Subject : FINANCE/BANKING   Title :       Role Of Insider In Banking Fraud  Author : Ms. Saloni Sharma      (This article has been contributed by Ms. Saloni Sharma and

Anuradha Brahma)

Introduction

The occurrence of frauds in the banks is not a recent observable fact; infact the misdemeanor of forgery is perhaps as old as writing itself. Of the inestimable types of financial offences that our nation and all countries across the globe have had to eyewitness and undergo from, a major one is financial frauds caused in the banks popularly know as “Bank Frauds”. Any organisation which deals with money is always vulnerable to frauds and this is more so in the case of financial institutions like banks which are dealing only in money and that to as a business commodity. Bank frauds are on the augment. The graph of fraud money is mounting steeply. The reasons for increase in number of frauds in the post nationalization period is attributed to a numerous reasons, the most likely ones are the widespread branch network, lack of trained staff for the expanding network and a shift from the security oriented lending to the development oriented approach i.e. advances to the priority sectors.

Frauds in Indian banks only prove that financial liberalization aggravates the inherent tendency of shallow markets to foster excessive speculation and worsens the systemic consequences of such speculative activity. Revelations of fraud, evidence of insider trading and a consequent collapse of investor interest have led to an almost unstoppable downturn in Indian banks. Bank frauds concern all citizens. It has become a big business today. Bank frauds are the creation of professional criminals, desperate customers or of errant bankers or their collusion inter se. However the prima donna in the drama is the insider or the banker. He opens the purse. He is often the target and at times the tool.

Occasionally, he is the victim of the temptations. Other contributory factors are incompetence, lethargy, negligence, connivance and ignorance. Situational pressures and permissive attitudes of the society promote them. High gains and low stakes encourage the incidence. The rising trend makes it more and more important that ways and means are found to combat the menace.

Fraud is any dishonest act and behaviour by which one person gains or intends to gain an advantage over other person. The gain may accrue to the person himself or to someonelse. Fraud causes loss to the victim, directly or indirectly. In earthly terms bank frauds include all sorts of misappropriations, embezzlements, manipulations of negotiable instruments (cheques, drafts, hundies, bills or statements of accounts, securities etc.). Also included are misrepresentations, cheating, thefts, undue favors and irregularities. The frauds may be intentional or incidental and can be committed by (I) the bank employees themselves, (ii) the staff members of the banks in collusion or connivance with the customers or outsiders, and (iii) the customers or outsiders.

The word “Fraud” has been defined in the Indian Contract Act. In short fraud is dishonesty leading to loss to someone. Dishonesty is never accidental. Therefore there is always a swindler behind each bank fraud. The number of bank frauds in India is substantial. It is increasing with the passage of time. Bank frauds are due to the bunko and the bungler bankers, situational pressures and permissive attitudes. Fraud has not been defined in the Indian Penal Code directly. However sections dealing with cheating, concealment, forgery, counterfeiting, misappropriation and breach of trust cover the same adequately.

Hence what this paper fundamentally tries to focus on is on the banker’s responsibility vis-à-vis the reach of deception therein, consequences of such incident and tries to look into

the entire possible panacea to such a menace in the society.

Banker’s Responsibility in a Fraud

Bank frauds crop up in all spheres of banking dealing, like: Cheque frauds, Deposit account frauds, Purchased bill frauds, Hypothecation frauds, Loan frauds etc. A dishonest banker can play havoc with the bank’s money. The bank has therefore to sentinel itself and its customer’s against the deceitful employee. The vicinity of business of the banker is extensive. The following operational avenues have been noticed time and again. Manipulation of cash by those handling cash, misappropriation of customer’s deposit accounts, misappropriation of money in telegraphic transfers, clearing forged cheques and other instruments, fraudulently while working in clearing departments, creaming of the sundry accounts, tinkering with the central accounts, accepting counterfeit currency for a consideration, helping the bank robber, by giving information etc.

An analysis of frauds reported by banks to RBI broadly indicated that frauds perpetrated on banks could be classified into the following categories:-

· Misappropriation of cash tendered by the banks constituents and misappropriations of cash remittance.

· Withdrawal from deposit accounts through forged documents/instruments.

· Fraudulent encashment of negotiable instruments by opening an account in fake/fictitious name.

