2025 Risk Series: Fraud Prevention & Internal Controls

The Regulatory Risks

Fraud threats are growing more sophisticated, and community banks are prime targets for financial crimes. Internal fraud, cyber-enabled fraud, and third-party fraud all present serious risks that can result in significant financial losses, regulatory enforcement actions, and reputational damage.

Regulators expect robust internal controls, fraud detection systems, and risk management frameworks to protect against both insider and external fraud. Weak internal controls and ineffective fraud prevention measures can leave banks vulnerable to regulatory scrutiny and substantial financial penalties.

Example Enforcement Actions

Regulatory agencies have issued enforcement actions against banks for failing to implement adequate fraud prevention, internal controls and transaction monitoring, including:

• Clear Fork Bank (2024):  Entered into OCC Consent Order that requires implementation of monitoring systems that apply appropriate rules, thresholds, and filters for monitoring transactions, accounts, customers, products, services, and geographic areas commensurate with the bank’s BSA/AML risk profile.

• Popular Bank (2023):  Fined $2.3 million by the FRB for processing $1.1 million Paycheck Protection Program loan applications despite detection of potential fraud in the loan applications and for failing to timely report the potential fraud.

• CommunityBank of Texas (2021):  Fined $1 million by the OCC and $8 million by FinCEN for significant failures to implement an adequate AML program to guard against money laundering, to allocate sufficient staffing for the AML program, and to investigate a substantial number of suspicious activity case alerts.

Key Risks to Address Now

• Inadequate Internal Controls & Segregation of Duties:  Banks must implement checks and balances to prevent unauthorized transactions and insider fraud. Proper role-based access, dual control procedures, and periodic audits are necessary to mitigate internal fraud risks.  

• Weak Fraud Detection & Monitoring Systems:  Fraud schemes evolve quickly. Banks need real-time fraud monitoring tools, analytics, and transaction anomaly detection to prevent fraud losses before they escalate.  Banks must also allocate sufficient resources to sustain these systems.

• Cyber Fraud & Digital Banking Threats:  Increasing reliance on digital banking services introduces heightened risks of account takeovers, phishing attacks, and wire fraud. Banks must ensure robust cybersecurity controls, customer authentication measures, and fraud detection mechanisms.

• Third-Party & Vendor Fraud Risks:  Banks that partner with vendors and fintechs must ensure these third parties uphold strong fraud prevention measures. Weak vendor oversight can lead to fraud exposure through compromised systems or bad actors.

• Lack of Employee Training & Oversight:  Employees must be regularly trained to recognize fraud red flags, follow fraud prevention protocols, and report suspicious activities. Without adequate training and oversight, fraud risks increase significantly.

Strategies to Strengthen Fraud Prevention & Internal Controls

• Enhance Internal Controls & Employee Oversight

  • Implement dual control measures for high-risk transactions.

  • Restrict access to critical financial systems based on job roles.

  • Conduct unannounced internal audits to detect and deter fraudulent activity.

• Invest in Advanced Fraud Detection Systems

  • Deploy appropriately vetted technology to monitor transactions in real-time.

  • Ensure transaction monitoring systems integrate with cybersecurity frameworks.

  • Ensure sufficient resources are allocated to maintain these systems.

• Strengthen Cyber Fraud Prevention

  • Require multi-factor authentication for digital banking access.

  • Implement real-time alerts for high-risk transactions and account takeovers.

  • Conduct regular penetration testing and cybersecurity audits.

• Ensure Strong Vendor Fraud Risk Management

  • Require third-party partners to maintain robust fraud controls and security protocols.

  • Establish clear contractual obligations for fraud prevention responsibilities.

  • Conduct vendor risk assessments and compliance audits regularly.

• Increase Employee Training & Fraud Awareness

  • Provide fraud prevention training for all employees at least twice a year.

  • Conduct internal fraud simulations to test employee responses to fraud scenarios.

  • Implement an anonymous fraud reporting system to encourage whistleblowing.

Take Action Now

Community banks must proactively implement strong internal controls and fraud detection measures to stay ahead of sophisticated fraud schemes and to avoid financial losses and regulatory fines.

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Stay tuned for the next edition in our blog series: "Governance, Compliance Management, & Board Oversight."