Banking fraud
Introduction
A competent banking system is required for any country’s economic growth and development. With a plethora of economic variables at play, both at the national and global levels, the banking sector’s role has evolved significantly over time. This allowed the financial sector to explore new prospects and expand its reach beyond a country’s territorial extent. The banking industry underwent huge revolutionary transformations in tandem with the enormous shift of trade and commerce. These reforms include the entry of new private sector banks, the introduction of information technology (such as the use of NEFT and Smart Cards), and modifications to capital adequacy standards, among others. These changes have improved the banking sector’s efficiency and productivity tremendously. While India’s banking sector continues to develop in terms of overall revenue and profits, the amount of money lost to bank fraud is increasing. The Reserve Bank of India and bank management are both concerned about this. These bank robberies appear to be novel in terms of their method of operation and are rather large in scale. This unfavourable trend in the financial system results in not just losses for banks, but also a deterioration of their trust. This article provides its readers with an idea about bank frauds in India thereby throwing light on the legal mechanisms governing the same.
What is a bank fraud
Bank fraud is a purposeful act of omission or conduct by any person in the course of a banking transaction or in the bank’s books of accounts, which results in unlawful temporary gain to any individual or otherwise, with or without any monetary loss to the bank. The losses incurred by banks as a consequence of fraud are equal to the combined losses incurred as a consequence of offences such as robbery, dacoity, burglary, and theft. Unauthorized credit facilitates are extended for illegal gratification such as cash credit allowed against pledge of goods, hypothecation of goods against bills, or against book debts.
Fraud’ denotes a false statement made knowingly or without trust in its truth, or recklessly careless, whether true or untrue,” according to Lord Herschell. In the case of Derry v. Peek (1889), he had opined that a false statement made by someone who does not believe it to be genuine is referred to as a fraudulent misrepresentation.
Pledging of fictitious items, inflating the value of goods, hypothecating commodities to several banks, fraudulent removal of goods with the knowledge and connivance of or ignorance of bank employees, and pledging of goods belonging to a third party are all common methods of operation of bank frauds. Goods hypothecated to a bank are found to contain obsolete stocks packed in between good stocks and cases of shortage in weight are not uncommon.
Components of a bank fraud
Any fraud conducted by a bank employee or in conjunction with a borrower has two key components, namely,
First, there is the subjective intention, and
There is the objective opportunity.
In a bank, conditions must be constructed such that a person who wants to commit fraud does not have the chance to do so. An examination of instances surrounding banking frauds reveals the following four primary aspects that are responsible for the commission of bank frauds:
Active participation of the personnel, both managerial and clerical, either independently or in collusion with outsiders.
Failure of bank employees to adhere to properly set out instructions and procedures.
External elements defrauding banks by forging or manipulating checks, drafts, and other financial instruments.
There has been increasing cooperation of business people, senior bank executives, public servants, and powerful politicians to cheat banks by bending the rules, flouting laws, and tossing banking standards to the wind.
Classification of frauds
The RBI’s Master Directions on Frauds – Classification and Reporting by commercial banks and select FIs (Updated as on July 03, 2017) provides different categories of offences that constitute fraud, putting specific reliance on the Indian Penal Code, 1860. The classifications are provided hereunder:
Misappropriation and criminal breach of trust.
Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts, and conversion of property.
Unauthorised credit facilities extended for reward or for illegal gratification.
Negligence and cash shortages.
Cheating and forgery.
Irregularities in foreign exchange transactions.
Any other type of fraud not coming under the specific heads as above.
Risks possessed by fraudulent activities on banks
Banks are exposed to a variety of dangers. A successful bank is one that can consistently avoid these risks while still generating considerable profits. Risk mitigation is only possible if hazards are properly identified, as well as the reasons for their occurrence and the potential damages they may produce.
Credit risks, market risks, operational risks, moral hazards, liquidity risks, business risks, and systematic risks are the key categories of risks that any bank faces. The Reserve Bank of India (RBI) cautioned that the banking industry is under significant stress in its bi-annual Financial Stability Report (FSR) issued on June 30, 2018, citing increasing bad loans and a surge in bank fraud, among other difficulties.