· Perpetration of frauds through clearing transactions.

· Misutilisation/overstepping of lending/discretionary powers, non-observance of prescribed norms/ procedures in credit dispensation etc.

· Opening/Issue of Letters of Credit, Banks Guarantees Co-

acceptance of bills without proper authority and consideration.

· Frauds in foreign exchange transactions, mainly through non-adherence to exchange control manual provisions.

Major Cases for Perpetration of Frauds

· Laxity in observance in the laid down systems and procedure by operational staff and also by supervising staff.

· Over confidence reposed in the banks constituents who, however, indulged in breach of trust and

· Frauds committed by unscrupulous constituents by taking advantage of laxity on the part of the officials in the observance of established Time-Tested safeguards.

Types of Bank Frauds

Ø Cheque Frauds: cheque frauds include frauds relating to customer’s cheques, banker’s cheques (drafts) or traveller’s cheques. They are the most important frauds both loss-wise. They take the following forms:

ü Issuance of Cheque Book under fake authority, frauds of this type have taken place where the miscreants have first successfully obtained the chequebook in the customers account and later got encashed cheques under forged signatures.

ü Frauds due to payment of materially altered cheques etc, these types of frauds are very common. The miscreant obtains/steals the cheque, materially alters the particulars of cheques and presents over the counter for payment/collection in the account with introduction/fake introduction.

ü Payments of cheques under forged signatures, such types of frauds are generally perpetrated by the

employees/partners of the account-holders.

ü Stolen Drafts/TPO leaves and issuing drafts on other branch without consideration under forged signature or otherwise, such types of frauds are committed by the staff as well as outsiders. The miscreants manage to have access to such security forms and either the whole book or some leaves out of the book are removed. The drafts are presented to the drawee branch for payment/collection. Before collection new accounts are opened without proper introduction.

ü Frauds in clearing transactions, this area is also grey for frauds in clearing process the sub-branches send their cheques to main branch and receive some cheques from the main branch. In delivery/receipt of cheques the miscreant removes/destroys some cheques manipulating the acknowledgement received/delivered to the main branch. The credit for the removed cheques is released without their actual presentation to the drawee bank. Such frauds are detected after long time where reconciliation takes place.

ü Frauds withdrawal against cheques sent in clearing-kite flying operations, misuse of cheques purchase facility without arranging for funds i.e. advances being allowed for self cheques, accommodation cheques or uncleared effects. The branch managers of different banks in the same place, acting in collusion with each other and along with constituents, allow kite-flying operations.

ü Counterfeit bank drafts, traveller’s cheques and other cheques are cashed.

ü Forged fingerprints are used on the instruments of illiterate persons.

ü Cheque-writers are employed to hide the fraud.

Ø Deposit Account Frauds: these frauds take the following

forms-

ü Accounts opened without introduction or with improper introduction, frauds under this head are generally attempted at the time of opening of new branch when such emphasis is not paid on obtention of introduction. Once the account is opened, the miscreant deposits, stolen/materially altered cheques for collection/payment etc.

ü A dormant account is fraudulently operated by a forger on forged signatures. Specimen signature card or signatures on letters are utilized as models.

ü Joint accounts are operated by one of the signatories (forger) by forging the signatures of others.

ü Mini deposit collections are not deposited by the collecting banker.

ü The banker becomes joint account holder and withdraws the money.

ü The banker manipulates the depositor’s Pass Book.

Ø Purchased Bill Frauds: the frauds in this area are often costly. They can take the following forms:

ü Bogus or stolen railway receipts and motor transport receipts accompanied by counterfeit bills are discounted.

ü Fake bills with inflated value, drawn on sister concerns, for discounts.

ü Genuine bills and railway are presented and got discounted from the bank but the material is got released from the railways on indemnity bond.

ü Bogus bills for worthless goods are discounted on the strength of dispatch papers.

Ø Hypothecation Frauds:   cash advances, against pledged goods, as security are fertile fields for frauds.

ü Stocks or part thereof, are removed unauthorizedly from the godowns.

ü Advance against pledge/hypothecation of securities, pledging inferior quality of goods, overvaluation of stocks.

