Frauds in banking sector have been in existence for centuries, with the earliest known frauds pertaining to insider trading, accounting irregularity, stock manipulation etc. Over the years, frauds in this sector have become more erudite and have been stretched to technology based services offered to customers. The banking sector in India is also experiencing the pain due to increase in number of fraud cases. Bank frauds have been doubled in the last 5 years. A majority of survey revealed that more than 50 fraud cases in the retail banking segment in the last two years (average fraud loss of around INR 10 lakh per case) and an average of 10 fraud cases in the non-retail segment (average loss amount to Rs 2 crore per case). India Banking Fraud Survey report showed that only 40 percent of respondents claimed such fraud losses. While most of the banks have reported an overall increase in fraud incidents within all banking segments, it comes as no surprise that retail banking has been classified as the main contributor to fraud, followed by corporate banking. As retail banking is more process as well as volume-driven, increased fraud cases in this area should trigger a wider review of the process and controls to detect the root cause as these cases could be just the tip of the iceberg. In this paper an attempt is made to understand the meaning of fraud and forgery, types of frauds, their impact on banking industry, how they can be identified and controlled.
Keywords: fraud, forgery, banking industry, rate of increase in number of fraud cases.
The number of frauds and forgeries in banks are throughout the world is ample and increasing with the passage of time. The frauds are either committed by the employers of the bank or the outsiders. Sometimes, the frauds are committed by the outsiders with the involvement and help or the negligence of the bank employees. Like banks in other countries of the world, banks in India are also facing with frauds and forgeries. The primary responsibility for avoiding or preventing frauds lies with individual commercial banks; however, the Reserve Bank of India (“RBI”) routinely advises commercial banks about major fraud prone areas and the safeguards necessary for prevention of frauds. The RBI even sets guidelines for the same. This is done so that banks can introduce necessary safeguards by way of suitable procedures and internal checks.
Meaning of Fraud:
Fraud means deceit or trickery, deliberately practiced in order to gain some advantage dishonestly, it is an intentional perversion of truth in order to induce another to part something of value or to surrender a legal right; it is an act of deceiving or misrepresenting or cheating.
The Institute of Internal Auditors “International Professional Practices Framework‟ (2009) defines fraud as, “Any illegal act characterized by deceit, concealment, or violation of trust. Frauds are perpetuated by parties to obtain money, property or services; to avoid payment, or loss of services; or to secure personal or business advantage.” It should be noted that frauds generally influences a bank by causing financial, operational or psychological loss.
Section 17 of the Indian Contract Act, 1872 defines fraud as: “Fraud means and includes any of the following acts committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive another party thereto of his agent, or to induce him to enter into the contract:-
the suggestion, as a fact, of that which is not true, by one who does not believe it to be true;
the active concealment of a fact by one having knowledge or belief of the fact;
a promise made without any intention of performing it;
any other act fitted to deceive;
any such act or omission as the law specially declares to be fraudulent.”
In Civil Law fraud is misrepresentation or connivance to deceive, commonly by way of a statement knowingly made falsely, or without honest belief in its truth, or recklessly, careless whether it is true or false, and intended to be, as in act, relied on, by the person deceived, but it may equally made by concealment, or deliberate omission to make a statement where one should have been made, or by actions.
In Derry v Peek, Lord Herschell observed:
“Fraud means a false statement made knowingly or without belief in its truth, or recklessly careless, whether it be true or false. The fraudulent misrepresentation is a false statement which is made by a person who does not believe it to be true.”
In Shri Krishna case, The Supreme Court held that in order to constitute fraud, the person making the statement must have been aware about the falsity of the statement and the party defrauded remains ignorant of the correct situation. Fraud is committed where one person induces another to enter into some contract or transaction on the false belief by a representation of fact which is not true and which he does not believe it to be true. But if the other party has the facts before it or has the means to know he cannot be said to have been defrauded, even if a false statement has been made. Even if the motive of the person indulging in deceit is laudable, he cannot escape from the consequences of his actions.
Meaning of Forgery:
Section 463 of Indian Penal Code, 1860 defines forgery as: “Whoever makes any false documents or false electronic record or part of a document or electronic record, with intent to cause damage or injury, to the public or to any person, or to support any claim or title, or to cause any person to part with property, or to enter into any express or implied contract, or with intent to commit fraud or that fraud may be committed, commits forgery.”