All of this, according to the RBI, can cause India’s economy to suffer. Public Sector Banks’ (PSB) average bad loans accounted for 75% of their net assets in March 2018. These problematic loans are reducing bank profitability and capital situations, putting India’s largest banks’ viability in jeopardy.
Bank frauds in India
In the case of Pradeep Kumar And Another v. Postmaster General And Others (2016), the Supreme Court of India had opined that individual employees are capable of being dishonest and committing fraud or wrongdoings on their own or in cooperation with others. Such activities of bank/post office workers, when done in the course of employment, bind the bank/post office at the instance of the person who is damnified by the bank/post office officers’ fraud and illegal conduct. Thus, post offices, banks are vicariously liable for fraud, wrongs by employees during their employment.
Forged currency notes
At the personal level, paper cash is the most common means of money transaction, however, checks and drafts are also widely employed in the business. The term ‘bank note’ is defined under Section 489A of the Indian Penal Code, 1860. If currency note forgery is effective, it has the potential to provide the forger with a fortune while simultaneously destroying the nation’s economy. A currency note is constructed of a special paper with plastic covering bonded on both sides to preserve the ink and anti-counterfeiting technology from harm. These notes also include security threads and watermarks. However, the majority of individuals are unaware of these facts.
Stolen payment cards
A phone call from a credit card issuer asking if the person has gone on a spending spree is often the first indication that a victim’s wallet has been stolen. The simplest form of this theft involves stealing the card itself and charging a number of high-ticket items to it in the first few minutes or hours before it is reported as stolen. A variation of this is to duplicate only the credit card numbers rather than taking the card itself and then utilise the numbers in online scams.
Duplication or skimming of card information
This can take many forms, from a dishonest merchant copying customers’ credit card numbers for later misuse or a thief stealing the information using carbon copies from old mechanical card imprint machines to the use of tampered credit or debit card readers to copy the magnetic stripe from a payment card while a hidden camera captures the numbers on the face of the card. A fraudulent card stripe reader would record the contents of the magnetic stripe, while a covert camera would take a glimpse at the user’s PIN. The data from the fake equipment would then be used to create duplicate cards that could be used to make ATM withdrawals from the victims’ accounts.
Frauds assisted by digital technology
Except for those in rural and distant locations, most bank offices have been digitised to provide efficient and quick service. As computerisation in Indian banks is still relatively new, there haven’t been many computer-related scams in banks that have been in discussion. However, in western nations, a high number of cybercrimes in the financial industry are regularly recorded. It is necessary to investigate the nature of such crimes in order to create effective prevention measures. Normally following types of frauds are committed:
Cyber crooks create spy software in order to crack passwords. They hack into banks’ computer systems and modify data to transfer money from other people’s accounts.
Computer viruses are developed by malicious individuals who get access to a computer system via email. These viruses corrupt data saved on computers and cause the entire system to slow down. It is frequently said that anti-virus software firms develop viruses in order to sell their product in the market.
Hackers are computer professionals who steal passwords and get access to sensitive data kept on computers. They have no qualms about ‘rendering’ government agencies, including military bases, in order to carry out their malicious plan to destroy and mutilate data contained in computer systems. Such crimes are typically undertaken not for financial gain, but to obtain mental joy from the pain of others.
Wiretapping is a crime in which a person taps the wire of a bank’s ATM to take money from another person’s account. The fraudster connects a wireless microphone to the telephone connection linking the ATM to the bank’s computer and wiretapping signals, while a client is using the ATM. These signals are later on utilised for withdrawing money.
Section 419 of the Indian Penal Code, 1860 provides an imprisonment of either description for a term which may extend to three years, or with fine, or with both, as the deterrent for the offence of cheating.
Offence of cheating is cognizable and non bailable. The trial is done by a magistrate of first class. FIR or Application can be filed under Section 156(3) and in case of private complaint under Section 200 of the Code of Criminal Procedure, 1973.
Concealment
Section 421 of the Indian Penal Code, 1860 provides that dishonest or fraudulent removal or concealment of property to prevent distribution among creditors will be accompanied by imprisonment of either description for a term which may extend to two years, or with fine, or with both.
The offence is non-cognizable, bailable, triable by any Magistrate and compoundable by the creditor who are affected thereby with the permission of the court.
