Fraud Risk Management: What It Is + How to Build a Program

March 30, 2023

Like many other crimes, fraud doesn’t discriminate in terms of who it affects. Even companies — big or small — can be targets. And the potential losses of money and trust a business suffers from being a victim of fraud can be difficult to recover from.

That’s why many businesses invest significantly in fraud risk management — trying to prevent or reduce the risk of fraud instead of dealing with it after it happens. This article will explain a bit more about fraud risk management, including why it’s important, the cornerstones of a fraud risk management framework, and best practices for building a fraud risk management strategy for your business.

We’ll start with a fraud risk management definition that explains what the concept is.

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What is Fraud Risk Management?

Fraud risk management is the process of a business identifying, understanding, and taking action against potential ways for criminals to defraud it. That involves developing a program to prevent fraud attempts, as well as to detect and cut off fraud attempts already in progress.

Fraud risk management is closely related to complilance risk management, with both being core elements of keeping your organization protected from fraud and money laundering.

Why is Fraud Risk Management Important?

Fraud risk management is important because fraud can cause a lot of damage to a company if it actually happens. And that isn’t just theft of money and/or sensitive information — it also includes a loss of trust from partners, clients, and regulators. It can even lead to civil or criminal liability for failing to protect customers’ assets.

Thus, trying to prevent — or at least reduce the risk of — fraud is usually much less costly for a business than what could happen if it’s actually victimized by fraud.

Fraud Risk Management Program: Developing a Framework

A fraud risk management framework typically involves five processes. These are:

Below, we’ll explain how each process contributes to an effective fraud risk management system.

1. Governance

Governance is about ensuring that all stakeholders in a company take the dangers of fraud seriously. If everyone from upper management down is committed to reducing the risk of fraud, it becomes far less likely that a business will be targeted for fraud.

Some things to consider for putting together a fraud risk management policy include:

  • Who will oversee anti-fraud operations in the company?
  • What values and ethics will the company’s anti-fraud operations be guided by?
  • How will the company handle potential conflicts of interest, including post-employment?
  • What will the company’s plan be for assessing the risk of internal fraud?
  • What steps are to be taken for investigating allegations of fraud?
  • How will the company work to prevent fraud from happening in the first place?

All of these facets should also be properly documented and easily accessible to all relevant stakeholders. Also, make sure that tasks are properly delegated, and that each organization member knows their roles and responsibilities in fraud risk reduction.

2. Assessment

Next, a company has to identify all the ways it could be susceptible to fraud, and evaluate how much of a threat each risk poses. Typically, risks are categorized by likelihood and impact: how vulnerable the company is to a form of fraud, and how much damage could be done if the fraud succeeds.

Try holding workshops, brainstorming sessions, surveys, and interviews with employees to understand what fraud risks the company faces. It can also be helpful to study other companies in the same industry and what kinds of risks they may be vulnerable to.

If a company already has existing fraud risk management strategies, it can be helpful to do an inherent risk evaluation. This is a hypothetical measure of how much greater the company's risk would be if controls weren’t in place. This helps to conceptualize how effective the company’s current controls are.

3. Prevention

Once a company has worked out how it could be defrauded, it should first work on proactive fraud risk management: how to prevent as much of this fraud as possible. Sometimes this will mean stopping non-essential activities or finding alternative ways to do them that are less risky. Other times it will involve delegating liability for fraud to other parties, such as insurance companies.

Mostly, though, it will be about implementing preventative controls to stop fraud risks before they have a chance to become actual fraud. For example, a company can do KYC screening of clients and partners at onboarding. It can also require proper authorization for access to sensitive operations or data.

As far as fraud prevention goes, fraud risk management programs should focus on motivation, rationalization, and opportunity — why people commit fraud in the first place, why the company would specifically be targeted for fraud, and how easy it would be for someone to get away with defrauding the company.

4. Detection

Sadly, not all risk can be avoided or delegated. So a company has to have fraud risk management solutions that can monitor vulnerable areas for suspicious activities that may lead to fraud. Employees should be trained on how these solutions work, and especially on how to use them to properly report suspected fraud in a timely manner.

A company’s fraud risk management plan should also include a process for assessing and investigating allegations of fraud and taking corrective action if necessary. It’s also important that this process be backed by educating employees on how to spot fraud, fostering open communication between company departments, and accommodating anonymous reporting for employees who may feel vulnerable.

