By Mike Holley, Senior Consultant, Political Risk & Trade Credit, Charles Taylor Adjusting 

Many of our clients are finding that fraud is a recurring cause of credit risk claims. Most have expert credit analysts in house who are more than capable of spotting weak credit risks. But if the obligor’s financial statements are fraudulent, the financial ratios often look good on paper, and it is easy to get caught out. Is there any defence against this?

Charles Taylor Adjusting has decades of experience in dealing with fraud risk. After all, fraud does not only affect credit claims – many financial lines policies offered to banks and other financial institutions specifically cover fraud, for example. And insurance claims fraud is a problem across all lines.

So, what can be done to minimise the risk in credit and political risk? Some tell-tale signs may be visible at the underwriting stage, including:

• Is the Cash Flow Statement consistent with the profit after tax stated on the Profit and Loss? If cash is ‘disappearing’ out of the business, you may see an unexplained mismatch.
• Do the Days Sales Outstanding (DSO), Days Payable Outstanding (DPO) and Inventory Days numbers make sense for what you know about the business? Especially focus on DSO as false invoices are often a feature in fraud. 
• Does the interest expenditure on the Profit & Loss match the amount of debt stated on the Balance Sheet? Work out the interest rate and see if it makes sense. In fraudulent cases, assets are often pledged to more than one lender and the debt may be larger than the accounts state.
• Is a very attractive premium rate, and/or interest rate offered? (relative to the credit rating from your credit model). If it feels too good to be true, it probably is.  
• Is the group structure hard to understand, with many different legal entities? The harder it is to follow, the greater the risk that fraud is present.
• Is the explanation of use of funds general and vague?
• Is there a very strong sense of urgency to close the deal?
• Do tempers flare inappropriately if someone says ‘no’ to the Directors or if there is a delay in getting funding done? 
• Do the Directors display ‘trophies’; an extravagant lifestyle, sponsorship of sports teams, lavish premises etc.? 
• Does the company use unconventional forms of lending from non-local, non-bank, financial intermediaries (e.g. supply chain financing)? 
• Is the turnover growing fast but assets or staff numbers staying the same or reducing?
• Be curious. There is no such thing as a stupid question. Do not be put off raising a query to assist with your understanding of the risk. Fraudsters are often very bold, and part of their confidence trick is to try to make a questioner look foolish.    

If a claim arises as a result of fraud, Charles Taylor has many tools to help you, including our own in-house dedicated counter fraud unit – Specialist Investigation Services – SIS. 

By its nature, fraud in credit and political risk will be sophisticated and it is unlikely to ever be eliminated completely. But with the constant vigilance, careful training, and the right tools we can each do our part to minimise the risk, and to deal with it effectively if we do get taken unawares.