Ø Loan Frauds: the general policy of the government is to encourage loans to agriculturists or to small artisans and businessmen. Infact, certain targets for these purposes are fixed for the banks. In the initial stages, it resulted in losses to the banks due to lack of expertise in the field. The following types of fraud were perpetrated.

ü Loans are taken by different persons on the same time.

ü Nomadic artisans obtain loans and vanish from the scene.

ü False firms appear everywhere and obtain loans.

ü Loans taken for agricultural development were later used as marriage celebrations.

ü In connivance with the suppliers, farm machinery bills were inflated for accessories which were never supplied and included in the bills.

ü Farm machinery purchased with loans and hypothecated to banks is sold without informing the banks or returning the loans.

Ø Fictitious entries made in book/ manipulation of record

ü These frauds normally take place with the active involvement of staff or where the books are exposed to the members of public. In such cases, subsequently the record is

destroyed.

Ø Cash shortages

ü Cash the most sensitive asset of the bank is prone to fraud. The shortages of fraud there is generally due to carelessness/negligence of the concerned staff who are the joint custodians of cash.

Ø Frauds in Borrower Accounts

ü Advance against clean/documentary bills purchased/discounted. The borrower committed frauds by tendering fake bills/accommodation bills/cheques for discounting. Later when the bills/cheques are received unpaid, the banks find it difficult to recover the amount.

ü Advance under some priority sector schemes.

ü Advance granted in haste or at the behest of top management or any pressure or some consideration.

ü Incomplete credit information

ü Lack of post disimbursement supervision.

ü Mis-use of discretionary powers or exceeding discretionary powers by Managers/Officers.

Ø Frauds in Investment Portfolios

ü Investment portfolio which constitutes a big chunk of the total assets of a bank is another fraud prone area. The dealer in securities in the absence of proper policy, direction and adequate system of checks and balances may misuse the position for his personal gains to the detriment of bank’s interest by putting through deals for passing on business to the brokers which are otherwise not warranted by business considerations.

Ø Frauds in Foreign Exchange Areas

ü Frauds in this area are perpetrated in the dealing room operations, documentary credits, export-import transactions, packing credit etc.

ü Some of the dealers have been put through fictitious deals with the help of brokers due to lack of back-up functions.

Ø Frauds in computerized environment

ü Hardware errors disable the working of any of the component of hardware with a view to creating/temporary/permanent malfunction to either destroy the data or present its disclosure for security. Prgomme errors are created by miscreants to cripple the system or to siphone off the funds to unauthorized accounts or to prevent/reduce charges to select accounts. Data entry errors are created by staff to give undue gain to interested accounts. Errors are made to give a wrong picture of sentive data such as balances, classification of advances, outstanding dues, interest rate applied etc.

Ø Frauds in inter branch and inter bank accounts

ü Debiting bank accounts without remitting cash.

ü Debiting branch adjusting account without remitting cash.

ü Adjusting branch books-clean cash.

ü Fraudulently debiting/crediting Head office account.

ü Debiting/Crediting various deposit accounts without authority.

Departmental Inquiries, Police Investigation and Punitive Action

The foremost steps in all cases of bank frauds are to

ascertain a prima facie case that a fraud has been committed. This is essential because in some cases what may appear as a case of fraud may be merely a case of negligence or a case of failure of rules and procedures prevailing at the time of occurrence. Or it may be just an unintentional non-cognizable offence where no dishonest or criminal intent is involved. To call a case of negligence or failure of judgement as a fraud case may not only be fruitless but it may also effect the morale and enthusiasm of dynamic bankers, who serve and venture beyond the normal routine, to provide better banking service and introduce innovations. Prima facie case is established through a preliminary investigation. It ascertains: corpus delicti, i.e. whether a crime has been committed or not, the nature of the offence, the identity of the culprits etc.

· Preliminary Investigation

These preliminary investigations are carried by bankers themselves in most of the cases-infact in all those cases where the case is not of an extraordinarily large dimension and has not become a “darling” topic of media men. The work s being taken up by a specialized branch of bank known as the vigilance department. However vigilance departments, in most of the banks are yet in their infancy and have not developed the necessary expertise or strength to carry the investigations have, therefore, to be carried out by the branch manager of the affected branch. Preliminary investigation starts with the information received from the informant, the enquiries are extended to the victim, perusal of the involved records and careful scrutiny of the files, account books and other fiduciary documents. They reveal facts which may indicate that a fraud has been committed. They may also point towards the possible culprits. Or the examination may reveal that no fraud has been committed.

