GURU GOBIND SINGH INDRAPRASTHA UNIVERSITY

FRAUD IN THE INDIAN BANKING SECTOR

SUBMITTED TO: SUBMITTED BY:

MR. ZUBAIR KHAN KANUPRIYA CHAWLA(01216503517)

NISHTHA GANDOTRA(01716503517)

BBA LLB, 5th SEMESTER

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INTRODUCTION

In today’s economic scenario, banks play a very important role in the economic development of the
country. Nowadays, banks have diversified their activities and are getting into new schemes and
services that create opportunities for financial inclusion. Though the banking industry is generally
well regulated and supervised, the sector suffers from its own set of challenges when it comes to
ethical practices, financial distress and corporate governance. Thus, as the banking sector of the
country is flourishing, it is also getting plagued by some operational problems such as frauds etc

The resilience of a growing economy such as that as in India is determined when the banking system
is put to test. India, with its massive potential for growth, has maintained a stable forefront throughout
a series of global recessions and has emerged reasonably unscathed. It is ironic however, that a
steadfast system such as this, would contain a series of vulnerabilities which have been left
unaddressed; increasingly becoming gaping black holes and tarnishing the image of the banking
sector. The most evident of the issues faced by the sector and also its primal risk factor is the resultant
impact of frauds. Frauds continue to be one of the major problems in the banking and financial
services domain and the rapid growth of fraudulent activity is a testament to how difficult fraud is to
detect and prevent — a fact that criminals take advantage of. The health of a nation’s financial and
banking system facilitates in determining its production and consumption patterns of goods and
services. It acts as a direct gauge of the standard of living and well-being of its citizens.

In recent years, instances of banking fraud reported in India are on a steady rise. Even though in India,
banking frauds have frequently been treated as one of the costs of transacting business, after
liberalisation their frequency, complexity and inherent costs of frauds have swelled manifold resulting
in a very grave cause of alarm for regulators due to its harsh impact on the banks profitability and
consequently on the Indian economy.

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TYPES OF BANK FRAUDS

ACCOUNTING FRAUD

Accounting fraud has a major effect on business lending. Businesses are increasingly committing
accounting fraud as they “cook the books” in order to look more profitable on paper than they actually
really are. Based on these very fraudulent statements, loans are granted by the banks to these
businesses, but ultimately, because these businesses are in an insolvent condition , they are unable to
repay the loans ultimately resulting in great losses to the banks. This results in massive losses for the
banks due to the misrepresentation by the businesses. The classic example of this is the Enron
scandal.1

LOAN FRAUD

Accounting fraud might lead to loan fraud, but this sort of fraud isn’t merely limited to businesses
presenting fraudulent information on their loan applications. This type of fraud occurs when
individuals present false information regarding their finances in order to obtain a loan from the bank.
Similarly, if a thief steals someone’s identity and applies for a loan in their name, that is another type
of loan fraud. Additionally, if someone has a line of credit and a scam artist draws funds from that
line, that also falls into this category.

WIRE TRANSFER FRAUDS

Wire fraud includes in it’s ambit all cases of fraud involving wire transfers or the internet.

In some cases, the scammers steal the username and password of a banking customer, and they wire
money to themselves from the bank customers account. For instance, when an attacker stole the sign-
in details from a company in Missouri, the attacker was able to steal $440,000 in wire transfers.2

In the cases of wire transfer frauds, often, the scam artist convinces the victim to wire money to them.
For instance, in one instance the scam artist convinced someone that they had been hired to be a secret
shopper for a particular wire transfer company or a bank. The scam artist further directed the victim to
wire some funds through that institution. The victim in this case fully believed the scammer and that if
they do this, they will be compensated for the funds they sent as well as for their work as a “secret
shopper”. However, as soon as they wire the funds, the other party completely disappears, and the
victim never gets their money back.

PHISHING FRAUD

Phishing is when a particular scam artist uses an email, text, phone calls, or other methods to try to
obtain a victim’s banking details in order to misuse them. This type of fraud often overlaps with other
types of fraud. For instance, fraudsters often use phishing emails to get bank account details from
their victims with the ultimate aim of committing ACH or wire transfer fraud.

1 https://www.investopedia.com/updates/enron-scandal-summary/
2 https://www.trendmicro.com/vinfo/us/security/news/cyber-attacks
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ATM FRAUD

ATM fraud includes in it’s ambit everything from reprogramming the machine to installing a skimmer
to steal card details. However, it can also include making fraudulent deposits by depositing empty
envelopes — an envelope-free ATM is usually the easiest way to avoid that.

MONEY LAUNDERING

Money laundering is when criminals deposit fraudulently obtained sums of cash into a bank. The
scammers generally try to make the funds look as though they have come from a legitimate source.

