Lenders must be vigilant on fraud, FSA warns
Published: 29 June 2011 | Author: Bernard Clarke
Lenders have made good progress in getting to grips with mortgage fraud, according to the Financial Services Authority (FSA). The ability of firms to protect themselves from criminal activity has improved, and lenders have developed a better understanding of the benefits of co-operating with each other – and with other professions working in housing and mortgage markets – to deter and detect fraud.
But although the FSA recognises the progress made by firms, it has also identified a number of areas in which improvements could be made. The FSA’s comments were made in a 'thematic review' of lenders’ systems and controls for detecting and preventing mortgage fraud, published earlier this month.
The review notes that in January this year the National Fraud Authority estimated the cost of mortgage fraud in the UK at £1 billion. Fraud extends from a stretched borrower misleading a lender to obtain a loan, to organised criminal rings seeking to defraud lenders systematically with the help of corrupt intermediaries, solicitors and valuers.
In theory, lenders act out of self-interest to reduce losses from fraud. But the desire to obtain new business and control processing costs can inadvertently expose a lender to fraud risk.
We will work with lenders and the regulator on continuing to address any areas of weakness that could undermine the effectiveness of firms and their ability to ensure that any risk of fraud is detected before it results in losses.
Areas in which we will be working with FSA to help firms protect themselves include helping ensure that:
- senior managers are addressing the right issues, and firms are making the best use of management information;
- lenders recognise the importance of sharing information about fraud and suspected criminal behaviour with other lenders and industry professionals;
- lenders manage effectively their relationships with other firms and individuals providing services for them, where these may be a potential source of fraudulent activity;
- firms prioritise training and competence on fraud prevention and detection, and reinforce this in the way staff are rewarded.
The FSA’s review highlights examples of good and poor practice that provide guidance for lenders in dealing with different types of criminal activity. We will be working with lenders to help them put this guidance into practice.
The regulator’s findings
Findings in the FSA’s review were based on visits to 20 lenders, over a 10-month period up to February this year. Visits were made to a variety of different types and size of firms, together accounting for more than half of mortgage lending last year. The review contains useful information for lenders on:
- the governance and culture of firms, including their attitudes to, and effectiveness in, sharing useful information;
- how firms process and underwrite mortgage applications, and whether their practices in these areas expose them to fraud;
- how firms prevent, investigate and recover losses from fraud;
- how firms manage relationships with solicitors, brokers, valuers and other professionals they work with in the housing market, and whether this exposes them to criminal activity;
- ways in which firms oversee internal compliance with measures to combat fraud and internally audit their processes; and
- how firms recruit and vet staff, and ways in which training and pay structures can help in fraud prevention.
Governance and information-sharing
The FSA acknowledges that lenders are becoming more aware of the benefits of sharing information about suspected fraud across the whole industry. It is, however, concerned that some firms are not fully engaged in this, and in particular with the regulator’s ‘information from lenders’ scheme.
The ‘information from lenders’ scheme was launched in 2007 following discussions between us and the FSA. It provides a mechanism for lenders to report voluntarily cases of proven or suspected fraud. We encourage lenders to participate in the scheme.
Individual lenders may receive mortgage applications that arouse suspicion or have concerns about individual solicitors, brokers, valuers or firms they have worked with in the property industry. Such suspicions may be well-founded enough to decline an application but insufficient to lead to a successful prosecution.
However, reporting suspicions to the FSA through the ‘information from lenders’ initiative allows the regulator to pool information from a variety of sources, putting together bits of information like pieces in a jigsaw to get a clearer picture of criminal activity. Sometimes this can yield enough evidence for a successful prosecution – even though no single lender has enough information to act upon.
The FSA says many lenders have good teams of front line specialists to combat mortgage fraud, but need stronger management support. The review highlights concerns that a lack of the right type of management information sometimes means that senior managers do not have an adequate understanding of the risks associated with fraudulent activity. Partly, the FSA believes, this may be because mortgage fraud is not properly identified, with some criminal activity misclassified as, for example, credit losses.
Mortgage processing and underwriting
The review highlights that applying effective fraud control measures to mortgage application and underwriting processes can be an important first line of defence for lenders. But it also identifies a series of potential weaknesses in these areas including:
- a potential conflict between requiring staff who are motivated (and rewarded) by the volume of sales they generate also to act as ‘gatekeepers,’ looking out for applications that may be problematic or require more robust scrutiny;
- underwriting staff who have been given flexibility to approve loans falling outside the firm’s standard lending policy;
- a lack of experience or awareness of fraud issues among some underwriting staff; and
- the need for adequate controls against fraud for loans that may be ‘fast tracked’ through a lender’s application process because they fall comfortably within lending criteria.
Staff who have direct contact with customers can be helpful in detecting fraudulent applications based on inflated income. But these staff may also be exploited by intermediaries, particularly if, in explaining to an applicant why a mortgage has been rejected, they pass on information that could help someone to submit a fraudulent application that is more likely to get through a lender’s systems undetected.
Other weaknesses in the application process include requirements imposed by lenders on staff to process mortgage applications quickly. An increase in business volumes may also expose a lender to a greater risk of fraud if resources for processing applications are not increased.
Relationships with property industry professionals
The FSA urges firms to recognise that other professionals working with lenders in the property industry may pose a risk. To guard against this, it urges that managing third-party relationships should be centralised. Lenders need to manage relationships rigorously, with vetting processes that go beyond merely checking registration with the appropriate professional body or, in the case of an intermediary, with the FSA.
The FSA makes a number of specific recommendations about how lenders work with solicitors, brokers and valuers. It recommends, for example, that firms ensure they follow up with the Land Registry to verify that a solicitor has a registered charge over the property. Lenders should also take steps to verify that funds are disbursed according to their instructions.
Other measures the FSA recommends include checking to ensure that intermediaries cannot ‘game’ their processes by re-submitting failed applications with amended details to ensure the new loan now fits the firm’s lending criteria. It also recommends that lenders have processes for verifying property valuations carried out on their behalf.
All processes for detecting fraud should be regularly scrutinised through a process of internal audit, the FSA recommends. It found, however, that some firms do not audit all their processes and urged a tightening-up of vetting procedures.
The FSA acknowledges that lenders generally have sound processes for vetting new staff, and do not rely to any significant extent on temporary staff from employment agencies. It does, however, recommend that firms continue to monitor staff after recruitment and also continue to assess the work they do to ensure that staff are not in a position where they are able to commit fraud.
On pay, the FSA warns lenders not to have a system of rewards that could encourage fraudulent behaviour. Firms are urged to focus on the quality, as well as the quantity, of new business, and to apply these standards to sales staff and to those managing relationships with intermediaries and other professionals.
Lenders need to make sure that adequate measures to target fraud are embedded in their businesses. Staff should be alert to signs of fraudulent behaviour, and to the sources from which it may arise. All staff should be aware of the firm’s policy and its approach to preventing mortgage fraud.
Mortgage fraud remains an issue, with increasing levels of sophistication and innovation from fraudsters.
Lenders must remain vigilant and employ the strongest possible systems and controls to fraud prevention and make sure they learn lessons from the past. Systems and controls may be adequate for current levels and patterns of business, but firms need to be forward-looking and alert to ensure that controls are appropriate for all market conditions. What may appear reasonable fraud prevention today may not be what lenders need in the future.
We will continue to work with lenders and the FSA to improve the way lenders deter and detect mortgage fraud.