· Departmental Processing

Real department processing starts after a prima facie case

has been established and a report on the preliminary investigation has been accepted by the regional office. The regional office ordinarily takes the following action: depute some senior bank officer to verify the preliminary report, instruct the branch manager to file an FIR, takes action against offending employees, informs vigilance, head office and audit and inspection departments, giving all the available details in the proforma devised by some banks and seeks guidance for further action. Processes insurance claims and monitors progress and informs head office. The decision, whether the case is to go to the police or to the vigilance department or whether it is to be dealt with by the administration department, is to be taken by the vigilance department. The decision is based upon the evidence collected in the preliminary investigations.

· Vigilance Department

Vigilance department of a bank plays a pivotal role in the departmental processing of all cases of frauds. Vigilance departments have come up in all the major banks with varying degrees of responsibilities, functions and staff composition. They receive the cases from various departments and refer them to the appropriate authorities; Legal cell, Disciplinary Authority, Disciplinary Action Cell, Central Vigilance Commission, senior bank officers, local- policies, CID, CBI etc. In addition they keep a statistical data and monitor the movement of the files on the case.

· Central Vigilance Commission

The CVC plays an important part in all vigilance cases where senior officers of the ranks of MMGS (Scale III) are involved. Theoretically, it plays only an advisory role in cases of bank frauds involving senior officers. The banks may not accept the advice of the CVC. However in practice, the CVC has complete strong hold. If the advice of the CVC is ignored, the reasons for the same have to be put up before the Parliament, where more harm is done than by the “ignored

advice” of the CVC. The bank, though, can delay its implementation indefinitely by shutting the files to and fro at the least speed it can muster. And the tortoise race, which may easily go on for a decade, can be enchanting to watch.

· The Reserve Bank of India

The RBI carries out the post mortem examinations of all bank frauds. All banks are requested to report details of all the fraud cases whenever they are discovered to the RBI on a standard format, formulated by the RBI and the banks. In addition, the RBI obtains reports on bank frauds periodically from all banks. The RBI has set up an Investigation Cell in its central office also. It is manned by ace investigators of high status and vast experience. It investigates cases like; bank frauds involving very senior executives, bank frauds which involve huge amounts, frauds involving more than one bank and complicated bank frauds of high sophistication and novel techniques. The bank team goes deep into the root cause of the bank frauds and suggests exhaustive preventive measures. The RBI carries out detailed studies and researches in the commission of bank frauds and suggests innovations to prevent frauds.

· Police Investigations

The police investigate cases which involve dishonesty and criminal intent. Such cases are cognizable offences. It is the duty of the police to take p investigation of all cognizable offences, when they come to their notice or they are informed about the same by anyone-in bank fraud cases usually it is the banker, the customer, auditor, etc. even the public is enjoined upon to report to the police such cases which involve corruption, breach of trust or counterfeit currency. The three police agencies which take up investigation of bank frauds and other bank crimes are: local police, district crime branch or the state Criminal Investigation Department CID and the Central Bureau of

Investigation (CBI).

· Punitive Action

Punitive action against a defaulter not only deters the culprit but also other potential defaulters. Punishment to the guilty is, therefore essential to maintain discipline and rule of law. The punishment must however be awarded with due regard to the principles of natural justice and rules and orders prevalent in the organisation. If they are not followed the administration is described as harsh, unreasonable and dictatorial.

Conclusion

In a bid to keep pace with the changing times, the banking sector has diversified its business; this has caused a dent on credibility of the system in terms of control and supervision. Many a times public funds are squandered in the guise of “commercial decisions”. “Replacement of the philosophy of class banking with mass banking in the post nationalization period has thrown a lot of challenges to the management in reconciling the social responsibility with economic viability” well said by the CBI. According to CBI reports on various cases on bank frauds, bankers often exceed their discretionary powers in allowing credit facilities to certain clients, which results in non-performing assets. They feel that factors extraneous to banking should not be allowed to influence the decision making process of bank officials even in case of valued customers. Since banks have clear cut delegated financial powers, sanction of credit facilities, strictly in terms of prudent banking norms, should be ensured. A large number of bank frauds also take place on account of active-employee-outsider partnerships, in which bank staff concerned facilitates the crime and are often its undiscovered beneficiaries. Such cases are more difficult to track down, particularly they are targeted for the operation is different from that in which the guilty staff is officially

working.

