Credit where it’s due

As business attempts to get moving again in a world changed forever by COVID-19, banks must play a pivotal role in protecting firms from insolvency. Government-backed schemes such as the UK’s Bounce Back Loan (BBLS) and Coronavirus Business Interruption Loan (CBILS) have delivered billions of pounds in financial aid already. Latest figures from the UK Treasury show £33.7bn has been delivered to more than 1.1 million businesses. Likewise in the US, US$2.2tn of economic stimulus has been pledged through the Coronavirus Aid, Relief and Economic Security (CARES) Act. This includes the Paycheck Protection Program (PPP) – US$6.6bn of business loans aimed at minimising losses caused by lockdown measures. The EU also finally agreed on €1.82tn in loans and grants at the end of July, after months of negotiations.

As banks around the world are faced with the huge responsibility of distributing these funds and bolstering economic recovery, inevitably, they are also faced with the associated risks.

Up to 50% of borrowers likely to default

According to reports, senior bank officials in the UK have already raised concerns that up to half of borrowers may default on loans taken out through the coronavirus recovery schemes. One source told the Financial Times that around 25% of the loans issued would not have made it through credit checks in normal circumstances. Add to this a very uncertain economic climate, with COVID-safe measures limiting the ability of businesses to operate, and mass defaults seem inevitable.

The loans issued by banks through the US and UK schemes (and many other equivalents around the world) are government guaranteed, meaning that if creditors do default on the loans, the repayments will be covered by their respective governments. However, guidelines state that the banks themselves are responsible for chasing repayment and that firms must treat the loans like any other form of debt. In practise, chasing thousands of small businesses could prove extremely challenging and many have raised concerns about a potential PR disaster for lenders, especially in light of how many small and medium-sized businesses were treated by banks during the global financial crisis.

An opportunity for fraudsters

Evidence is already emerging of fraudsters abusing the system. Last month, two men were arrested in the UK in connection with an alleged £500,000 BBLS scam. The main suspect, a man in his 40s, is accused of recruiting individuals to open fake bank accounts and register fake companies in order to launder money obtained through government financial recovery schemes. According to reports, detectives froze 10 bank accounts linked to the scam, containing a total of £553,305. This alarming story demonstrates just one of the potential risks faced by firms in this process. With minimal credit checks in place to ensure the smooth running of the scheme, it is likely many more incidents will emerge as time goes by. In the US, a Florida man was arrested and charged with fraudulently obtaining US$3.9m in PPP loans and using them to purchase a sports car. Authorities seized a US$318,000 car and US$3.4m from bank accounts, according to the US Justice Department.

Government guarantee – potential grey areas

The fraud itself is risk enough, but another key challenge will be deciphering whether or not governments will cover defaults that occur as a result of this fraud, or whether the guarantee only applies to non-repayment due to insolvency. It may be dependent on whether the bank can prove the fraud was not as a result of their own customer due diligence (CDD) failures.

UK Finance, a trade association comprising the former British Bankers’ Association and a number of other industry bodies, raised its concerns about another potential grey area in the government guarantee: “Increased money laundering risks exist from future repayments on both CBILS and BBLS loans being made using illicit funds, especially if the lending bank is not the primary banking partner of the applicant,” it said in a blog post on the topic. “Opportunistic launderers may seek to attach themselves to solvent firms and submit otherwise valid applications as a means of obtaining clean funds which are then repaid over time using illicit money. Where lenders have concerns about the source of repayments, would the government guarantee cover what might be considered an elective loss if firms were unwilling to receive payment from what they considered to be an illicit source?”

The US Government Accountability Office (GAO) has also expressed concerns over PPP loan fraud. It said in a statement: “Because of the number of loans approved, the speed with which they were processed and the limited safeguards, there is a significant risk that some fraudulent or inflated applications were approved. In addition, the lack of clear guidance has increased the likelihood that borrowers may misuse loan proceeds or be surprised they do not qualify for full loan forgiveness.”

Customer due diligence

CDD measures will be a crucial risk mitigation factor during this time, despite banks around the globe being instructed not to complete the usual full credit checks. An added challenge is that not all banks are taking part in government schemes, meaning the remaining banks are required to lend to new customers. In the UK, the FCA states that “where an authorised firm has carried out appropriate Customer Due Diligence (CDD) before it received an application under the Schemes, it does not need to make further checks. However, if an authorised firm has information – including any relevant flags or alerts – suggesting a customer poses a higher risk, for example, of fraud, money laundering, or terrorist financing, it should carry out additional checks.”

The FCA also acknowledges that the risks associated with new customers may be significantly higher and so the usual CDD checks should be carried out in this instance. However, if the money laundering and terrorist financing risks associated with the new business relationship are low, firms are still permitted to use “simplified due diligence.”

The US Treasury has been criticised heavily for its handling of rules surrounding PPP eligibility and loan forgiveness, which changed almost daily in the initial stages of the scheme. This is likely to result in discrepancies in CDD checks and will have provided a perfect opportunity for fraudsters.  

Other risk factors

As we live through this pandemic, the memories of the 2008 financial crisis are still fresh in the minds of many. Some of the world’s largest banks are still smarting from the sting of record-breaking regulatory fines and litigation costs, so the potential legal fallout arising from COVID-19 relief loans is a very real risk. Getting the process right and minimising issues further down the line is essential if banks are to avoid (or at least minimise) long-term costs. The TARP scheme (Troubled Asset Relief Program) which was launched in the US post-crisis is still seeing fraud cases being investigated 12 years later. The many varying financial relief schemes being rushed through by governments around the world as we speak are likely to reap similar consequences. 

UK Finance raises one issue that could prove disastrous for banks who’ve worked hard at rebuilding their reputations post-crisis. “There is a risk of persons who are registered or attempt to be registered as loan beneficiaries being named on national or international lists as terrorists, drug traffickers, criminals or other persons wanted by authorities,” it warns. “Instances of this being identified and reported on by the media would likely lead to significant adverse press coverage and reputational damage.”

Failing to provide loans to businesses quickly enough during their time of need could also result in class-action lawsuits further down the line. With the onus on banks to use their discretion, questions will inevitably be raised about why some businesses made the cut and others did not. Ensuring a consistent approach to approving loans will be key, with accurate and comprehensive CDD data being essential.

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