Artful dodgers, these bank fraudsters

Fishing in troubled waters may be risky but profitable. Whether the business cycle is at the peak or in a trough, in a recovery phase or on a downward swing, irrespective of bearish or bullish markets, fraudsters flourish with innovative modus operandi to swindle people’s hard-earned money! It may not technically be fraud when credible investors are hoodwinked by unscrupulous security marketeers selling deviously designed complex high risk financial instruments. They may combine equities, bonds, insurance, hybrid derivatives, forwards, options swaps and money market instruments to innovate financial products promising a very long horizon for an amazing money multiplying jamboree!

Financial market regulators — the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), the Insurance Regulatory and Development Authority (IRDA), the Forward Markets Commission (FMC), the Pension Fund Regulatory and Development Authority (PFRDA) — and wings under the ministries of finance and corporate affairs issue circulars and guidelines aplenty. Their design is based on benchmarked processes good enough to prevent fraud. Despite this, frauds in banks are increasing.

The vital concerns of stakeholders are whether the regulators, board of directors, and internal, statutory and government auditors charged with authority, discharge their assigned responsibilities in exercising due diligence, and adhere to the prescribed professional standards and code of ethics. If they don’t, are there adequate controls and safeguards in the system to deal with the problems?

Frauds are classified primarily based on the provisions of the Indian Penal Code: 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.

Cases of theft, burglary, dacoity and robbery should not be reported as fraud, but may be reported separately.

Reporting frauds The RBI specifies how reports of fraud involving different values of money have to be reported by banks within a week with details including “amount involved, nature of fraud, modus operandi, name of the branch/office, names of parties involved, names of officials involved and whether a complaint has been lodged with the Police”.

A recent RBI report on frauds in public sector banks (PSB) tells the dismal story of an 86 per cent increase in fraud in 26 PSU banks during from 2011-12 to 2013-14.

There were 1,200 fraud cases of loan per year amounting to more than Rs ₹10,000 crore, involving loan disbursement cases above ₹1 lakh. Interestingly, fraud cases showed an increasing trend despite sluggish economic growth and fluctuating business cycle swings.

The amount involved in PSB frauds in 2011-12 was ₹2,246 crore, increased to ₹3,773 crore in 2012-13, and reached ₹4,184 crore in 2013-14. The banks included State Bank of India, Indian Overseas Bank, Canara Bank, Central Bank of India, Allahabad Bank and Bank of Baroda. These six PSBs accounted for 59.4 per cent of the fraud cases. In terms of the average amount involved in such cases, Canara Bank comes first with ₹7.37 crore followed by Dena Bank with ₹6.57 crore.

In total, 6,203 employees of the 26 PSBs were probed including 789 employees from SBI, 479 from Allahabad Bank, 426 from Punjab National Bank and 392 from Central Bank of India.

New RBI master circular The increase in fraud forced the Reserve Bank of India to come up with an updated master circular on frauds on July 1, 2015. The fact that the RBI has been issuing master circulars frequently — for instance, from July 1 to July 6, 2015, the banking regulator issued more than 117 circulars with more than a hundred on the first day itself to safeguard against financial improprieties in banking — provide a barometer showing the extent of financial indiscipline in Indian banking.

The circular provides comprehensive guidelines on classification of frauds, how to deal with frauds involving different money value, frauds committed by unscrupulous borrowers, provisioning by banks for frauds, reporting on frauds to the board and the RBI, quarterly and annual review on frauds, as well as reporting to the police.

The RBI has been disseminating details of frauds of an ingenious nature not reported earlier to enable them to build appropriate controls. Banks report frauds long after they have been perpetrated, and without the requisite information. Often, the RBI gets to know of these from press reports. A system of streamlined reporting of fraud will help the regulator make other banks aware of the modus operandi and issue advisories to prevent their being perpetrated elsewhere. The RBI must take penal action as prescribed under the Banking Regulation Act, 1949. Banks should specifically nominate a senior official responsible for submitting all the returns on time.

Governance risk Intense business competition combined with credit risk, liquidity risk, fluctuating interest rate risk, operational risk, funding and capital management, profit planning and business projection make the banking business terrain enormously challenging.

Over-advancing of credit, high-level nonperforming assets, deteriorating asset quality, non-adherence to prudential norms, and lack of adequate segregation of duties and controls lead to a multiplicity of frauds, and erode the stakeholder’s confidence in the banking industry.

There is no alternative but to establish a holistic, robust system of governance, risk, compliance management and internal control appropriate to the size and operation of the banks whether in the private sector or the public sector.

As the board has overall responsibility for risk management, it should introduce suitable enterprise risk management policy with governance, risk and control procedures prescribing prudential limits, auditing, reporting and review, and taking preventive punitive detective and remedial action promptly.

The writer was a director-general, CAG of India. The views are personal

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