Forgeries are committed by using computers. Some examples are: printing of counterfeit currency notes, certificates, stamp papers. Modern printers and scanners photocopiers are used to carry out such frauds.
RBI guidelines for fraud cases
Granting of cheque discounting facility to customers is not wrong business or practice in view of Section 6 of the Banking Regulation Act, 1949 and RBI guidelines. Abuse of prevalent banking practice by officers of the bank for the purpose of causing wrongful loss to the bank and wrongful gains to the customers or others does not itself amount cheating so as to hold persons guilty for the commission of offence under Section 420 of the Indian Penal Code, 1860 as all actions of Bank Officers were in consonance with the long standing banking practices.
The RBI, being the central bank and an overall watchdog of the Indian banking industry, has laid down, in detail, the policy guidelines, and procedures to follow for detection, investigation, taking legal action; as well as, avoiding and reporting of various types of bank frauds. It is a well-known fact, that in a large majority of fraud cases, banks do not follow the guidelines set by the central bank. As part of their routine, the central bank takes various steps to control frauds in banks. For example, as soon as the RBI learns of the fraud cases, they inspect the case in detail, and direct the concerned commercial bank to report the case to the Central Bureau of Investigation (CBI), police, or Serious Fraud Investigation Office (SFIO). Also, bank should take apt action to recover the amount involved from the fraudster. The RBI also issued several notifications and circulars warning the banks about common types of fraud.
Bank Officer – Breach of trust for violating norms:
An officer of the bank holds a position of trust. He is expected to perform his duties in terms of statutory directions as well as the directions of the RBI and his own employer. Established banking norms are binding on an officer of the bank in the discharge of his duties or trust. Where the accused officers of the bank acting in violation of banking rules caused wrongful gain to customer dishonestly, they are held to have committed offence of criminal breach of trust. However, commission of the offence of forgery and false document was not convincingly established. Definition of false document is a part of the definition of forgery and both must be read together.
Impact of fraud in the Indian banking industry
RBI’s edition of Financial Stability Report showed that the commercial banks accounted for an astonishing 85 per cent of nearly 6,500 fraud cases, amounting to more than Rs 30,000 crore. Top 10 banking frauds in 2018 alone resulted in a financial loss of Rs 10,000 crore. In fiscal year 2017, banks had reported nearly 5,000 frauds amounting to Rs 20,000 crore.
According to the Report of the Central Board of Directors on the working of the Reserve Bank of India for the year ended June 30, 2018 submitted to the Central Government in terms of Section 53(2) of the Reserve Bank of India Act, 1934, “The number of cases on frauds reported by banks were generally hovering at around 4500 in the last 10 years before their increase to 5835 in 2017-18. Similarly, the amount involved in frauds was increasing gradually, followed by a significant increase in 2017-18 to 410 billion. The quantum jump in the amount involved in frauds during 2017-18 was on account of a large value fraud committed in gems and jewellery sector, mainly affecting one public sector bank (PSB). During 2017-18, PSBs accounted for 92.9 per cent of the amount involved in frauds of more than Rs. 0.1 million, as reported to the Reserve Bank while the private sector banks accounted for 6 per cent. As regards cumulative amount involved in frauds till March 31, 2018, PSBs accounted for around 85 per cent, while the private sector banks accounted for a little over 10 per cent. At the system level, frauds in loans, by amount, accounted for more than 75 per cent of frauds involving amounts of Rs 0.1 million and above while frauds in deposit accounts were at just over 3 per cent. Within the loan category of frauds, PSBs accounted for a major share (87 per cent) followed by the private sector banks (11 per cent). The share of PSBs in frauds relating to ‘off-balance sheet items’ such as Letter of Credit (LCs), LoU, and Letter of Acceptance was even higher at 96 per cent. New private sector banks accounted for more than 20 per cent of the frauds related to ‘cash/cheques/clearing’ and ‘foreign exchange transactions’. New private sector and foreign banks accounted for 36 per cent each of all cyber frauds reported in debit, credit and ATM cards, among others. Out of the seven classifications of frauds in alignment with the Indian Penal Code, ‘cheating and forgery’ was the major component followed by ‘misappropriation and criminal breach of trust’. In ‘cheating and forgery’ cases, the most common modus operandi was multiple mortgage and forged documents. Mumbai (Greater Mumbai), Kolkata and Delhi were the top three cities in reporting of bank frauds through ‘cheating and forgery’. In respect of staff involvement in frauds, banks reported that it was prominent in the categories ‘cash’ and ‘deposits’, which had a much smaller share in the overall number of fraud incidents and the amount involved. One of the major initiatives in recent times in fraud mitigation was the introduction of a Central Fraud Registry (CFR), a web-based online searchable database of reported frauds, for the use of banks.”