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FRAUDS IN THE INDIAN BANKING SECTOR IN INDIA

The number of frauds reported by banks in 2018-19 increased 15 per cent on a year-on-year basis.
There were 6,801 fraud cases in 2018-19 as compared to 5,916 cases a year ago. There was a noted
increase of 73.8 per cent in the amount of money involved in frauds. The total amount involved in the
frauds amounted to Rs 71,542.93 crore in 2018-19 as compared to Rs 41,167.04 crore in 2017-18, a
73.8 per cent increase.

In terms of the number of frauds, share of public sector banks is 55.4 per cent, private banks
30.7 per cent share, and foreign banks 11.2 per cent. The public sector banks accounted for
90.2 per cent of the amount that was involved in fraud in 2018-19, while the private sector
banks accounted for 7.7 per cent, and the foreign banks accounted for 1.3 per cent.

The average time gap that was noted by RBI in the date of occurrence of the fraud and the
detection of the same was 22 months. A point of concern thus, for regulators and
policymakers came from the fact that it took banks an average of nearly 2 years to detect
frauds. Large frauds above Rs.100 crore took banks nearly four and a half years to detect,
RBI said. Nearly Rs 52,000 crore worth of frauds detected were classified as big frauds

Also, frauds relating to loans accounted for 90 per cent of the share followed by off-balance
sheet items and foreign exchange transactions. Frauds related to off balance sheet saw a
massive decline in 2018-19 as it constituted 39.6 per cent of the frauds in 2017-18. In 2018-
19, it was merely 7.7 per cent.

In terms of the number of frauds, too, those related to advances were predominant followed
by card/internet-related frauds and deposits-related frauds. Frauds relating to card/internet
and deposits constituted only 0.3 per cent of the total value of frauds in 2018-19,” the RBI
said.

The RBI, being the central bank and an overall regulator 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, prevention 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 prescribed

by the central bank. As part of their routine, the central bank takes various pro-active steps to control
frauds in banks. For example, after the RBI learns of the fraud cases, they examine the case in detail,
and advise the concerned bank to report the case to the Central Bureau of Investigation,
police, or Serious Fraud Investigation Office (SFIO). Also, bank should take Prompt action to
recover the amount involved from the fraudster.

The RBI also issued several notifications and circulars sensitizing banks about common types of fraud
examples, fraud prone areas, and issued caution notices against the repeat offenders. As remarked by

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E&Y (2010), “The evolving fraud landscape around banking and the increase in fraud-related
losses requires automated detection systems and robust fraud defense processes.”

Banking frauds attracted national attention when the Punjab National Bank reported earlier this year
that it had been defrauded by companies related to jeweler Nirav Modi and Mehul Choksi. Several
other cases of large banking frauds were reported subsequently, which raised questions about the
ability of banks to contain them.

 In 2011, the investigative agency CBI revealed that executives of certain banks such
as Bank of Maharashtra, Oriental Bank of Commerce and IDBI created almost 10,000
fictitious accounts and an amount of Rs, 1,500 crore worth loans were transferred.
 Another scam was unfolded in 2014 which was the bribe for loan scam involving ex
chairman and SK Jain, MD of Syndicate Bank for the involvement in sanctioning Rs.
8000 crore.
 In 2014, Vijay Mallya was also declared a willful defaulter by Union Bank of India,
following which other banks such as SBI and PNB also followed suit.
 In 2015, another fraud that raised eyebrows involved employees of Jain Infra projects
, who defrauded Central Bank of India to tune of over Rs. 2,000.
 One of the biggest banking frauds of 2016 is the one involving Syndicate Bank, where
almost 380 accounts were opened by four people, who defrauded the bank of Rs. 10
billion using using fake cheques, Letter of Undertakings (LoUs) and LIC policies.
 The fresh bank fraud to the tune of Rs. 11,450 crore involving diamond merchant
Nirav Modi. It has come to light that the company , in connivance with retired
employees of PNB, got at least 150 LoUs , allowing Nirav Modi Group to defraud the
bank and many other banks who gave loans to him.

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FRAUD DETECTION

Banks response to fraud is critical as it has the ability to prevent future occurrences. Any
response to fraud should be swift and effective so as to percolate the right message to
employees. Based on a survey conducted by the International Review of Social Sciences on
how fraud incident is typically detected in bank, a large majority of 21% respondents gave
the reason of complaint by a customer. However, the second important reasons given by 18%
of respondents were internal whistle-blower and during audit of accounts or
reconciliation process. Over 16% of respondents gave the reason ―through automated data
analysis or transaction monitoring software. Moreover, other important reasons given by the
respondents were: at the point of transaction (10%), through a third-party notification (7%),
by accident (6%) and review by a law enforcement agency (4%), respectively.

