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A smart investment.

SINCE JANUARY 1, 1969, WHEN THE Bank Protection Act first became law, security professionals in the banking industry have made significant progress in physical security. Proprietary alarm systems have been greatly improved with expanded capabilities and reduced costs through multiplexing signals over existing data lines. The quality of surveillance photographs has been enhanced through improved technology

Other devices, such as dye packs, have established remarkable track records of success. Vendors have improved the quality of vault and safe equipment, and training programs have improved the level of performance of bank employees in identifying criminals who perpetrate crimes against financial institutions. Some banks have exceeded the requirements of the Bank Protection Act and installed such preventive devices as bullet-resistant barriers, which have drastically reduced bank robberies.

What all of these factors translate to is, in the opinion of most observers, a general feeling of satisfaction that the Bank Protection Act has done a commendable job of improving the physical security of financial institutions. In the past several years the number of bank robberies has leveled off.

But let's look at another critical area of exposure in the industry-loan fraud. According to figures published by the General Accounting Office, the 30-year cost of the savings and loan (S&L) bailout will be $500 billion or about $2,000 for every person in the United States.

If you consider the estimates of how much of that loss is due to fraud-20 to 80 percent-you have a general idea of the loan fraud exposure to S&Ls alone. The lowest estimate of fraud, 20 percent, would place the fraud loss in the S&L debacle alone at $100 billion over the next 30 years. This figure does not include other catastrophic losses suffered by other thrift institutions and commercial banks.

In a recent case involving a regional bank in the Northeast, $65 million was lost on one fraudulent loan, more than one and a half times the amount lost in robberies for the entire country in a year. Clearly, loan fraud represents one of the most serious problems to face the financial industry, and all indications are that the problem will get worse in the coming months with the downturn in the economy.

In 25 years, I cannot recall a bank failing from either check fraud or bank robbery. But in 1989 alone, more than 200 banks failed from bad loans, many of which involved fraud. As the result of these continued reports of internal fraud, consumer confidence in the financial industry is at great risk.

In August 1990, a major fraud case involving $6 million in losses against two Connecticut banks was tried in the Federal District Court in West Hartford, CT. Judge Alan H. Nevas admonished bank lenders by stating publicly, "It's unbelievable, handing out money to people they don't know. The stupidity of bank officers contributed to their losses. "

At the annual meeting of the American Bankers Association in Orlando, FL, last year, Robert Clarke, comptroller of the currency, advised CEOs and other senior bank management that banks must return to sound lending practices. Other speakers urged bankers to scrutinize loan portfolios more closely and prepare for federal legislation mandating more diligent procedures in the extension of credit.

A recent study by the Comptroller's Office listed the following six major reasons for bank failure and their frequency of occurrence:

* no policy for making loans, or one that was poorly followed-81 percent

* a passive, uninformed, or inexperienced board of directors-60 percent

* inadequate systems to ensure compliance with bank policy and law-69 percent

* a poor system for identifying problem loans-59 percent

* domination of one bank by a single person-57 percent

* overly aggressive management geared to excessive growth, with too-liberal standards for making loans-43 percent.

Said Clarke, "Our finding is that banks continue to fail the old-fashioned way, through managerial incompetence." In this atmosphere of concern and, in some cases, panic caused by loan fraud, what can security professionals do to make a significant contribution to the bottom line of financial institutions? Every security officer has a network of peers within his or her geographic area and beyond. Many security practitioners today are former local, state, or federal law enforcement officers and bring with them additional contacts in that particular community.

It is a generally accepted theory that a law enforcement officer is only as good as his or her network, and one of the most important benefits of attending national security conferences is the development of networks to assist bank security officers in resolving common security problems when they arise. While this network is commonly used to gather information, we need to raise this informal method to a more sophisticated level.

During my 25 years as a security professional, I have been called on by commercial lenders, senior management, and in some cases CEOs to look into a large commercial loan loss to determine the background of the principals after millions of dollars were charged off. Using my own network, I have discovered that in a variety of fraudulent loan cases, principals had long criminal records or collateral was nonexistent.

In other cases, applications for loans and statements of financial condition were riddled with fraudulent information. In one particular situation, several banks in the Northeast, including the one I work for, lost a total of $130 million dollars in fraudulent loans to a coffee exporter from Colombia.

As it turned out, a Big Eight auditing finn certified that the collateral, which consisted of coffee beans, was stored in warehouses and in holds of ships when, in fact, it did not exist. After lengthy negotiations and litigation, the banks recovered their losses through the bonding coverage of the auditing finn.

In 1987, while speaking at a bank security meeting in Miami, I mentioned this situation and the name of the person who perpetrated this scheme and the room erupted in laughter. This same person had defrauded many banks in South Florida and was well-known. My contention is that if the lenders had asked their security staff to look into the character of the borrower before the loans were made, $130 million in losses could have been prevented.

In 1990, after sustaining a $65 million fraudulent loan loss to a con artist in Chicago, Walter Connally, then CEO of the Bank of New England, was quoted in an article in The Boston Globe as saying, "In retrospect-post mortern-we can see that in spite of our best efforts we misjudged the character the borrower. " This entire article as summed up in one sentence! The fraud could have been prevented with a competent due-diligence inquiry.

Clarke's advice that the banking industry needs to get back to sound banking principles is right on target. One way to ensure the quality of the loan portfolio, as we go forward, is to devote more resources up front in the form of due-diligence inquiries, involving verification of the three C's in lending: character, capacity, and collateral.

The banking industry desperately needs to change its archaic culture. It must become proactive in preventing losses; its present reactive approach has had disastrous results. Commercial lenders, credit review analysts, auditors, and security professionals need to get together and develop formal guidelines that include all of the existing procedures plus a detailed verification process through which all applications that fall within certain parameters will be screened.

Addresses, places of business, telephone numbers, social security numbers, criminal history background checks, and previous banking relationships are but a few of the facts security can check with little effort. In addition, generic tapes that include loan application information can be run against known national and regional derogatory data bases to determine any negative information for approximately $20 per name, a small price to pay for a premium on insurance against fraudulent loan losses.

Security professionals are underused in the banking industry. Instead of being viewed as the uniformed security officers checking alarms and surveillance systems, security professionals need to convey the message that they are an extremely valuable asset that can make a significant contribution to the bottom line. They can provide valuable services to other departments, such as preventing criminals from being hired, setting up deposit service control units to prevent check-kiting, and establishing procedures to prevent fraudulent accounts from being opened. But most importantly, they can assist lending functions in making quality decisions, which are vital if the financial industry is to recapture the image of credibility and trust.

About the Author . . . William F. Gearin is vice president and director of corporate security for Shawmut National Corporation in Boston.
COPYRIGHT 1991 American Society for Industrial Security
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:banking security and loan fraud
Author:Gearin, William F.
Publication:Security Management
Date:Jul 1, 1991
Previous Article:Master the budget, line by line.
Next Article:The likelihood of liability.

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