While the bulk of banking frauds was loan-related, a sharper rate of increase in total number of fraud cases was noted in 2017-18, which was also driven by a significant jump in card and internet banking related scams. RBI data showed that the quantum and share of Public Sector Undertakings bank frauds was much higher than their credit and deposit share which stands at 65 and 75 per cent respectively.
Pasricha and Mehrotra (2014) observed that “one of the most challenging aspects in the Indian banking sector is to make banking transactions free from electronic crime.” All the major operational areas in banking offer a good opportunity for fraudsters, specifically in deposit, loan and inter-branch transactions.
Bhasin (2011) concluded, “Frauds generally take place in banks when safeguards and procedural controls are inadequate, or when they are not carefully followed, thus providing ample opportunities to the fraudsters. Frauds are increasing and fraudsters are becoming more sophisticated and ingenious.”
Types of Bank Fraud
Money laundering and sanctions screening
Money laundering is a leading source of compliance penalties for financial institutions. Banks can use smart transaction segmentation to spot money laundering attempts right away and dodge being fined. By reducing the number of false positive and negative alerts, banks will spend fewer resources on taking captive the bad actors red-handed.
That’s why banks are turning to artificial intelligence (AI) which promises to renovate segmentation into a powerful anti-money laundering (AML) process that provides considerable improvements with full transparency for model review. Banks can use AI solutions to supervise activities from an extensive, global perspective and link bad actors together to lessen false positive alerts without compromising compliance with regulatory guidelines.
In banking industry, it is very difficult to Dodgy employee expenses are more popular than one can expect. For committing internal fraud, employees commit fraud suo moto or in collusion with outside parties or amongst themselves against the insurer.
Credit card fraud
That type of fraud is commonplace, but new tools using machine learning algorithms for risk management offer a light in the tunnel for resolving the problem. In the case of credit card frauds, some banks follow the system of reporting the frauds net of chargeback credit received, while others report the amount of the original transactions. To overcome such discrepancies, a uniform rule of reporting amounts involved in frauds is being recommended by the RBI.
The mobile industry is no alien to fraud. As mobile banking services expand, so do fraud attempts using mobile device capabilities. Fraudsters are creating new fraud schemes by unifying old strategies with new technologies or banking services.
A report released by Fidelity Information Services (FIS) shows that Indian consumers have taken to digital banking in a big way, but they are also among the major victims of banking frauds. The report, surveying people across multiple countries, showed that 18 per cent of Indian customers reported a fraud in the past year – more than any other country studied by the organisation.
Identity and social fraud
As criminals are equipped with more advanced digital methods, banking customers need more advanced solutions for protecting their identity and ensuring safe access to banking services.
One way to remove money from a bank is by taking a loan, a practice bankers would be more than willing to boost if they knew that the money will be repaid in full with interest. A fraudulent loan, however, is one in which the borrower is a business entity managed by a fraudulent bank officer or an accomplice; the “borrower” then declares bankruptcy or vanishes and the money is gone. The borrower of the loan may even be a non-existent entity and the loan merely an artifice to mask a theft of a large sum of money from the bank.
Forged or Fraudulent Documents
Forged documents are often used to mask other thefts; banks always count their money meticulously so every penny must be accounted for. A document appealing that a sum of money has been borrowed as a loan, withdrawn by an individual depositor or invested or transferred can therefore be valuable to someone who wishes to conceal the minor detail that the bank’s money has in fact been stolen and is now gone.
Classification on the basis of provisions of Indian Penal Code:
Misappropriation and criminal breach of trust;
Fraudulent encashment through forged instruments, manipulation of books of accounts or through fictitious accounts and conversion of property;
Unauthorised credit facilities extended for reward or for unlawful gratification;
Negligence and cash storage;
Cheating and forgery;
Irregularities in foreign exchange transactions;
Any other type of fraud not coming under any of the specific heads as mentioned above.
