Frauds in Banks- An Overview

Malpractice :

Malpractice is the unethical conduct by the professional or holder of official position. The
act or an instance of improper practice in day to day in some areas of branch banking is
now widely spreading. Malpractice is grievous threat to normal functioning of bank and
may arise catastrophic risks, which might be the ‘Root cause of Bank failure”. It is the
observations of experienced bankers that the Fraud and Forgery in banks is the
consequential of Malpractice.

Causes behind Malpractice:

Ignorance:

 Lack of knowledge about job procedures spelled out in the Book of Instructions
 Ignorance about the bank practice
 Lack of knowledge of Banking Laws
 Unethical delegation of power
 Supervisory lapses, Breaking chain of command

Negligence:

 A lapse or omission in meeting obligation by- Non-attendance, Delinquency, law

breaking, contravention, carelessness & recklessness
 Violation the Banking manual
 Violation Bank Circulars from Head Office
 Violation other official instruction from Higher authority

Offence:

For the purpose of gaining or restoring personal interest by

 Unfairness, Biasness
 Influence, manipulation
 Prejudice, discrimination
 Concealment of facts, camouflage the reality, Breach of trust

Affect of Malpractice
  Financial loss for the bank
 Reputation loss
 Customers Trust Loss
 Personal Loss(victimize innocent employees)

Prevention of Malpractice

 Consolidation of Internal Control & Compliance procedures in bank as“

Corporate culture”
 Risk based audit & inspection system to be introduced for all areas in banking.
 Job specifications & job procedures must be spelled out clearly for every tiers in
bank
 Strict compliance of General Banking Manual and Head Office instructions,
circulars
 Strict compliance of Business Delegation, Financial Delegation, Administrative
Power at all level in Bank.
 Chain of command and accountability must be established in every spheres of
organization
 The internal inspection should be strengthened and compliance of inspection
objections should strictly be reviewed.
 Official must be transferred at reasonable intervals to prevent creation of vested
interest.
 Affluent living of officials beyond their means should be taken into cognizance of
as warning signals and a close watch should be kept on them
 New account introduction should be taken cautiously. Thanks Letter should be
sent to the account holder.
 In no case should one employee be allowed to have an absolute and exclusive
control over any important financial operation and its accounting aspects.
 No bank employee should normally maintain more than one account in his name
and all his transactions should be reviewed on the size and volume of transaction.
 Update the knowledge of all employees with the change of law, practice,
procedures and products of the Bank.
 Careful review of Returns/statements from the branches and take necessary action
incase of any deviation.

Fraud :

The term “fraud commonly includes activities such as theft, corruption, conspiracy,
embezzlement, money laundering bribery and extortion. The legal definition varies from
country to country, and it is only since the introduction of the Fraud Act in 2006, that
there has been a legal definition of fraud in England & Wales.

Fraud essentially involves using deception to dishonestly make a personal gain for
oneself and/or create a loss
Fraud is defined as falsification of information or misrepresentation by an applicant,
customer, employee or any third party with an intention to defraud the bank.

Types of Fraud in Bank

Financial Statements Fraud

1) Deliberate misstatement of numbers

 Booking fictitious sales

 Understating expenses
 Overstating assets
 Understating liabilities
 Mischaracterization as one-Time Expenses

2) Misapplication of accounting rules

 Recording expenses in the wrong period

 Improper use of reserves
 Materiality
 Timing differences
 Misrepresentation or omission of information through the “Notes to the financial
statements”

Other ways of classifying Frauds

 Internal versus external fraud based on whether the perpetrator is the internal or
external to the victim organization
 Employee stealing from the company or a manager cooking the books are
examples of internal fraud
 Frauds committed by vendors, suppliers or contractors are example of external
fraud
 The statement fraud is “ The intentional misstatement of certain financial values
to enhance the appearance of profitability and deceive shareholders or creditors.
 Transaction fraud is intended to embezzle or steal organizational assets thru
forged instruments.

According to the Association of Certified Fraud Examiners (ACFE), there are three main
categories of fraud that affect organizations. The first of these is asset misappropriations,
which involves the theft or misuse of an organization’s assets. Examples include theft of
inventory or cash, false invoicing, accounts receivable fraud etc.

The second category of fraud is fraudulent statements. This is usually in the form of
falsification of financial statements in order to obtain some form of improper benefit. It is
also includes falsifying documents.
The final of the three fraud categories is corruption. This includes activities such as the
use of bribes , improper use of confidential information, conflict of interest etc.

