Combatting The Growing Challenge of Small Business Fraud for Community Banks and Credit Unions

Fraud targeting small businesses is a growing threat that directly impacts Community Banks and Credit Unions, costing them trust, resources, and significant financial losses. In order to combat fraud, these institutions have to navigate the dual challenge of safeguarding their operations while protecting their small business clients and members from external threats.

The issue of fraud is particularly acute in the SMB space, where opaque ownership structures, outdated verification methods, and increasingly sophisticated bad actors create an environment ripe for exploitation. For Community Banks and Credit Unions, getting to the root causes of small business fraud and implementing practical solutions to protect themselves and their small business clients is essential to maintaining trust, minimizing losses, and staying competitive.

The Cost of Fraud to Community Banks and Credit Unions

Fraud in the small business sector has far-reaching consequences for Financial Institutions, including:

1. Direct Financial LossesEvery fraudulent transaction or account results in monetary losses for the affected businesses and the institutions that facilitate those transactions. The ratio is not 1:1. A recent study from LexisNexis found that every dollar an institution loses to fraud costs it $4.45. 

2. Reputational DamageCommunity Banks and Credit Unions are trusted partners to their small business clients. Being involved in fraud incidents can erode that trust, damaging long-term relationships and customer loyalty.

3. Operational StrainInvestigating and resolving fraud cases takes away valuable time and resources that could otherwise be used for other critical areas of operation, such as customer service.

These reasons are why Community Banks and Credit Unions need to find ways to protect themselves from fraudulent entities while still providing value to their small business customers and members.

Why Small Businesses Are Vulnerable to Fraud (And Why Financial Institutions May Fail To Notice)

Nobody is immune to fraud, but small businesses are particularly vulnerable for several reasons. First, they often lack transparency in reporting. Unlike larger corporations, which have extensive reporting and public records that date back years or even decades, small businesses often have limited records. The lack of documentation can make it difficult for Financial Institutions to get a complete picture of a small business’s operations, ownership, and risk profile. 

In addition, ownership details may change hands without notice in small businesses, and bad actors can use these blind spots to commit fraud. For example, a business that seems outwardly legitimate could have been taken over by a fraudulent entity posing as a legal business. Or, transactions that look routine on paper could actually be tied to illicit activities. These gaps in visibility create a significant challenge for Community Banks and Credit Unions that are trying to evaluate and support local small businesses. 

Finally, many Community Banks and Credit Unions are still using outdated verification processes. Traditional methods of assessing small business legitimacy, like reviewing financial statements and relying on vendor references, have limitations. Financial statements may not reflect ownership changes or fraudulent activities, and vendor references can be manipulated. As a result, Community Banks and Credit Unions often struggle to verify whether a small business is operating legitimately and need to make an educated decision based on the limited information available.

Why Fraud Persists in SMB Banking

The fraud Community Banks and Credit Unions encounter is both widespread and diverse. Common forms include check fraud, digital payment fraud, and vendor scams. One of the most glaring examples of small business fraud is check fraud. While it might seem outdated to consumers who haven’t written a check in years, this is a crime that continues to thrive in the small business world despite the banking industry’s push toward digitization. In 2023, nearly one-third of all small businesses in the U.S. were victims of check fraud, representing a 12% increase year over year.

Community Banks and Credit Unions face a unique dilemma in this area. On the one hand, they want to invest in next-generation tools and technologies to improve customer experiences and streamline operations. On the other hand, they still need to service traditional clients, many of whom rely on checks as a primary payment method. This reliance on checks creates a loophole that fraudsters are eager to exploit. 

Another reason fraud remains persistent in small businesses is that many financial institutions still rely on financial statements as indicators of a business’s legitimacy. While financial statements have long been a key tool for evaluating small business clients, they can no longer stand on their own as a sufficient source of information. For example, a small business may have been legitimate in the past but could have undergone ownership changes that aren’t reflected in its financials. Additionally, a sophisticated fraudulent actor can easily manipulate illicit transaction data to appear normal. This makes it increasingly difficult for bankers to identify red flags.

What Community Banks and Credit Unions Can Do to Prevent Fraud

To combat these risks, Community Banks and Credit Unions need to think beyond financial statements by leveraging additional sources of information. Tech tools like Crux Analytics provide hyper-localized data, enabling institutions to verify ownership details, uncover hidden risks, and gain a clearer picture of small business operations. Here are a few other steps that can be taken to mitigate risks and prevent fraud:

1. Invest in Advanced Fraud Prevention ToolsLeveraging technology to enhance transparency and detect fraud early is essential. From AI-powered algorithms to centralized data platforms, these tools can provide the insights needed to make informed decisions.

2. Educate Small Business ClientsMany small businesses are unaware of the risks they face or the steps they can take to protect themselves. Financial Institutions can be proactive in educating their clients about fraud risks and prevention strategies.

3. Collaborate Across the IndustryFraud prevention is not a problem that any single institution can solve alone. By collaborating with other Community Banks, Credit Unions, and industry organizations, Financial Institutions can share knowledge, resources, and best practices to combat fraud more effectively.

4. Streamline ProcessesSimplifying and modernizing fraud detection workflows can reduce operational strain while improving accuracy. For example, integrating fraud detection systems with an existing tech stack can provide a more holistic view of each client, making it easier to spot potential issues.

Preventing fraud in the small business sector is essential for Community Banks and Credit Unions. By addressing the unique vulnerabilities of SMBs, leveraging the right tools, and prioritizing education and collaboration, these institutions can make meaningful strides in mitigating fraud risks. 

Ready to bring transparency to your small business portfolio? Discover how Crux Analytics can help your institution gain actionable insights and build trust with your small business clients. Contact us today to get started.