Internal controls to prevent frauds in retail banking products
Inadequate measure to prevent banking fraud is the primary reason for widespread frauds. Delay in reporting by banks is another main reason. Banks should, therefore, ensure that the reporting system is suitably streamlined so that frauds are reported without any delay. Banks must fix staff accountability in respect of delays in reporting fraud cases to the RBI. Delay in reporting of fraud cases and the consequent delay in alerting other banks about the modus operandi (a particular way or method of doing something) and issue of caution advices against unscrupulous borrowers could result in similar frauds being perpetrated elsewhere. Banks may, therefore, strictly adhere to the timeframe set by RBI for reporting fraud cases failing to do so banks would be liable for penal action as prescribed under Section 47A of the Banking Regulation Act.
Incidents of frauds in banks are a matter of concern. The primary obligation of preventing frauds lies with banks themselves. In view of the enormity of fraud in banks, the management of various banks has employed different measures, for example: establishment of internal control unit, fraud alerts, security measures etc. Though, the details may differ from one bank to another, it all depends on size, location and general environment nationally and internationally.
Every bank is required to be alert and identify the types of frauds prevalent in the society, including the international society, the causes of the frauds and the potentials and prospects of some of them occurring in the bank. This will be a task of volume, types and concentration of the banks’ operations and the management control systems. There are the internal and external management controls. Internal management controls are put through the inside of the company, on the contrary external controls are carried out on the outside. Internal management control is further classified into following two major groups:
Internal Checks: Internal checks are the operational controls, which are built into the banking system to shorten and simplify the processing of entries in order to secure prompt services, to help in minimizing accounting errors and to act as insurance against collusion.
Internal Audit: Internal Audit on the other hand involves the review of operations and records undertaken within a business by particularly assigned staff, which is usually the Internal Auditor. There are people called external auditors too who examine the books of the bank to determine its truth and fairness.
Fraud Prevention and Detection
The process of identification of frauds will permit the bank to access its fraud proneness and identify which types it has to address particularly. Having done so, the next stage would be to evolve measures to prevent the occurrence of such frauds.
The existing control systems can be categorized into two, those aimed at prevention and those aimed at detection.
An Expert Committee on Bank Frauds (Chairman Dr N.L. Mitra) submitted its Report to RBI in September 2001. The Committee examined and recommended both the preventive and remedial aspects of bank frauds.
The important recommendations made by the Committee include:
A need for including financial fraud as a criminal offence;
Amendments to the IPC by including a new chapter on financial fraud;
Amendments to the Evidence Act to shift the burden of proof on the accused person;
Special provision in the Cr.PC for properties involved in the special Financial Frauds.
Confiscating unlawful gains; and deterrent measures including the development of Procedural Codes by banks and financial institutions.
Thus it can be concluded that the following measures should necessarily be adopted by the Ministry of Finance in order to reduce Fraud incidents.
There must be a Special Court to try financial fraud cases of critical nature.
The law should provide a separate structural and recovery procedure. Every bank must have a domestic enquiry officer to enquire about the civil dimension of fraud.
A fraud involving an amount of ten crores of rupees and above may be considered serious and be tried in the Special Court.
The 29th Report of the Law Commission had dealt with some categories of crimes one of which is “offences calculated to prevent and obstruct the economic development of the country and endanger its economic health.” Offences relating to Frauds in the banking sector will fall under this category. The most important feature of such offences is that ordinarily, they do not involve an individual direct victim. They are punishable because they harm the whole society. It is clear that money involved in Bank belongs to the public. They deposit there whole life’ security in Banks and in case of Dacoity or Robbery in banks the public will be al lost. Thus it is important that sufficient efforts should be taken in this regard.
There exists a new kind of risk in the cyber world. Writers are referring it as “Salami Attack” under this a special software is used for transferring the amount from the account of the individual. Hence the culprits of such crimes should be found quickly and should be given strict punishment. Moreover, there is a requirement of more number of IT professionals who will help in discovering a solution against all these security threats.
Areas in which frauds are committed in banks
The forger, counterfeits instruments like cheques, bank drafts fixed deposit receipts, traveler cheques or government securities.
Cheques are materially altered by raising the value of the cheques, changing the validity date or beneficiary of the character of the cheques, for example, a crossed cheque is changed to a bearer cheque.
The signature on cheques endorsement on a collection of bills, endorsement of holders of instruments, the miscellaneous document like deposit receipts, value register receipts etc are forged.