Who is Fraudster/ Who Commits Fraud

Everyday people commit fraud given situational pressures. The characteristics of a

Fraudsters are :

 Unusually high personal debts. Debts could be caused by family crisis or hardship
overspending, living beyond one’s means, financial mismanagement or several
personal financial losses.
 Excessive gambling, alcohol or drug problem- addictive behaviors and out of
control spending leads to financial pressures.
 Undue family, institutional and peer pressure to succeed, high expectations by
family or close friends that pressure the individual to perform beyond
expectations.
 Dissatisfaction with job, feeling underpaid or not recognized. Feeling that the
individual’s efforts and loyalty to the organization is not being recognized or
rewarded. Compensation is not equitable to the performance of the individual.
Feeling that the individual is being held back or cannot get ahead
 Overwhelming desire for personal gain. Addictive behavior that leads to the
individual to try, by and means necessary to achieve professional and financial
success.
 Belief that job is in jeopardy. Faced with the loss of job and financial stability.
 Close associations with suppliers or customers
 Lack of Personal stability. Frequent changes in job, residence .
 Intellectual challenges to beat the system. The thrill-seeker commits fraud
“ because I Can”. Attempts to commit fraudulent acts to prove that the individual
has the ability to outsmart the control environment.
 Not taking vacations or sick time.
 A typical fraudster on the surface is a long time employee, holds a position of
trust, appears to be extremely dedicated, living beyond his/her means and has a
wheeler dealer attitude.

Characteristics of Fraudsters

Internal Fraudster:

 Knows the systems and procedures well

 A risk taker. A rule breaker
 Hardworking
 Intelligent and Inquisitive
 Big spender and expensive life style
  Greedy or has genuine financial needs

External Fraudster:

 Too friendly and charming

 Very confident and convincing but too much exaggeration
 Articulate
 Sophisticated and appears wealthy but no way to trace the wealth
 Aggressive ; in a hurry

Fraudsters usually fall into one of three categories:

1. Pre-planned fraudsters, who start out from the beginning intending to commit
fraud. These can be short-term players, like many who use stolen credit cards or
false social security numbers; or can be longer-term, like bankruptcy fraudsters
and those who execute complex money laundering schemes.

2. Intermediate fraudsters, who start off honest , but turn to fraud when time get
hard or when life events, such as irritation at being passed over for promotion or
the need to pay for care for a family member, change the normal mode.

3. Slippery-slope fraudsters, who simply carry on trading even when, objectively,

they are not in a position to pay their debts. This can apply to ordinary traders or
to major business people.

In 2007, KPMG carried out research on the profile of a Fraudster, using details of fraud
case in Europe, India, the Middle- East and South Africa. The ACFE carried out similar
research on frauds committed in the US. These survey highlight the following facts and
figures in relation to fraudsters:

 Most fraudsters are aged between 36 and 55

 The majority of frauds are committed by men
 A high percentage of frauds are committed by senior management.
 Losses caused by managers are generally more than double those caused by
employees
 Longer term employees tend to commit much larger frauds.
Four Keys to Fight Fraud

 Fraud Prevention
 Early Detection
 Investigation
 Legal Action & Resolution
Fraud Triangles
There is no single reason behind fraud and any explanation of it needs to take account of
various factors.

A common model that brings together a number of these factors is the Fraud Triangle.
This model is built on the premise that fraud is likely to result from a combination of
three factors : Opportunity, motivation & rationalization.

Opportunity

Motivation Rationalization

Opportunity:

Opportunity always comes first. All employees have a certain degree of opportunity
within the organization . It is unavoidable.

When an employee is given all sorts of access to assets and records, systems and
information in order to carry out his/her job duties, that access is one of the key
components of fraud.

Banks have become more complex and managers have become responsible for a wider
range of employees and functions. Individual employees have been given more access
and control over the resources of the organization.

Incidentally, increased access to resources and data, along with increased control over
functional areas of organizations, has created a situation in which it may be easier than
ever for employees to commit fraud.

Motivation:

 Non-sharable financial pressure

 A situation that is so insurmountable that a person cannot see any other way out
 Family pressure
 Insatiable desire for financial gain.
 Pressure to meet institutional goals
 Desire to take revenge on someone/organization.
Rationalization :

An attitude ,character or set of ethical values that allows someone to intentionally commit
a dishonest act or a situation in which someone can rationalize a dishonest act.

A way of justify in the person’s consciousness that the act of fraud is not so bad.

Common beliefs: Person is owed this money, Just borrowing until they are able to pay it
back, Everyone else is doing it.

Fraud Prone Areas in Bank

 Identity theft- a new customers with fictitious ID and other forged documents and
signature.
 Opening accounts in the names of payees of stolen cheques.
 Abuse of system access rights thru sharing or hacking
 Static data changes- address, occupation.
 Customer statement or bank certificate rendition.
 Cheque frauds- forged signatures, unauthorized alterations
 Dormant accounts activated through forged instructions
 Loans and credit cards in fictitious or stolen identity names
 Perfection & custody of loan documentation
 Collateral inspection & asset valuation.
 Acceptance of L/C Bill
 Credit facilities which are approved and disbursed by the branch (Branch is
responsible for approving lending up to a certain limit )

Definition of Forgeries, irregularities, embezzlement, misappropriation.

Forgeries: An inferior substitute imitating of an original, giving a false impression of

truth or authenticity for the purpose of illogical gain. Forgery means make or write in
fraudulent imitation, act of forging, forged documents etc.

Embezzlement: The fraudulent appropriation of funds or property entrusted to your care

but actually owned by some one else.

Misappropriation/defalcation : A attempt by speculators to defraud investors.