Artificial intelligence (AI) has been mooted as a solution to help stamp out fraud in the alternative credit sector, in the wake of several high-profile bankruptcy cases triggered by alleged wrongdoing.
Fraud risk remains one of the main concerns for investors entering the space, a fear brought into sharp focus by the collapses of auto parts dealer First Brands and auto lender Tricolor last year.
The most common types of fraud in private credit typically include misreporting, the invention of non-existent assets, the double pledging of assets that do exist or “carrousel fraud”, which involves collusion with connected companies.
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Nick Stainthorpe, partner at law firm Reed Smith, explains that preventing fraud largely depends on the information available to lenders or other transaction parties. The main need here is objectively verified information on assets and performance, he says, and using software or technological solutions may be key to monitoring in a continuous way.
“This also goes to misreporting – AI comes into that and the way that it can be used to interpret relatively complex data sets and correspondence in a more flexible way,” Stainthorpe told Alternative Credit Investor. “That is part of the solution.”
For example, software could verify reporting by cross-checking lending systems against company bank account cashflows. This could also help curb double pledging, particularly if paired with a third-party verification agent with visibility over all assets in all financing arrangements, he explains.
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“If these risks are largely eliminated then there should be more funding available to honest borrowers,” Stainthorpe added.
He acknowledges that there will always be “bad actors” but insisted that if lenders are receiving verified real time information it becomes “a great deal harder to commit fraud”. “The more difficult that is, the less tempting it will be,” he said.
Speaking to ACI, Lucas Detor, managing principal and member of the investment committee for global alternative investment manager AB CarVal, agrees that AI could help combat fraud.
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“AI is a thought tool, so I think if you use it smartly it can help you think better or faster,” he said. “We’re using it very intensely at AB CarVal by and large.
“In places where we are analysing big data like our loan portfolios and things like that, yes absolutely. As we can interrogate the data much differently and much more quickly.”
