Fraud is a serious issue. In 2020 alone, the total global loss from payment fraud rose to $32.39 billion. This amount is expected to rise even further to reach $40.62 billion in 2027. As businesses selling online goods and services are likely to encounter fraud cases, the rise of the digital economy could bring about even more risks.  

While Know-Your-Customer (KYC) is a commonly used and widely adopted process that plays a crucial role in reducing the risk of fraud, many businesses fail to realise that fraudsters do not only disguise themselves as customers. Instead, merchant fraud is one of the most common and costly causes of financial loss for merchant acquirers. 

As such, it is of utmost importance to understand some of the common types of merchant fraud and how Know-Your-Business (KYB) processes can work to protect businesses from merchant fraud. 


The Common Types of Merchant Fraud

Generally, in merchant fraud schemes, defrauders pretend to be legitimate businesses with fake merchant accounts. While there are a large variety of fraud schemes out there, there are a few common types of merchant fraud that occur:

Bust-Out Fraud

In a bust-out fraud, a “merchant” opens up a merchant account with no intention of being legitimate. After creating the merchant account, the “merchant” will try to process as many fraudulent transactions as possible before cashing out and disappearing. In this type of fraud, fraudsters can choose to either use stolen card data or open up lines of credit with false identities. 

As this fraud scheme happens quickly, these fraudsters will often have disappeared with a significant amount before the acquiring bank is made aware of the fraudulent transactions. 

Identity Swap

In an identity swap fraud, the merchants that set up a merchant account might be running legitimate businesses. However, these merchant accounts are set up using either false or stolen identities as the merchants are prohibited from opening up a merchant account through normal channels. 

From businesses that have roots in countries where economic sanctions are imposed to merchants who belong to extremist groups (or are put on watchlists such as World Bank Ineligible Firms, US’s Denied Persons List, and EU Terrorist List), these merchants commit identity swap fraud in order to bypass the AML compliance programmes that are set up by the merchant acquirers.

Changing Business Format

In order to get approval for a merchant account, some merchants who own high-risk businesses conceal their activities and apply for an account by changing the nature of the products and services provided. By disguising the true nature of their business, merchants are able to breeze through the checks put in place by the merchant acquirers and obtain a low-risk profile. 

In a world where there is an increasing amount of micro-merchants, it is becoming difficult for merchant acquirers to conduct checks that are thorough enough to prevent these high-risk businesses from obtaining a merchant account. 


What is Know-Your-Business (KYB)

Similar to KYC processes, the KYB process includes a set of measures that are put in place to collect comprehensive information. Unlike KYC, however, KYB focuses on identifying the person accountable (or legal representative) of a business rather than a consumer.

By carrying out the due diligence with the businesses during the onboarding process, fraudulent entities can be prevented from carrying out their schemes. With an effective and comprehensive KYB protocol in place, institutions will also be able to verify and validate all the data collected, allowing them to build a proper risk profile for every business that they are dealing with. 

With the digitalisation of KYB, digital solutions can assist institutions to speed up the process while also guaranteeing that all information obtained is vetted and reliable, allowing them to avoid situations of merchant fraud.