“Fraud in the Banking Sector – causes,

concerns and cures”

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Presented by

Venkatesh, M.K.

Sr. MBA (ABM)

Introduction

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Banks are an essential part of the Indian economy.

While the primary responsibility for preventing frauds lies with

banks themselves.

Banks are dealing with public's money and hence it is imperative

that employees should exercise due care and diligence in handling

the transactions in banks.

The RBI has been advising banks from time to time about the

major fraud prone areas and the safeguards necessary for

prevention of frauds.

Definition of fraud

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Fraud can loosely be defined as “any behaviour by which one

person intends to gain a dishonest advantage over another“

fraud, under section 17 of the Indian contract act, 1872,

RBI not defined the term “fraud” in its guidelines on frauds

which reads as under.

“A deliberate act of omission or commission by any person,

carried out in the course of a banking transaction or in the

books of accounts maintained manually or under computer

system in banks, resulting into wrongful gain to any person for

A temporary period or otherwise, with or without any monetary

loss to the bank”.

Table 1: Number of frauds cases reported by RBI

regulated entities

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Sl. No. Category No. of cases Amount involved

1 COMMERCIAL BANKS 169190 29910.12

2 NBFCs 935 154.78

3 UCBs 6345 1057.03

4 FIs 77 279.08

5 Total176547 31401.01

(No. of cases in absolute terms and amount involved in Rs. crore)

Source: BIS central bankers’ speeches 26 July 2013.

Types of frauds

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Account opening fraud: this involves a deposit and cashing of

fraudulent cheques.

Cheque kiting: is a method where by a depositor utilizes the

time required for cheques to dear to obtain an unauthorized

loan without any interest charge.

Cheque fraud: most common cases of this kind of fraud are

through stolen cheques and forged signatures.

Counterfeit securities: documents, securities, bonds and

certificate could be forged, duplicated, adjusted or altered and

presented for loan collection.

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Computer fraud: hacking, tampering with a diskette to gain

access to unauthorized areas and give credit to an account for

which the funds were not originally intended.

Loan fraud: when funds are lent to a non-borrowing customer

or a borrowing customer that has exceeded his credit limit.

Money laundering fraud: this is a means to conceal the

existence, source or use of illegal obtained money by converting

the cash into untraceable transactions in banks.

Money transfer fraud: alteration of a genuine Funds transfer

request.

e.g Mail, telephone, electronic process, telex.

Latest technology of using GSM phones.

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Telex Fraud: The messages that are passed through telex in

form of codes could be altered to divert the funds to another

account

Letters of Credit: Most common in international trading, these

are instruments used across borders ads can be forged, altered,

adjusted and take longer to identify.

Advanced Fees Fraud: Popularly known as ‘419’, advanced

fees fraud may involve agent with an offer of a business

proposition which would lead to access often for a long term.

Table 2: Year-wise and amount of fraud cases in

the banking sector

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(No. of cases in absolute terms and amount involved in Rs. crore)

Sl. No. Year No. of cases Total

amount

1 2009-10 24791 2037.81

2 2010- 11 19827 3832.08

3 2011- 12 14735 4491.54

4 2012- 13 13293 8646.00

5 Total frauds reported as of march 2013 169190 29910.12

Source: BIS central bankers’ speeches

Table 3: Bank Group wise fraud cases

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Sl. No. Bank group No. of

cases

% To total

cases

Amount

Involved

% To total

Amount

1 Nationalised banks

including SBI group

29653 17.53 24828.01 83.01

2a Old Pvt. Sector banks 2271 1.34 1707.71 5.71

2b New Pvt. Sector Banks 91060 53.82 2140.48 7.16

3 Sub total (private banks) 93331 55.16 3848.19 12.87

4 Foreign banks 46206 27.31 1233.92 4.12

6 Total 169190 100 29910.12 100

(No. Of cases in absolute terms and amount involved in Rs. Crore)

Source: BIS central bankers’ speeches

Category of frauds

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1. Technology related

2. KYC related (mainly in deposit accounts)

3. Advances related

Technology related: The Technology related fraud around 65%of the total fraud cases reported by banks.

(covering frauds committed through /at internet bankingchannel, ATMs and other alternate payment channels likecredit/debit/prepaid cards)

Banks are adopt newer service delivery platforms like mobile,internet and social media, for enhanced efficiency and cost-cutting.

Banks’ customers have become tech savvy and started usingonline banking services and products.

.

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The above evident that incidence of cyber frauds is extremely

high, the actual amount involved is generally very low.

RBI has advised banks in February 2013 to introduce two

factor authentication in case of “card not present” transactions,

converting all strip based cards to chip based cards for better

security.

The electronic modes of payment like NEFT and RTGS are

introduce.

RBI has advised banks to introduce preventive measures such

as putting a cap on the value/ number of beneficiaries, velocity

checks on number of transactions effected per day/ per

beneficiary, and introduction of digital signature for large value

payments.

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Table 4:Bank Group wise Technology Related Frauds

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Source: BIS central bankers’ speeches

KYC related fraud

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KYC (Know Your Customer) is a framework for banks which

enables them to know / understand the customers and their

financial dealings to be able to serve them better.

RBI has advised banks to make the KYC procedures

mandatory while opening and operating the accounts.

Issued the KYC guidelines under section 35 (A) of the banking

regulation act, 1949.

For this purpose, the fraudsters generally use deposit accounts

in banks with lax KYC drills.

Therefore, customers to guard against such temptations for

easy money but should also ensure that deposit accounts

maintained with them are fully KYC compliant.