Any response to fraud should be swift and effective so as to percolate the right message to
employees. Fraud investigation requires specific skill sets like ‘forensic accounting and
technology’ to collect adequate evidence, which can be admissible in a court of law. In the
absence of these, banks may not have the confidence to take legal resource or action on the
fraudster, which could be one of the reasons why banks may not be reporting all the cases to
law enforcement agencies.

The RBI, in a report, pointed out that “detection of fraud takes very long-time, and banks
tend to report an account as fraud only when they exhaust the chances of recovery. Delays in
reporting of frauds further delay the alerting of other banks about the modus operandi through
caution advices that may result in similar frauds being perpetrated elsewhere.” There is lack
of trained and experienced bank staff, and tremendous increase in banking business. By-and-
large, new recruits do not have adequate training or experience before they are put into a
responsible position.

The life has become fast and the bank staff does not have enough time to scrutinize
documents thoroughly. Dilution of system and non-adherence to procedures is also a
significant reason for bank frauds. This shows that a full-proof system has not been
developed and implemented to familiarize the bank employees of various types of frauds that
take place in banks every year.

The primary responsibility for preventing frauds lies with individual banks. Major cause for
perpetration of fraud is laxity in observance in laid down system and procedures by
supervising staff. However, the RBI routinely advises banks about major fraud prone areas
and the safeguards necessary for prevention of frauds. This is done so that banks can
introduce necessary safeguards by way of appropriate procedures and internal checks. With
growing usage and dependency on electronic forms of transaction, banks have employed
more secured means and platform separate from the normal channels of communication. The

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authenticity and integrity of such a platform is ensured through usage of specific software,
which ensures the validity of the bank‘s electronic documents.

WHAT IS THE ROLE OF TECHNOLOGY IN COMBATTING BANK

FRAUD?
Technology is like a double-edged sword. On the one hand, perpetrators are using it to further
fraudulent schemes; on the other hand, we are making some of our best progress using the
same technology. Undoubtedly, technology can prove helpful in fraud detection and
prevention in banks. But unfortunately, the fraud takes on many forms to be handled with any
‘single’ application or approach. Instead of relying on reactive measures like whistleblowing,
banks can and should take a more hands-on approach to fraud detection.

Neural Networks have been extensively put to use in the areas of banking, finance and
insurance. Usually such applications of neural networks systems involve knowing about the
previous cases of fraud, to make systems learn the various trends. Fraud cases are statistically
analyzed to derive out relationships among input data and values for certain key parameters
in order to understand the various patterns of fraud. This knowledge of fraud trends is then
iteratively taught to feed-forward neural networks, which can successfully identify similar
fraud cases occurring in the future.

In the realm of fraud detection, the ability to reveal relationships, transactions, locations and
patterns can make the difference between uncovering a fraud scheme at an early stage as
opposed to having it grow into a major incident. Forensic analytical tools can help explore
data and quickly identify errors, irregularities and suspicious transactions embedded within
your day to day business, thereby providing clarity to concerns raised by managers and
employees (Deloitte, Survey 2015).

The new technologies adopted by banks are making them increasingly vulnerable to various
risks, such as, phishing, identity theft, card skimming, vishing (voicemail), SMSishing (text
messages), Whaling (targeted phising on high networth individuals), viruses and Trojans,
spyware and adware, social engineering.

While some of the risks in the banking sector have always been there, they keep on changing
with the constantly evolving technology standards and regulatory framework. For instance,
check fraud is in decline while electronic fraud is on the rise, and the latter tends to be
perpetrated by more sophisticated criminals. Cheque fraud has been around the globe since
the ancient time, but the pace of changing schemes has been very slow for banks to react with
very good procedures—many of them still ‘manual’.

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SERIOUS FRAUD INVESTIGATION OFFICE
The legislation in India which contains provisions with respect to corporate frauds is the
Companies Act, 2013.

Section 447 of the Companies Act 2013, includes any concealment of any fact, omission, act
or abuse of position committed by any person with the connivance in any manner, with intent
to gain undue advantage from, or to injure its shareholders or the interests of the company or
any other person, whether or not there is any wrongful gain or wrongful loss. A wrongful
loss means the loss by unlawful means of property to which the person losing is legally
entitled whereas a wrongful gain means the gain by unlawful means of property to which the
person gaining is not legally entitled.

The Indian Government under Mr. Naresh Chandra (former cabinet secretary) set up a
Committee on Corporate Governance. The Committee inter-alia recommended setting up of
the Corporate Serious Fraud Office. Thereafter, considering the recommendation of the
committee in the backdrop of the failure of non-banking companies resulting in a huge
financial loss to the public, the Cabinet decided to set up a Serious Fraud Investigation Office
(SFIO).

