Regulatory Consequences: Failing to prevent fraud can lead to regulatory penalties.
A Fraud Risk Management Framework (FRMF) is a structured approach that organizations use to identify, assess, prevent, detect, and respond to fraud risks. It helps ensure that fraud risk is managed proactively and systematically, rather than reactively or informally. The framework includes identifying the three lines of defense.
First Line of Defense
- The first line of defense is fraud prevention, detection and response
- The first line of defense documents fraud risk, corrective action plans, and the fraud reports.
Second Line of Defense
- The second line of defense includes policies, testing, monitoring, oversight responsibilities, and communication with regulators.
- The second line of defense determines the organization’s fraud risk, ensures compliance with relevant regulations, and sends reports to senior management.
Third Line of Defense
- The third line of defense includes independent assurance and testing.
- The audit is an independent review that determines the reliability of the process. It can identify any areas that were overlooked, or that require improvement.
All three lines of defense should stay up to date with the latest fraud issues. This is done through reporting, taxonomy, training, policies and procedures, internal audits and risk assessments. The fraud risk assessment identifies the risks/organizational weaknesses, which reduces the risk of fraud before it occurs:
- Data analytics is used to efficiently identify unusual transactions or patterns that could indicate fraudulent activity.
- Process mapping detects weaknesses in controls and workflows within an organization.
- Scenario analysis helps identify risks that have a low probability but have a chance of severe losses.
- Forensic accounting analyzes financial records for anomalies and inaccurate data that might indicate fraud.
- Employee surveys use the knowledge of internal subject matter experts to identify areas susceptible to fraud.
- Reviewing complaints can provide valuable insights into emerging fraud trends and areas needing mitigation.
Fraud risks that should be reviewed during the risk assessment can include transactional fraud, origination fraud, operational process fraud, seasonal fraud, and first-party transaction fraud. (Read about categories of fraud here)
- Transactional Fraud
- Has four dimensions: customer, jurisdiction, product, and channel. Understanding the risks posed for each dimension is required to limiting exposure.
- Origination fraud
- Occurs with applying for a new line of credit. It could be a criminal using stolen information, or it could be a customer misrepresenting information.
- Operational process fraud
- The exploitation of an organization’s systems or controls, which typically occurs with inadequate controls or lack of oversight. The results could be embezzlement, falsifying records, and unauthorized transactions.
- Seasonal fraud
- Occurs during holiday and back-to-school periods when there is a typical surge in online purchases as well as during tax season periods.
- First-party transaction fraud
- When a person intentionally misrepresents themselves or their intentions to gain financial or other benefits.
Financial fraud is an ongoing risk, but awareness and proactive action can make all the difference. Stay informed, stay cautious, and protect what matters most.
To learn more about combating fraud with SAS Fraud Detection, see https://www.sas.com/en_us/software/fraud-decisioning.html
Find more articles from SAS Global Enablement and Learning here.