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They provide an essential part of sound risk management

system (basis for identifying, limiting and controlling risk

exposures in assets & liabilities.

4 key elements of KYC policies

customer acceptance policy

customer identification procedures

monitoring of transactions

risk management

Frauds in banks’ advances portfolio

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Frauds related to the advances portfolio accounts for the largest

Share of the total amount involved in frauds in the banking

sector. (Involving amount of Rs. 50 crore and above)

Another point that public sector banks account for a substantial

chunk of the total amount involved in such cases.

Declaration of frauds by various banks in cases of consortium/

multiple financing we have on occasions observed more than 12–

15 months lag in declaration.

The large value advance related frauds, which pose a significant

challenge to all stakeholders, are mainly concentrated in the

public sector banks.

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Majority of the credit related frauds are on account of deficient

appraisal system, poor post disbursement supervision and

inadequate.

Reserve bank has also advised banks to audit periodically so

that cases of multiple financing may be detected in the initial

stages itself.

Table 4: Bank Group wise Advance Related Frauds

Rs. 1 Crore & above in value

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Source: BIS central bankers’ speeches

Case 1

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Date of Detection: 05/03/2012

Name of the Branch: Dhuri Branch, State Bank of Patiala.

Amount involved in Rs: 8.75 crores

Brief facts of the case: The branch had financed agriculture business.

Cash Credit limits to 3527 sugar cane growers under tie up

arrangement with M/s Bagwanpura Sugar Mills, who stood as a

guarantor.

As per the tie up arrangement the antecedents of the borrowers were

to be verified by the company.

only 1186 borrowers were resident of the villages and they were

found to be agricultural labourers & not cane growers.

Source: Banking Division, Ministry of Finance, New Delhi.

Case 2

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Date of Detection: 03/02/2011

Name of the Branch: Gharyala, Punjab National Bank

Amount involved in Rs: 1.14 crores

Brief facts of the case: The manager along with shri gurmeetsingh, and clerk in collusion with a group of persons in the areamisappropriated Bank's funds.

housing loans, on fabricated / fictitious revenue record,disbursed fictitious loans under small business / transport /dairy without creating any security as a conduit to siphon-offthe funds

Source: Banking Division, Ministry of Finance, New Delhi

Table 7:Year wise details of fraud cases closed

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Source: BIS central bankers’ speeches

Reporting of frauds to RBI

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Frauds involving amounts of less than Rs 1.00 lakh:

less than Rs 1.00 lakh are not to be reported individually to the

RBI.

Statistical data in respect of such frauds should, be

submitted to RBI in a quarterly statement.

Frauds involving amounts of Rs 1.00 lakh and abovebut less than Rs 25.00 lakh:

Frauds involving amounts of Rs1.00 lakh and above but lessthan Rs 25.00 lakh should be reported to the regional office ofurban banks department of RBI .

In the format given in FMR-1, and within three weeks from thedate of detection.

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Frauds involving amounts of Rs 25.00 lakh and above :

frauds involving amounts of Rs 25.00 lakh and above should

be reported to central frauds monitoring cell, department of

banking supervision, RBI.

A copy of FMR-1 should also be submitted to the regional

office of urban banks department of RBI.

In addition banks may report the fraud by means of D.O. Letter

addressed to the principal chief general manager of the

department of banking supervision, RBI, central office.

The letter may contain brief particulars of the fraud.

Letter should also be endorsed to the regional office of urban

banks department of RBI under the bank's branch.

Expectations of the supervisor

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RBI has clearly indicated that fraud risk management, fraud

monitoring and fraud investigation function must be owned by

the bank’s CEO, audit committee of the board.

In respect large value frauds, the special committee of the

board are CMDs, CEOs, audit committee and the special

committee evolving robust fraud risk management systems.

They are responsible for effective investigation of fraud cases

and accurate reporting to appropriate regulatory and law

enforcement authorities.

Top management puts in place targeted fraud awareness

training for its employees focusing on prevention and detection

of fraud.

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Audit systems prevalent in banks have not proved effective in

detecting fraud cases.

Providing individuals a means to report suspicious activity is a

critical part of an anti-fraud program.

A system of protected disclosure scheme has been evolved

which is regulated by CVC in case of public sector banks.

RBI in case of private and foreign banks.

Table 6:Bank group wise fraud cases reported

as on march 31, 2013

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Source: BIS central bankers’ speeches

CIBIL

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It is a company of checking the credit history.

Fraudulent borrowers could still seek credit from the

banking system even after defrauding one bank.

Worthwhile to consider setting up a fraud registry on the

lines of credit information bureau.

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Conclusion

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The impact of frauds on entities like banks, and the economic

cost of frauds can be huge in terms of likely disruption in the

working of the markets, financial institutions, and the payment

system. Besides, frauds can have a potentially debilitating

effect on confidence in the banking system and may damage

the integrity and stability of the economy. It can bring down

banks, undermine the central bank’s supervisory role and even

create social unrest, discontent and political upheavals. The

vulnerability of banks to fraud has been heightened by

technological advancements in recent times.

Reference

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Inaugural address by Dr K C Chakrabarty, deputy governor of

the reserve bank of India, during the national conference on

financial fraud organised by ASSOCHAM, new Delhi, 26 July

2013.

BIS central bankers’ speeches.

ACFE (Association of Certified Fraud Examiners’ Association

of Certified Fraud Examiners’)

Banking Division, Ministry of Finance, New Delhi

Int. Journal of Business Science and Applied Management /

Business-and-Management.org

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Thank you!