Forgery
Section 465 of the Indian Penal Code, 1860 provides an imprisonment of either description for a term which may extend to two years, or with fine, or with both, for the offence of forgery.
Counterfeiting
Counterfeiting of bank notes or currency notes under Section 489 A of the Indian Penal Code, 1860, can cost the offender with an imprisonment for life, or with imprisonment of either description for a term which may extend to ten years, and shall also be liable to fine. The RBI Master Circular on the same can be referred here.
Misappropriation
Section 403 of the Code of 1860 lays down provision for dishonest misappropriation of any movable property which shall be punished with imprisonment of either description for a term which may extend to two years, or with fine, or with both.
Breach of trust
Section 406 of the Indian Penal Code, 1860 provides punishment for criminal breach of trust which ranges from an imprisonment of either description for a term which may extend to three years, or with fine, or with both.
The Information Technology Act, 2000
The Information Technology Act of 2000 was adopted by the Indian government to make ways for punishment and penalties for computer-related frauds. In the case of unauthorised acts committed in respect of another person’s computer system, such as access, downloads, or making copies of the information or data stored, the introduction of a computer contaminant or computer virus, damages to the computer or its system, etc., Section 43 of the said Act provides for hefty damages up to rupees ten lakhs payable by the offender to the person affected. Furthermore, the aforementioned Act makes tampering of computer source documents and hacking computer systems punishable by up to three years imprisonment.
Efforts extended by RBI
Frauds, deceptions, robberies, and other types of crimes at banks are a source of concern. While banks bear the main responsibility for fraud prevention, the RBI has been counselling banks on significant fraud-prone sectors and the precautions required to avoid fraud on a regular basis. The Reserve Bank has also been sending information to banks about sophisticated scams that were not previously disclosed so that institutions might put in place the required protections/preventative measures through suitable processes and internal inspections. Banks are also being given information on unethical borrowers and linked parties who have committed bank fraud so they should be cautious when dealing with them. To help with this continuing process, banks must provide detailed information concerning frauds and the actions taken in response to them to the RBI.
Chapter III of the Master Directions on Frauds-Classification and Reporting by commercial banks and select FIs (Updated as of July 03, 2017) introduces the Central Fraud Registry (CFR) based on the Fraud Monitoring Returns, to be filed by banks and select FIs. The same has been made available, along with updates, to which banks have been allowed access through user-ids and passwords. CFR is a searchable database that is accessible over the internet. The practice of giving Caution Advice (CA) on paper has now been phased out. However, CAs will be given as and when needed for frauds, including attempted frauds with systemic implications. Banks should make full use of CAs/CFRs for rapid fraud risk detection, control, reporting, and mitigation. Banks should also put in place suitable systems and procedures to ensure that the information in CA/CFR is used in credit risk governance.
Chapter VI of the aforementioned RBI Circular provides a guideline for reporting frauds to police/CBI. When dealing with incidents of fraud or embezzlement, banks should be driven not just by the desire to recover the funds as quickly as possible, but also by the public interest and the need to ensure that the perpetrators are brought to justice.
Chapter VIII of the Master Direction lays down a set of three guidelines to be adopted for the purpose of filing complaints with law enforcement agencies in cases of bank fraud.
When a bank detects fraud, it is obligated to quickly file a report with the appropriate law enforcement agency. There should ideally be no delay in submitting complaints with law enforcement authorities since delays can result in the loss of relevant ‘reliable’ papers, non-availability of witnesses, borrowers absconding, and the money trail becoming cold, in addition to asset-stripping by the fraudulent borrower.
It has been found that banks lack a central location for submitting CBI/police complaints. As a result, banks have a non-uniform method to report complaints, and the investigating agency must deal with many levels of authority inside the institutions. This is one of the most common causes for complaints getting converted into FIRs taking so long. As a result, banks are required to appoint a nodal point/officer to file all complaints with the CBI on behalf of the bank and to act as a single point of coordination and remedy for complaints with flaws.