The dividing line between operational neglect and the perpetration of fraud is rather thin, considering the growing aspiration for effortless money which is always sweet, because it is not hard-earned but belongs to the seating taxpayer. If financial systems and their large financial resources, drawn from public money, are to be protected, the occurrence of fraud big and small has to be stamped out. What is needed not another piece of complex legislation or another high-powered expert body of the RBI, but analysis and concerted application of controls by bank managements and their operational staff.

Every law/regulation has ambiguity and loopholes, for the criminally minded to take advantage of. Developed countries like USA and UK have regulations to prevent and put a stop to banking fraud for the past several decades. But every now and then a major scam surfaces. Even if case of role of insider in banking fraud is established, can it book the “culprit” before he is encouraged to repeat it, in the light of our complicated judicial process and the courts mind-boggling backlog of work! With the long time lag between the commission of an offence and the conviction of the same, how can one ensure that the ill-gotten gains are taken out of the hands of the perpetrator?

The role of insider in banking fraud, however, pernicious it may be, is here to stay. For one detected case, there can be numerous instances, which remain undetected. Constant vigilance may reduce its frequency and magnitude, but complete eradication is just not possible, at least in India under the present social, political and economic set up.

Types of banking fraud

As a customer you may be seen as a potential target for fraudulent activities. However by arming yourself with information and tools you can protect yourself from becoming a victim of fraud.

Do you know the four biggest fraud threats you face?

Electronic fraud

Identity theft

Credit/Debit card fraud

Cheque fraud.

Credit/Debit card fraud

Credit card and debit card fraud is a crime whereby your credit or debit card can be reproduced in order to use the credit balance to obtain a financial advantage. The creation and/or alteration of a credit/debit card occurs when the information contained on the magnetic strip is reproduced. This type of crime is known as ‘skimming’.

Credit or debit card fraud can also occur when your card is lost or stolen and used by a third party to purchase goods with those cards or to remove cash from the cards.

Credit or debit cards can also be intercepted in transit while being sent to you. Your cards can also be compromised by a dishonest merchant who undertakes unauthorised duplicate transactions on your card.

Protect your credit / debit card:

Memorise your personal identification number (PIN). Don't use the same PIN for all your cards, and don't choose your birth date or other easily identifiable numbers that might be on something else in your wallet.

Check statements and call your credit card issuer immediately if you see anything suspicious on your bill. You could help the company uncover fraud—and save yourself from paying unauthorised charges.

Do not let your credit card out of your sight at anytime – for example, at a restaurant – go with the card.

Card fraud is not applicable in Australia only – be just as vigilant when travelling overseas, credit card skimming is an international crime.

Always sign your card in ink as soon as you receive it.

Keep track of when new and reissued cards should arrive, and call the credit card issuer if they don't come on time.

Make sure your mailbox is secure, and that only you and the postal carrier have access to it.

Tear up all credit card receipts and pre-approved credit card offers into small pieces before you throw them away. Keep your billing statements in a safe place.

When you use your credit card online, make sure you are using a secure website. Look for a small key or lock symbol at the bottom right of your browser window.

Never give your card number to strangers or telemarketers who call you on the phone. Don't give your card number unless you initiated the call.

 

Cheque fraud

What is cheque fraud?

Cheque fraud is the use of a cheque to get financial advantage by:

altering the cheque (payee/amount) without authority

theft of legitimate cheques and then altering them

duplication or counterfeiting of cheques

using false invoices to get legitimate cheques

depositing a cheque into a third party account without authority

depositing a cheque for payment knowing that insufficient funds are in the account to cover the deposited cheque.

How to protect yourself from cheque fraud

Reconcile your accounts promptly and regularly

Never sign blank cheques, and only sign cheques after all details have been completed.

Limit the number of signatures to your account to ensure control.

Ensure that your signature is not with documents that can be accessed by the general public.

Keep all cheques secure when not in use to deter theft.

