It did not take long after the Silicon Valley Bank failure for politicians in Washington to rush to the next available microphone and lament the “loosening of bank regulations”. Instinctively the finger pointing began, and in many quarters ended up in the direction of the prior administration’s policy to generally roll back stringent business regulations and allow free market decisions to govern various industries. Chief among the complainants (no pun intended) was Sen Elizabeth Warren, who emerged out of the 2008 crisis as an architect and advocate for the Wall Street Reform Act and the creation of the vaunted Consumer Financial Protection Bureau ( CFPB), which she briefly directed. Just yesterday in DC’s The Hill publication, Sen Warren was reported as blaming the the collapse of Silicon Valley Bank on Republicans in Congress, which in 2018 helped pass a law to ease bank regulations put in place following the 2008 financial crisis. “No one should be mistaken about what unfolded over the past few days in the U.S. banking system: These recent bank failures are the direct result of leaders in Washington weakening the financial rules,” Warren is quoted as saying. According to The Hill piece, Warren, who voted against the 2018 bank deregulation bill, said that the crises would have been avoided if the banks were required to hold more liquid assets because the bill exempted banks with less than $250 billion in assets from rigorous Fed stress tests. Warren and other Democrats say the old rules could have caught the issues at SVB sooner. Given that politicians generally “never let a crisis go to waste,” many now suspect that the banking industry is about to be slammed with heightened regulatory scrutiny, tighter operational rules, more audits and exams, and larger and very public fines, penalties and consent orders. What does this mean for independent mortgage bankers (IMBs)? It means that they have to get back to the compliance mindset they were frightened into adopting between 2008 and 2018, and before the bottoming out of interest rates led everyone to believe that easy money was here to stay and that self-regulation meant hiring more loan officers. Keep those risk management officers and compliance directors close by folks, we are all in for a bumpy ride on the regulatory

Fraud is pervasive in virtually every industry.  The reason is that fraud is the consequence of a human condition that exploits the opportunity to gain assets through rationalization and need.  Every one of us is vulnerable to committing a fraud crime given the right circumstances and the opportunity.  Mortgage lenders and banks need to understand the underpinnings of the Fraud Triangle to design programs, policies and procedures to identify risk and deter fraud before it makes them a victim.

Risk managers and CPAs specializing in forensic accounting work to root out fraud have for many years relied upon the Fraud Triangle diagram, first created by renowned criminologist Donald R. Cressey, to effectively identify the three “legs” of fraud and the human behavior that predict the propensity to commit fraud.  Then applying internal and external policies and procedures designed to identify behaviors and practices that may lead to fraud, these experts minimize the risk of harm to organizations.

A visualization of the “Cressey Triangle” appears below:

The theory postulates that in order for fraud to take place there are three key elements which must be present. The first is “motivation” or “need.” A person finds themselves in a situation where they are, perhaps unexpectedly, facing financial stress, personal pressures or psychological issues caused by external forces.  Some examples are an IRS audit, a divorce, a gambling debt, a reduction of employment hours or wages causing a need to maintain a high lifestyle, and greed.

The second element is “rationalization.” Since it is against human nature to break the law, most people need rationalization to boost their confidence to commit fraud.  Examples include feeling underpaid, a sense of entitlement (“I deserve that”), and a sense of unfairness (“he has more than me”).

Last and most important is “opportunity.”  A perpetrator of fraud needs access to money and some control over the means of getting to it (or a loophole or lapse in controls that enables easy access).  In the mortgage industry opportunity exists in (a) trust account access (mortgage proceeds theft) and (b) access to personal financial information of borrowers (identity theft).

Risk management experts, like those at our firm, focus on the three legs of the Fraud Triangle to design vetting and monitoring programs to spot possible fraud characteristics before an event takes place.  The SSI risk metrics evaluation system was built on the basis of years of collaborative analysis of typical mortgage fraud events working with risk analysts at Lloyds of London. While evidence shows that the mere existence of an independent fraud deterrence process, such as vetting and monitoring, creates a significant perception of oversight and controls that deters potential fraudsters, SSI’s process does much more by studying a person’s background details to reasonably estimate the propensity for fraud.

As the science of risk management and fraud detection and deterrence matures, more advances will be made.  For example, we are developing both enhanced technological analytics as well as highly focused personality testing modules to enhance the future vetting process and give the industry key risk data available nowhere else.     The ultimate goal for any risk management process is the total elimination of fraud losses.  While total elimination is unlikely, at SSI we spend all of our time seeking new ways to approach that lofty goal for our clients.