Banking Fraud

Banking 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,

1. First, there is the subjective intention, and 
2. 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:

1. Active participation of the personnel, both managerial and clerical, either independently or in collusion with outsiders.
2. Failure of bank employees to adhere to properly set out instructions and procedures.
3. External elements defrauding banks by forging or manipulating checks, drafts, and other financial instruments.
4. 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:

1. Misappropriation and criminal breach of trust.
2. Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts, and conversion of property.
3. Unauthorised credit facilities extended for reward or for illegal gratification.
4. Negligence and cash shortages.
5. Cheating and forgery.
6. Irregularities in foreign exchange transactions.
7. Any other type of fraud not coming under the specific heads as above.

Risks possessed by fraudulent activities on banks 

1. 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. 
2. 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. 
3. 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.

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.  

Cheque frauds, deposit account frauds, purchase bill frauds, hypothecation frauds, loan frauds, frauds in foreign currency transactions, and inter-branch account scams are all examples of bank frauds. The failure of supervisory employees to follow established systems and processes is a major source of fraud. Unscrupulous constituents conduct frauds by taking advantage of authorities’ weakness in enforcing the Reserve Bank of India’s (RBI) time-tested safeguards. In its central office, the RBI has established an investigation unit. It is manned by an ace investigator with extensive expertise. The bank team delves into the core causes of bank fraud and offers comprehensive prevention recommendations. The RBI conducts in-depth analyses and research into the commission of bank frauds and makes recommendations for fraud prevention measures.

To maintain depositors’ interests and public trust, a good banking system should have three key features which are provided hereunder: 

1. A society that is devoid of deception,
2. A tried-and-tested best practice code, and
3. An in-house method for resolving pressing grievances. 

In India, all of these criteria are either absent or severely weakened.