Don’t leave any gaps in the completion of the payee name, amount in words and in figures.

If cheques are lost or stolen contact ANZ immediately and ask them to stop payment on the cheque.

Ensure that any invoices are valid before payment.

Consider using electronic means of payment (if possible) for high value payments.

Ensure that your mailbox is secure to protect your inward cheques.

Electronic fraud

Email scams and fake websites

A number of customers from Australian financial institutions have been targeted with hoax emails. These emails appear to be genuine bank emails.

Some emails inform the customer that their security details and passwords need to be updated by logging into an authentic looking, but fake website. The purpose of these websites is to obtain your log on details to access your bank accounts.

Others communicate security messages and advise you to install software from the email that checks and removes viruses. By downloading the software you are in fact tricked into downloading a virus.

ANZ will not send you an email asking for your Account Details, Financial Details, or login details for ANZ Phone Banking, ANZ Mobile Banking or ANZ Internet Banking.

If you have any concerns, call the Internet Banking Help Desk on13 33 50 

Identity theft

Identity theft is where your personal details are obtained to get some sort of financial or other benefit, leaving you the owner of that identity often in large debt with a negative credit history and in some cases with legal implications.

Your information can be obtained in many ways:

Theft, including theft of mail from your mailbox at home

By going through your garbage bins

Telephone, Fax and Mail scams

Internet.

The following can be used to assume your identity:

Date of birth

Utilities bills (phone, gas, water and rates notices)

Address.

Given the revelations about alleged fraud within UBS, where Kweku

Adoboli is accused of losing the bank £1.4bn, it is worthwhile reminding

ourselves of some basic facts wrt frauds.If you think that a fraud may be happening then fear the worst.In my roles as Head of Internal Audit and International Forensic Co-ordinator, in

both Philips and De Beers, I have had many years of experience investigating

frauds. Based on this experience I have put together my personal ‘top ten’ list of

reasons why frauds occur.

1. Greed – good old fashioned human nature intervenes when an individual, or

group of individuals, sees a chance to make ‘a fast buck’. A good example being

those cases where people ‘adjust’ their expense claims upwards.

2. Lack of transparency - complex financial transactions that are difficult to

understand are an ideal method to hide a fraud. The Barings fraud was

perpetrated by use of an accounting ‘dump account’ that no one understood.

3. Poor management information – where a company’s management

information system does not produce results that are timely, accurate, sufficiently

detailed and relevant; the warning signals of a fraud, such as ongoing theft from

the bank account, can be obscured.

4. Excessively generous performance bonus payments – the more generous

the bonus, when coupled to a demanding target; the more temptation there is to

manipulate results, such as year end sales figures, to reach that target.

5. Non independent internal audit department – where an organisation’s

internal audit department is not independent, e.g. where it does not report to a

truly independent audit committee but to the Finance Director, the more likely

that when there are signals that a fraud is occurring the more likely they will be

ignored. It is indeed interesting to note that Cynthia Cooper (Head of Internal

Audit at WorldCom) had to bypass her boss (the CFO) and go directly to the

audit committee to report the discovery of the capital expenditure fraud.

6. Lack of clear moral direction from senior management – leadership comes

from the top. Where the senior management indulge themselves in ‘semi corrupt’

behaviour, e.g. adjusting their expense claims upwards, others will follow

adopting the well worn mantra ‘everyone’s at it’.

7. Excessively complex organisational structure - designed to obfuscate the

revenue streams; and so hide reality from third parties, such as the Internal

Revenue Service. Enron, with its complex off balance sheet structure and

transactions, is a textbook example of this.

8. Poor accounting controls– where the accounting controls, such as a monthly

reconciliation of the bank account, are lapse the signals that a fraud has occurred

will be missed.

9. Arrogance – some people believe that they are better than ‘the system’, and

that they can get away with anything. The late Robert Maxwell plundered his

company pension scheme, arrogantly assuming that since he was chairman of

the company he could get away with it; he almost did!

10. Complacency – I have met many a manager who has an almost childlike

faith, based in part on the ‘old boy’ network, in the probity of their colleagues;

believing that fraud ‘is not the sort of thing that could happen here’. Others will,

and do, take advantage of that trust.

My simple advice is, if you think that a fraud may be happening then fear the

worst; because it probably is.