Consequent to the decisions of the Cabinet, the Central Government issued a resolution
constituting this organisation in 2003. In continuation of the aforesaid Resolution, charter of
Serious Fraud Investigation Office stated that the responsibilities and functions of the SFIO.
It is a multi-disciplinary organisation consisting of experts in the field of, forensic auditing,
accountancy, company law, information technology, law, investigation, taxation and capital
market for prosecuting or recommending prosecuting or detecting any frauds or white collar
crimes.

The Act empowers the Central Government with the right to investigate the affairs of the
company, especially in cases of an alleged fraud or even in the oppression of the minority
shareholders.

When a case has already been assigned to the SFIO no other agency of the government has
the authority to proceed to investigate an offence which is committed under this Act and the
same is to be transferred to the SFIO. The company and its officers and employees, who are
or have been in the employment of the company, shall be responsible to provide all
information, explanation, documents and assistance to the investigating officer as he may
require for the conduct of the investigation.

As per the notification by the Ministry of Corporate Affairs in August 2017 powers of arrest
have also been bestowed upon by the government. Although the powers of arrest have been
made limited to the Director, Additional Director and Assistant Director who during the

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investigation of a serious fraud have a reason to believe that a person has committed an
offence under Section 212, he may arrest shall person on the prior written approval of the
Director of SFIO.

Despite giving so many powers by the Act, SFIO still has to face a lot of hurdles and
challenges while performing their functions some of them are:-

 Measures not pre-emptive in nature

 Dependence on Central Government for accountability and intimation of an
investigation.
 The inadequacy of resources and manpower.

Landmark Cases Investigated By SFIO

Satyam Scam

SFIO investigated the Satyam scam and had opined in their report that the directors of the
organisation were not involved in the accounting fraud in the company. The SFIO had a
14,000-page report submitted to the government, marking the end of a three-month-long
investigation. SFIO had investigated and interrogated the directors and opined that the fraud
was done allegedly by the chairman and other top executives of the company. The Central
Government after it was admitted by the chairman that there is a fraud of around 7,000crores
at the company, probe by SFIO was ordered into the scam. The independent directors came
under scanner when Satyam had said that the proposal of taking over two firms was taken
unanimously, though the independent directors had given their disclosure before the SFIO
that they had no knowledge of the same.

Deccan Chronicle Holding Ltd (DCHL)

This Hyderabad based company which owns two English daily newspapers namely Asian
Age and Deccan Chronicle came under the scanner of SFIO which found it to be running in
contravention of about 20 sections of the Companies Act which included those provisions
having a punishment of imprisonment. The Deccan Chronicle later on registered with BIFR.
But it did not the lenders to take action against the company.

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CONCLUSION
While the banking industry in India has witnessed a steady growth in its total business and
profits, the amount involved in bank frauds has also been on the rise. It is important to
understand that fraud investigation requires specific skill sets like forensic accounting and
technology to collect adequate evidence. While the evidence unearthed by a fraud
investigation can vary on a case-to-case basis, typically, it needs to be relevant and
comprehensive to be admissible in a court of law. Certain additional aspects such as the
source of the evidence, a legitimate witness, electronic evidence and data etc., can all add
credibility to the case. In the absence of these, organizations may not have the confidence to
take legal recourse or action on the fraudster which could be one of the reasons why banks
may not be reporting all the cases to law enforcement agencies.

Prior to Satyam fraud, most companies perceived fraud as largely an internal event, primarily
pinching the bottom line. They now understand that fraud can have an impact not only on the
reputation and business prospects but also on the survival of the firm. This concern has led to
higher demand for forensic chartered accountants (FCAs) in countries like India and China.
The Ministry of Corporate Affairs in India has also established the Serious Fraud
Investigation Office, which seeks the help of FCAs. The government recently proposed to
give more teeth to the SFIO under the new Companies Bill by providing it statutory
recognition and empowering it with more powers. The FCA‘s being professional members of
the CG and Audit Committees, can play a far greater role in coordinating company efforts to
achieve a cohesive policy of ethical behavior within an organization. By helping companies
to detect and prevent fraud, FCAs can create a positive work environment, establish effective
lines of communication, and be vigilant as a corporate watchdog, the FCAs role can gradually
evolve into a key component in the CG system.

Last, but not the least, effective customer education and communications programs–helping
customers recognize how to prevent fraud, but also helping them understand their own
responsibilities–should go hand-in-hand with sophisticated cyber security measures. Only by
working in partnership with their customers can financial institutions develop truly effective
fraud prevention efforts.

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