The bank’s complaint to law enforcement authorities should be correctly written and should always be verified by a legal professional. Banks have also been located filing complaints with the CBI/police on the basis of borrowers’ deception, theft of money, diversion of funds, and so on, without categorizing the accounts as fraud and/or reporting the accounts to the RBI. As such circumstances are inherently grounds for categorizing an account as fraudulent, banks should classify such accounts as frauds and report them to the RBI.
Nirav Modi PNB scam: Rs 14,000 crore
Nirav Modi, a diamond merchant, and his uncle Mehul Choksi were accused of defrauding Punjab National Bank of approximately 14,000 crores, reportedly with the aid of certain bank employees, irresponsible bank management, and inadequate bank auditing.
Preventive measures that can be adopted to curb bank frauds
Almost every aspect of life has changed dramatically in the twenty-first century. Technology has promised humanity enormous progress, with computerization serving as a wellspring of new age wisdom and a slew of innovative, rapid, and efficient financial services. However, this facility introduced hazards to a variety of banking activities, necessitating well-defined and timely preventative actions. Computer automation, which provides a plethora of services, is susceptible to various security/precautionary procedures to protect against its inherent weaknesses, and RBI, in outlining the activities, recommends preventive vigilance steps to be done to avoid such risks. The ways in which fraud can be effectively averted have been provided hereunder:
Recruitment and selection
The correct people with the proper credentials and abilities should be hired by bank authorities to look after its functioning. Qualifications, experience, performance, efficiency, and reputation should all be considered when selecting officials. Staff at all levels should get adequate training.
No undue reliance
There should be no excessive dependence on the bank’s personnel. Explanations should not be taken at face value. Agents, clerical employees, and officers should be shifted from branch to branch on a regular basis to avoid entrenched interests.
Basic honesty
No bank official should think of accepting presents and bribes from the borrowers with the belief that everything is safe and nothing would go wrong. A borrower’s financial situation and dealings should be closely monitored if he or she invites bank officials to drinks and dinners too frequently or sends them gifts.
Private lives of staff
Staff members’ personal life should be scrutinized, no matter how tough that may be. A staff member who is a frequent borrower or lives beyond their means may be the one to let the bank down in the end.
Supervision and audit
The authorized officer should check the books and records on a regular basis. Without warning, the godowns should be examined. A bank branch audit is also required.
Routine
The bank’s system, routines, and processes must all be followed meticulously. The instructions manual and circulars are the results of the head office’s extensive expertise with persons and problems over a lengthy period of time.
Vigilance
The term vigilance refers to a state of alertness or watchfulness. This is a mental condition that affects both rank and file personnel. The management job of vigilance is essential. Preventive vigilance should ensure the following:
The firm is planned and run in accordance with the corporate goal, using correct systems and processes.
Transactions are allowed and assessed correctly.
Assets are protected and obligations are managed, reducing the risk of losses due to anomalies or fraud.
Accountability and recordkeeping ensure that information is thorough, accurate, and timely.
Finally, bank officers cannot afford to be sluggish, complacent, or careless in the performance of their jobs.
Unscrupulous parties
Accepting new clients, particularly debtors, should be done with caution by the bank. Customers who have been observed engaging in questionable practices or who have been accused of fraud should be avoided. It is in the bank’s best interests to adopt the adage “once bitten, twice shy.”
Danger signals
Pay special attention to accounts where the debt total is frequently close to the sanctioned limit or the withdrawal limit. When borrowers’ checks begin to bounce for reasons such as “exceeds arrangement” or “effect not cleared present again,” or when the account’s turnover is low and securities are charged, bank staff must be on the lookout.
Conclusion
Banks are the engines that propel the financial sector’s activities and an economy’s growth. With India’s burgeoning banking industry, bank fraud is on the rise, and fraudsters are getting more clever and cunning. While it is impossible for banks to operate in a fraud-free environment, proactive measures such as risk assessments of operations and policies can assist them to mitigate the risk of fraud-related losses. As a result, the time has come to address the banks’ security concerns on a priority basis. Poor hiring procedures and a lack of adequate employee training are common issues that banks are encountering, along with overworked employees, weak internal control systems, and low compliance levels among bank managers, offices, and clerks. However, technology may help governments, regulatory bodies, and banks battle the increasingly sophisticated form of fraud by means of proactive forensic data analysis and data mining techniques.
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