Detecting Trade Fraud: Tunnel Vision, Blind Spots and Human Biases

Lenders across the world are grappling with the trade finance asset class. In Singapore, a string of legal cases has left banks facing the prospect of staggering losses with the nature of the trade finance asset class, as secure and self-liquidating, facing an existential crisis. Year after year, from REI Agro to Qingdao to Hin Leong, banks get befuddled by the simplicity of the frauds perpetrated against them through fake invoices, photocopy bills of lading (BLs) and duplicate documents. The fallibility of paper documents is often blamed as the source of the problem, but sometimes the real danger lies in the intangible aspects of human psychology behind decision-making processes. A compelling narrative and competitive lending market set against challenges in verification of trades/finances, can unwittingly lead a lender into a blinkered decision. 

Far from sophisticated, trade fraud can be so breathtakingly simple, that the mind does not address and arrest its possibility (see: modus of employing photocopy BLs). The deception often occurs well before the fictitious trade peddled and lies in the all-consuming need for liquidity.

Having worked on trade fraud cases for close to a decade, the common denominator in most if not all cases is that liquidity is the actual commodity being traded. Cobbling a trade together can be the means to access lower costs of borrowing in Dubai and Singapore and apply it elsewhere: for other trades, for working capital or even to unrelated investments in other sectors/geographies with high borrowing costs.

Liquidity could also be transferred by loans between traders dressed up as trades or to raise multiple financing, where the physical goods are secondary or sometimes completely absent. The temptation to create such structures even without the underlying goods, cannot be understated.

Balance sheets soar, everyone benefits and, in any case, who will find out?

The balance sheet bias

The need for liquidity brings into prominence the central role played by a compelling narrative backed by glittery balance sheets. Narratives are powerful invisible forces that affect us all: once formed, they are difficult to dislodge and has every prospect of snowballing as the mind sieves through vast amounts of information to confirm the formed bias. Hype around an individual or company level creates a powerful self-perpetuating loop, where lenders might take the balance sheet as gospel and gloss over doubts. But balance sheets have historically proven to be poor tools to accept unquestioningly.  The balance sheet is at best a snapshot of the company’s financial health at a point of time. There are weaknesses in the document because it doesn’t give a clear indication of leverage. There is no distinction between a structured trade and physical trade (the former arbitraging on financial positions rather than physical goods). Receivables, sometimes the only asset of a trader and the backbone of receivables financing, can often be difficult to verify. In a world where the balance sheet is supreme, there is every temptation and ability to dress it up to fit the narrative.

The biggest blind spot tends to be when the lender is actually part of that growth story – this is how modest lines can turn into staggering sums, without ever visiting the offices of their borrowers to test the financials against the reality: can a handful of people run a 100m balance sheet; can one trader be responsible for 10 different products; is the owner the sole decision maker? Lenders might deploy such checks at the on-boarding stage but reliance on “track record” might catch them off-guard when traders move from physical trades to purely financial structures over time.

Groupthink: Others can’t be wrong

Even when circumspection in the balance sheet starts to creep in, biases tend to find a justification. Trade finance is a high velocity and competitive business where decisions need to be made fast. The involvement of other lenders is perhaps one of the most persuasive factors that can sway a decision even if it is never articulated. It once again provides confirmation bias as it diverts attention from ambiguities in the statement and encourages a logical fallacy that the involvement of other lenders is some form of quality assurance and even amplifies the desire for involvement in what can loosely be described as a fear of missing out.

Interrogating the trade

The lure of an impressive balance sheet might divert attention from the fundamentals, i.e., the trade. Fraud flourishes in fragmented information chains: physical goods are placed in the custody of a third party such as a vessel carrier or warehouse operator, while the trades are being conducted on paper with the passing of title documents by traders using financing. It is this disjunct which lies at the heart of most trade fraud. Shipping documents can only tell you information relating to the start and finish points of the journey but it is the opaque nature of transit where fraud can occur. When we investigate trade fraud, we painstakingly piece together the actual movement of physical goods from shipper to receiver – that knowledge shouldn’t just be the purview of litigation lawyers like myself but would be better placed before credit and risk committees prior to a lending decision. More importantly, interrogating the trade is really ensuring that each party in the trade can justify its role in the chain: why is a small trader inserted as a sleeve in between two large traders; why are trades being conducted in circles; what has the trader done to verify title back to the shipper listed in the BL?

* A version of this article was first published in Trade Finance Global on 3 May 2023.

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