5. Monitoring + Reporting

A company’s fraud risk management program needs to be monitored and reported on frequently to assess its effectiveness. Criminals continually come up with new ways to commit fraud, so some policies and processes that worked in the past may not cover new avenues of fraud risk.

Also, remember that, as the company grows and potentially shifts its focus, its fraud risk profile will change. Some risks may cease to be relevant, while new ones that weren’t an issue for a smaller company may present themselves. So adapt the company’s fraud risk management strategy to new fraud risks, while also ensuring that it stays aligned with the company’s values and ethics.

Fraud Risk Management Strategies + Best Practices

Here, we’ll expand a bit on some of the ways to effectively implement the five pillars of the fraud risk management process.

Identify and Assess All Risks

Risk related to fraud isn’t the only kind of risk that a company faces. So go beyond and think of any other possible risks that could threaten the company. Remember that a company may face different kinds of risks depending on factors like what kinds of products it sells, what kinds of services it offers, and even what payment rails it uses.

It’s important to identify and evaluate other types of risks because they can have a domino effect on each other. A company may have a solid fraud and corruption risk management plan, but if its IT infrastructure isn’t very secure, a data breach could allow fraud to happen anyway.

Develop Risk Management Strategies

Fraud risk management tactics tend to fall into one of four categories: avoid, mitigate, transfer, and accept.

Avoiding risk means not engaging in whatever process causes the risk, or finding an alternative way to do it that’s less risky. Mitigating risk is about implementing controls that either prevent risks from causing problems or catch problems quickly before they do much damage. Transferring risk involves getting another party to underwrite (at least some) risk. And some risks must be accepted because the cost of avoiding, mitigating, or transferring them isn’t justifiable.

Companies need to consider the likelihood and impact of each risk they face, and then decide which kind of risk management strategy they will use for each one. Avoiding risk is ideal, mitigating risk is the next best thing, and transferring risk is next best after that. Accepting risk should only be done after a business’s leaders are made aware of the risk, as well as the possible advantages and disadvantages of accepting it.

Implement Risk Management Plans

Once a company has decided on how it’s going to handle each of the fraud risks it has identified, it needs to put those plans into action. For this to be successful, it needs to secure buy-in from all departments and management levels. It should also have open communication and collaboration channels between departments to avoid siloing. This ensures that everyone in the company is on the same page and working with the same information in terms of fighting fraud.

Monitor and Evaluate Risk Management

Again, it’s not enough to simply implement a risk management and fraud prevention strategy and assume it’s doing its job. A company needs to monitor how the program is being carried out in practice — what’s working properly, what needs improvement, and what risks may not be covered. This will let it assess how well its policy is actually preventing or mitigating the risks it’s meant to.

Maintain an Updated Risk Profile

Changes in a company (e.g. size, direction) or industry (e.g. business trends or regulatory requirements) may require the company to re-evaluate its fraud risk profile, or what kinds of risks it needs to cover. That’s why it’s important for a company to periodically do a new assessment of the risks it faces — fraud-related or otherwise — to ensure its prevention and mitigation strategies are up-to-date.

Foster a Risk-Aware Culture

Part of getting total buy-in at a company regarding enterprise fraud risk management is creating an environment where employees feel comfortable talking about risk detection and prevention. This should include things like an anonymous hotline for reporting risks and fraud to protect the confidentiality of employees who may fear exposing themselves. It should also include policies that reward employees for bringing risk to light instead of punishing them.

Continuously Improve Risk Management

There’s always an opportunity for a company to improve its risk management and counter fraud program. Taking lessons from the company’s past experiences — as well as those of other businesses in the same industry — can help the company discover new risks to be aware of or new ways of doing things that involve less risk.

Companies need to keep up with industry best practices and standards to ensure they are using the right tools and procedures to prevent or mitigate fraud risk.

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Make Unit21 Part of Your Company’s Fraud Risk Management Program

We’ll reiterate that part of executing an effective fraud and risk management program is having the right tools backing it. Unit21’s risk management infrastructure combines identity verification, suspicious activity monitoring, and case management into a consolidated dashboard to make compliance and reporting easy.

To see how it can help your organization, book a demo with us today.

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