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Detecting and Preventing Loan Application Fraud with AI-Powered Online Document Verification

Jul, 22, 2021
Pavlo Sidelov

 

 

It’s a lender’s nightmare. You approve a home loan or a line of credit. A few months later, the account holder tells you someone else had taken out the loan in their name using a stolen ID. You try to track down the money, but it is long done. You contact the authorities but there’s nothing they can do to help you. So your business has to eat the loss.

Loan application fraud is no boogeyman tale. It’s a real issue faced by thousands of lenders all over the world. 

It is estimated that financial institutions lose billions of dollars yearly to this type of scheme, with synthetic identity fraud alone being responsible for over six billion dollars of credit losses. In the US alone, close to 300,000 people fall victim to credit fraud every year. And the average amount a bank can expect to lose due to a single loan fraud case is estimated to be around 6,000 USD.

With the amount of consumer debt increasing steadily over the last five years, it looks like the situation will only get worse. So lessening the negative impact of fraudulent payments should be a top priority for financial institutions.

Read this article to find out more about fraud on loan applications and how the latest trends in lending software development can help shield you and your customers from it.

What Is Loan Application Fraud? 

Loan Application Fraud Definition

Credit fraud or loan application fraud is a type of financial fraud during which the criminal takes out an illicit loan they have no intentions of ever paying off.

They can take out the loan in their own name, in which case we would label it first-party fraud. 

More commonly, however, the line of credit will be taken out in the name of a third party using faked or stolen identification documents. In this case, we will label it as third-party fraud.

Loan Application Fraud Statistics

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According to the 2021 report by the Federal Trade Commission (FTC), almost 30% of all financial fraud complaints in the US involved identity theft. This represents a 50% increase from the year before. And loan application fraud was one of the main sources of these increased complaints.

It is currently estimated that a whopping 10% of all “bad debt” held by banks in the United States is a product of credit fraud. And it’s not just payday lenders with lax identity check procedures that get defrauded. Criminals target all types of institutions, with experts estimating that first-party loan fraud accounts for 0.75%-1.50% of AAA prime bankcard and demand deposit portfolios.

Which Loan Types Are Most Susceptible to Financial Fraud in 2021?

According to the FTC, federal student loans, personal loans, and auto loans experienced the biggest rises in financial fraud last year. That being said, this year’s report revealed a general sharp increase in loan application fraud, with all types of lenders suffering more damage than the year before.

#1 Federal Student Loan (188% Increase)

Federal student loan fraud rose by a whopping 188% between 2018 and 2019. In the vast majority of cases, this was first-party fraud.

#2 Personal Loans (116% Increase)

Business and personal loan fraud rose by 116% over the same time period.

#3 Auto Loans (105% Increase)

The data also revealed a sharp increase in car loan application fraud, with auto-loan and lease fraud increasing by 105% in 12 months.

Types of Loan Application Fraud

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There are two main types of loan application fraud: first-party and third-party fraud. 

First-Party Loan Application Fraud

First-party fraud involves the criminal applying for a line of credit or a personal loan using their own legal name and documents. The criminal will then withdraw all of the money from the account and disappear without a trace.

Naturally, this method represents a high degree of risk for the fraudster as they have to voluntarily hand over their own personal data to the lender. While an unscrupulous actor could simply cross a state border and start a new life a century ago, this is borderline impossible in today’s digital world.

As a result, this method is becoming less and less popular every single year.

Third-Party Loan Application Fraud

Third-party loan fraud, on the other hand, involves receiving loans in the name of another person. To do this, the criminals can use either stolen or faked identity documents. If you want to know more about how they do this, read our article about document fraud

As we discussed in our article about payment fraud, by the time the identity theft victim notices that something is amiss, the criminal (and the money) is usually long gone. And the financial institution that issued the loan has to suffer the loss.

And because the criminals can switch to a new identity after every loan application spree, third-party application fraud can inflict a lot more damage to your business.

Synthetic Identities in Third-Party Loan Fraud

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The last few years have seen a sharp increase in the use of so-called synthetic identities in loan fraud. Explained simply, a synthetic identity is a legitimate-looking persona that is created via a combination of real and fictitious information.

SAS calls synthetic identities the “gold standard” of banking application fraud. And for a good reason. Artificial identity loan applications are notoriously difficult to spot and prevent.

Why Synthetic Identities Are Hard For Financial Institutions to Deal With?

Loan fraud using synthetic identities is harder for financial institutions to detect for a variety of reasons.

First of all, most fraud models were not created with detecting synthetic identities in mind. As a result, a reported 85-95% of all cases of synthetic identity fraud cases are not being flagged as even potentially fraudulent by traditional loan application fraud detection systems.

Secondly, as there is no actual identity theft victim, no one will alert your team about it. The account will be dealt with like a legitimate one until your team realizes what’s going on. Which can take weeks or months. Further increasing the criminal’s chances of avoiding punishment.

How Big of a Problem Is Synthetic Identity Fraud?

A report by Auriemma Consulting attributed an astonishing one fifth of all credit losses suffered by financial institutions to synthetic identity fraud. 

 

How to Prevent Loan Application Fraud

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Banks can battle fraud on loan applications in a wide variety of ways. By integrating these methods into your company’s lending software development efforts, you will make your financial institution much more resilient to credit line fraud.

In-Depth Monitoring of New Account Application Data

By maintaining a corpus of existing and closed accounts, your financial institution can look out for device fingerprints and data reuse.

