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FRM Exam Part II · Case Study: Financial Crime and Fraud

Types of Financial Crime and Fraud for FRM Part II

Updated 11 October 2026 · Fact-checked

Financial crime is illegal conduct that targets or uses a financial institution for gain. Main types are internal fraud, external fraud, money laundering, bribery, insider trading and cyber-enabled fraud. To solve questions, identify who acts (insider or outsider), what the aim is (theft or hiding proceeds), then map to the Basel event type.

Understand Types of Financial Crime and Fraud

Financial crime is a broad term. It covers any illegal act that steals from, deceives, or misuses a financial firm or the financial system. Fraud is one part of it. Fraud means deliberate deception to gain money or an advantage.

The first split is by who does it. Internal fraud involves at least one employee or insider. Examples are unauthorised trading, embezzlement, falsifying records, and bribery taken by staff. External fraud is done by outsiders with no insider role. Examples are forged cheques, loan application fraud, card fraud, account takeover and hacking for theft.

Other crimes differ by purpose. Money laundering is not theft. It hides the illegal origin of funds so they look legitimate. It typically runs through placement, layering and integration. Bribery is offering or accepting something of value to influence a decision. Insider trading is trading on material non-public information. Cyber-enabled fraud uses technology, such as phishing, business email compromise or ransomware, to commit theft. It is a method, so it can be internal or external.

In Basel operational risk taxonomy, two event types matter most here. Internal Fraud covers intentional misreporting, unauthorised activity, theft, fraud, bribery and insider trading on the firm's own account (not the employee's personal account), where at least one internal party is involved. Insider trading by staff more broadly is mainly a conduct, legal and compliance issue. External Fraud covers theft, forgery and hacking damage by third parties. Money laundering and sanctions breaches are mainly seen as compliance and conduct risks. They often map to Clients, Products and Business Practices, or to compliance failures, and they carry large fines and reputational damage.

A fast rule: the Basel event type follows who committed the act, not the tool used. A cyber attack by an outsider that steals funds is External Fraud. The same theft done by a staff member using system access is Internal Fraud.

Key formulas to remember

Internal vs external test
Insider involved → Internal Fraud; outsider only → External Fraud
Basel internal fraud needs at least one internal party. Collusion between an employee and an outsider is internal fraud.
Money laundering stages
Placement → Layering → Integration
Placement puts cash into the system. Layering obscures the trail. Integration returns funds as apparently legitimate wealth.
Fraud triangle
Pressure + Opportunity + Rationalisation
Three conditions that tend to be present when fraud occurs. Controls mainly reduce opportunity.
Cyber-enabled fraud mapping
Technology = method; actor decides the event type
Do not create a separate Basel category for cyber fraud.

How to solve Types of Financial Crime and Fraud questions

Use this sequence for any scenario question on types of financial crime.

  1. 1Read the facts and find the actor: employee, outsider, or both.
  2. 2Find the purpose: stealing value, hiding illegal funds, gaining an unfair market edge, or influencing a decision.
  3. 3Name the crime: fraud, money laundering, bribery, insider trading or a cyber method.
  4. 4Map to the Basel event type: Internal Fraud or External Fraud for theft and deception; consider Clients, Products and Business Practices or compliance for laundering and sanctions.
  5. 5Check for collusion. Any insider involvement makes it Internal Fraud.
  6. 6Eliminate options that confuse method with category, such as calling phishing its own event type.
  7. 7Pick the answer that matches both the actor and the purpose.

Quickest way: Actor and purpose in ten seconds

When to use it: Use when a scenario is short and options list crime names or Basel event types.

  1. Ask: insider or outsider? Any insider means Internal Fraud.
  2. Ask: stealing or hiding money? Hiding means money laundering.
  3. Ask: trading on secret information? That is insider trading.
  4. Treat cyber as the tool and keep the actor-based category.

Common mistakes in Types of Financial Crime and Fraud

  • Treating money laundering as a type of theft or fraud loss

    Both involve illegal money and appear together in AML teaching.

    Fix: Laundering hides the source of funds. Fraud takes funds by deceit. They can be linked but are distinct.

  • Classifying a cyber attack as its own Basel event type

    Cyber is a popular topic and sounds like a category.

    Fix: Map by actor. Outsider theft is External Fraud; insider misuse of systems is Internal Fraud.

  • Calling employee and outsider collusion external fraud

    The outsider seems to be the main beneficiary.

    Fix: If at least one internal party is involved, it is Internal Fraud.

  • Assuming rogue trading is only a market risk event

    The loss shows up in trading positions.

    Fix: Unauthorised trading with intentional concealment or misreporting is Internal Fraud under operational risk. Basel lists unauthorised activity under Internal Fraud, but a trade that breaches limits without any concealment may be treated differently, for example as a process or conduct failure. Always check the facts for intent and concealment.

  • Thinking insider trading means any trade by an employee

    The word insider is read literally.

    Fix: It needs material non-public information used for trading advantage.

Worked examples

Example 1

A branch manager approves loans to shell companies run by his cousin and takes a share of the proceeds. Which Basel operational risk event type applies, and why?
A. External Fraud
B. Internal Fraud
C. Clients, Products and Business Practices
D. Execution, Delivery and Process Management

Show the solution
  1. Actor: an employee, the branch manager, is involved.
  2. Purpose: theft through deception, with bribery-like kickbacks.
  3. An outsider is also involved, but one insider is enough.
  4. Basel Internal Fraud requires at least one internal party.

Answer: B. Internal Fraud.

Example 2

A criminal sends convincing emails posing as a corporate client's CFO and persuades a bank clerk, acting in good faith, to wire USD 2 million to an account the criminal controls. Classify the event.
A. Internal Fraud
B. Money laundering
C. External Fraud
D. Insider trading

Show the solution
  1. Actor: an outsider. The clerk was deceived and did not collude.
  2. Purpose: stealing funds, not hiding their origin or trading on information.
  3. The method, email impersonation, is cyber-enabled but is not a separate category.
  4. Outsider theft maps to External Fraud.

Answer: C. External Fraud.

Exam tips

  • Look for the actor first. Most questions turn on insider versus outsider.
  • Expect distractors that name the method, such as phishing, as the category.
  • Remember money laundering questions often test the three stages or the compliance consequence, not loss type.
  • Collusion cases are a favourite trap. One insider makes it Internal Fraud.

Practice questions from Case Study: Financial Crime and Fraud

Types of Financial Crime and Fraud in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Types of Financial Crime and Fraud: frequently asked questions

What is the difference between fraud and money laundering?

Fraud is deception to obtain money or advantage. Money laundering is disguising the illegal origin of funds so they appear legitimate. Fraud proceeds are often what get laundered.

What is internal fraud vs external fraud in Basel event types?

Internal Fraud involves at least one employee or insider acting intentionally against the firm or its rules. External Fraud is committed by third parties with no internal involvement.

Is cyber fraud a separate operational risk event type?

No. Cyber is a method. The event type depends on who commits it, so outsider theft is External Fraud and insider misuse is Internal Fraud.

Where does insider trading fit in operational risk?

Basel Internal Fraud includes insider trading on the firm's own account. It does not clearly cover staff trading on their personal account. Staff insider trading more broadly is a conduct, legal and compliance issue, and it also creates reputational risk.