Factors that Play a Key Role in Identifying Fraud before Providing Loans
This is an examination of your capability to pay back a business loan or business line of credit. This includes cash flow, repayment history, as well as extra cash the company has on hand. The best way to reveal your ability is by having strong business credit ratings, a healthy bank ranking (minimum low 5 rating), a well-developed business plan and/or prior year(s) financials that show you have an adequate cash flow to pay off the loan or credit line.
It always looks more favorable when a business owner has his very own funds invested in the business. Before a financial institution will want to extend a business line of credit or loan to a company, the amount of skin an owner has in the game plays a role. It may even be the distinction between an approval and denial.
Commercial property, heavy machinery, business devices, inventory, stocks as well as bonds, and various other company possessions that can be sold if a business fails to repay the financing are taken into consideration.
Be ready to confirm that the conditions are correct for your company. Show that there is a market possibility, adequate positioning, competitiveness, and experience to back up your strategy.
Lenders have to believe that a company owner is a trusted individual who can be depended upon to repay the loan or line of credit. Some of the things they check out include individual credit ratings, experience & education, as well as a track record.
Banks can secure the safety, integrity and authenticity of the transactions by employing multipoint analysis – cryptographic check hurdles. Services of persons working on sensitive seats should be rotated by banks, and keep strict watch of their working, update the technologies being used periodically and employ more than one person in larger transactions. Banks can also verify the credentials of the person approaching the bank, the documents produced by them, the details provided by them in the forms they fill and utmost care in selecting and recruiting the staff. Banks should educate and make its customers aware of such frauds by sending e-mails and also providing precautionary tips on their websites. Banks can give assurance to its customers if they have prescribed and follow best practices and also the guidelines that have been provided by the RBI, have a fraud-free culture and in-house grievance redressal mechanism.
The Indian Banking Industry has undergone remarkable growth since nationalization of 14 banks in the year 1969. There has an almost eight times increase in the number of bank branches from about 8000 during 1969 to more than 60,000 in 2017 belonging to 289 commercial banks, of which 66 banks are in private sector.
It happened because of two successive Committees on Computerization (Rangarajan Committee) that set the tone for mechanization in India. While the first committee drew the outline or the blue print in 1983-84 for the computerization in the banking industry, the second committee set up in 1989, paved the way for combined use of telecommunications and computers for applying technological breakthroughs in banking sector.
However, with the spread of banking and banks, frauds have been constantly increasing. It could be a natural consequence of increase in the number of customers who are using banks these days. In the year 2000 alone, the Indian banking industry has been a victim of a fraud of Rs 673 crores in as many as 3,072 number of fraud cases. These are only those cases that have been reported, there are many unreported cases of which the world has heard of. Though, this is 0.075% of Rs 8,96,696 crores of total deposits and 0.15% of Rs 4,44,125 crores of loans & advances, there are any numbers of cases that are not reported. There were nearly 65,800 bank branches of a total of 295 commercial banks in India as on June 30, 2001 reporting a total of nearly 3,072 bank fraud cases. This makes nearly 10.4 frauds per bank and roughly 0.47 frauds per branch.
With the advent of e-banking solutions, it also becomes necessary for the banks to adopt an increased level of security measures. In order to reduce, rather eliminate incidences of frauds and cyber frauds in the country, frauds should be immediately reported to Reserve Bank, in consonance with its classification and guidelines. There should be strict action adopted against the banks which do not disclose such incidents or take inordinate delay for the same. Furthermore, it is important to strengthen Know Your Customer (KYC) norms as it discourages persons with fraudulent intention at the very onset from gaining entry into the bank. Another important factor is creating awareness and educating the customers about the proper security procedure to be adopted especially in transactions over the internet, use of ATMs, etc. Additionally, the banks should frame internal policy and security measures to manage fraud risks, investigation and reporting of the same. With a little addition of precaution, the banks and customers can viably reduce fraud incidences.
2. Section 17 of the Indian Contract Act, 1872
3. (1889) 14 AC 337: 5 TLR 625
4. Shri Krishna v. Kurukshetra University, Kurukshetra, AIR 1976 SC 376
5. Section 463 of Indian Penal Code, 1860
6. Mir Nagvi Askari v CBI, (2009) 4 SC 243
7. CBI v Maninder Singh, 2015 (9) SCALE 365
8. Reserve Bank Of India Annual Report 2017-18
9. Pasricha P, Mehrotra S. Electronic Crime in Indian Banking, Sai Om Journal of Commerce and Management. 2014
Author : Mr. Nitin Sharma – Student of Amity Law School, Noida.