Implemented as part of a rule system, this information can serve as an effective tool for loan application fraud prevention at the earliest stages.

Monitoring of Existing Accounts For Suspicious Activity Patterns

A financial institution’s loan application fraud detection efforts should not just focus on new applications. Identifying cases of fraud in already-issued loans is key when it comes to minimizing your fraud losses.

Here are a few suspicious patterns you need to look out for:

  • An account that uses up its credit lines shortly after it is created.
  • Accounts with a dormancy period followed by a sudden increase in transaction frequency.
  • Several accounts making payments to the same merchant from one device (via device fingerprinting).
  • An account whose data points match those seen on high-risk accounts.
  • Payments to merchants that seemingly have no plausible connection to the account holder (e.g. 18-year-old male from a small town in Kansas paying for ESL English lessons in Curaçao).

Identity Verification Tests to Prevent Loan Account Fraud

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There are a variety of third-party identity tools and methods that can greatly improve your security systems. Using a combination of them can help your financial institution lower its risks of getting defrauded.

Identity Verification Testing

The most common, widely used loan fraud detection method is identity verification testing. This can come in a wide variety of forms.

You may ask the user to verify their identity via a real-time selfie or have one of your representatives call them.

The most common way of identity verification testing, however, are personal questions the answers to which only the client can know.

The main downside to identity verification testing is that it invariably introduces friction into the banking process and a frustrated client may elect to take their business elsewhere.

Identity Verification with Enriched Data Collection

As we mentioned in our article on CNP fraud prevention, data enrichment is one of the most effective tools for detecting fraudulent financial activity. Data enrichment solutions can take the information you already have about your client and use sophisticated algorithms to gain additional data about the account holder.

If your client is a real person, the service will find a lot of additional information about them (no matter how “off-grid” they are). Your security system can then use this enriched information to better assess the risk associated with the client. If the client’s name appears in registers of known payment dodgers or databases of stolen IDs, your team can decide on a course of further action.

On the other hand, if the system can’t find any (or can only find minimal) information about the account holder, you are likely dealing with a case of synthetic identity fraud.

Machine Learning-Based Document Verification

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One of the most exciting new developments in the field of preventing finfraud is AI-powered document verification. While criminals have found clever ways to bypass traditional identity document verification methods, AI-powered tools are much more difficult to fool. 

A properly configured AI-powered document verification tool can:

  • Recognize ID documents from various countries of territories.
  • Run a near-instant check for document inconsistencies.
  • Accurately recognize biometric data using state-of-the-art facial recognition.
  • Detect the use of deep fakes, masks, and other face alteration methods.

AI-Powered Online Document Verification by SDK.finance

We are proud to say that one of the best loan application fraud detection solutions was developed by our very own team of security and artificial intelligence experts.

The SDK.finance AI-Powered Document Verification Solution is a state-of-the-art solution that was designed to give financial institutions an easy-to-use, cost-effective method of loan application fraud prevention.

Our system was trained on a gigantic ID database that allows it to accurately recognize and detect anomalies in over 1,000 different types of identification documents (from passports and ID cards to bank statements and COVID-19 passports) from over 200 countries.

It has in-depth knowledge of all document safety systems, including those unreadable to humans, such as microprint and machine-readable zone code.

  Our system features an advanced digital document tampering detection system that checks every pixel of the photo for signs of manipulation. This means that it can’t be fooled by even the most masterful Photoshop experts. 

The system can also automatically extract the image file’s metadata. This allows it to see if the file was modified and which tools were used to manipulate it.

Final Words

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Fraudulent loans are responsible for an astonishing 20% of all bad credit held by banks and other types of financial institutions. A single fraudulent loan costs the lender an average of 6,000 USD. Today’s fraudsters are much more technologically sophisticated than those of yesteryear and routinely use deep fakes and advanced image editing techniques.

Having quality loan application fraud detection measures in place is paramount for every financial institution.

Proper in-house security techniques and third-party AI-based solutions can protect financial institutions and their clients from the negative impact of fraud on loan applications.

AI-Powered Online Document Verification by SDK.finance

If you want to protect your financial institution from the threat of loan application fraud, then SDK.finance’s ML-based fraud prevention and document verification solutions are a perfect fit for you.

Contact us to learn more about the many ways in which SDK.finance can help shield your business from financial fraud.

 

FAQ

Which Loan Types Are Most Susceptible to Financial Fraud in 2021?

According to the FTC, federal student loans, personal loans, and auto loans experienced the biggest rises in financial fraud last year. That being said, this year’s report revealed a general sharp increase in loan application fraud, with all types of lenders suffering more damage than the year before.

#1 Federal Student Loan (188% Increase)

Federal student loan fraud rose by a whopping 188% between 2018 and 2019. In the vast majority of cases, this was first-party fraud.

#2 Personal Loans (116% Increase)

Business and personal loan fraud rose by 116% over the same time period.

#3 Auto Loans (105% Increase)

The data also revealed a sharp increase in car loan application fraud, with auto-loan and lease fraud increasing by 105% in 12 months.

What Is Loan Application Fraud? 

Loan Application Fraud Definition

Credit fraud or loan application fraud is a type of financial fraud during which the criminal takes out an illicit loan they have no intentions of ever paying off.
They can take out the loan in their own name, in which case we would label it first-party fraud. 

More commonly, however, the line of credit will be taken out in the name of a third party using faked or stolen identification documents. In this case, we will label it as third-party fraud.

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