Like all areas of financial services, asset based lending and invoice factoring bring with them a raft of inherent risks that banks and providers must face and ensure are minimised to protect both themselves and their clients. The sheer range of risks is daunting, and the repercussions of poor of risk management can have potentially serious consequences on both a bank’s balance sheet and its reputation.

Unless they put the right measures in place, banks and lenders could face commercial default, bankruptcy, operational error, fraud, and financial penalties resulting from an inadequate compliance environment, naming just a few. The key areas institutions should consider investing in must include up to date cyber security systems; the latest technology; education; and constantly monitoring data flows and credit risk, all the while recognising that different aspects of risk management take priority in different countries and jurisdictions.

Below, I offer my insights into effective risk management for those offering asset based finance services, and present tips on how financial institutions can minimise the threats and losses to their business.

Risks

There are multiple risks facing institutions supplying asset based lending and invoice factoring. When establishing their risk management programme, they should consider, amongst others; buyer credit risk – when buyers can’t pay due to financial inability; supplier fraud risk – when a PO or invoice presented to a lender for financing may be fake, duplicative, or altered; receivable title risk – the risk that the supplier may have already assigned or pledged the receivable to another financial institution; and receivable transfer risk – the risk that applicable law may not allow the lender to take good and marketable title to the receivable.

Solutions

Cyber security is a critically important consideration – providers need to address the security of their data sources, and enforce measures including password protection, data encryption and secure communication channels. Lenders must block the possibility that ABF accounts of their SME borrowers are hacked and information stolen which can be used by criminals to fraudulently request further funds from lenders to be sent to their own accounts. In addition to this, smart secured lenders should evaluate cybersecurity risk at all phases of the due diligence process, evaluating client practises, as well as enforce multi-factor authentication for all parties to access key information. Cyber security risk was reemphasised to me at a Receivables Finance event in London (RFIx) last week. A recent fraud technique has come to light where perpetrators use the vulnerability of weak passwords, used in social media activity of employees (easily hacked), being reused ‘lazily’ by the employees of lenders for their at-work passwords. Hackers were able to infiltrate the email of the employee and eventually masquerade as clients to redirect funds.

Onboarding the smartest tech that can detect potentially worrying profiles or fraudulent client activity significantly earlier than manual processes can mitigate potential losses and should be a core consideration of the risk management process. Daily risk metrics, which continually track client activity, such as unusual trends and material changes, allow lenders to take a threat based approach to portfolio management and identify clients deemed ‘higher risk’, thus diverting resources to those at the riskiest end of the spectrum. We would recommend centralising all information, giving lenders a single view of risk across the business, much like our own HPD LendScape platform, which offers such capabilities. Advanced technology can further promote automation and streamlining of transaction processing, enabling a fast and responsive service to your clients, while providing real-time risk management information to your operations team.

Monitoring to accurately observe, assess, and analyse the streams of data that lenders receive from their asset-based lending and factoring clients is key. Trends on utilisation of facilities, changing credit quality of the business, a slowdown in sales, and other business critical factors, can provide excellent insight into any potential fraudulent activity while also assessing any financial pressures or stress faced by the borrower creating a propensity to commit fraud. Banks and lenders should investigate operating cycles and carry out collateral assessments/audits, as well as market monitoring, as an additional risk mitigation tool to profile their asset based finance clients and contextualise a borrower’s business activity from a real world perspective. Finally, a high quality source of data can facilitate evolving AI or machine learning in the analysis and behavioural patterns, supporting data-driven decision-making, an approach that is becoming more prevalent year on year.

Recognising the regional nuances for banks and lenders who operate cross-border and in multiple jurisdictions are an important consideration for risk managers, particularly when taking into account differing legal frameworks and cultural business practices for those looking to expand operations overseas. The success of lenders looking to do this will depend on how well they understand the environment in which they are lending, such as the transfer of legal title of the collateral, reporting regulations and local threats that may impact the operation.  

Educating your team to understand best practice for managing risk is critical. It is all too easy for staff to have a false sense of security and miss the tale tell signs of an ensuing fraud or bad debt. We have enjoyed a decade or relatively benign economic conditions so many newcomers to this field may not have had the experience of heightened risks in more turbulent times. Industry bodies provide a wealth of training courses so now is the time to invest in your people.

In summary

Risk management can never deliver a completely risk-free environment in today’s very fast-moving and interconnected markets, however, implementing the above initiatives will go some way to ensuring that it is as effective as possible for the benefit of the financial institution and also its clients.

Ends.