Banking System Frauds and Legal Control

Banking System Frauds And Legal Control
Banking System
What is banking?
While walking on the streets of any town or city you
might have seen some signboard on buildings with names –
Canara bank, Punjab national bank, State bank of India,
Commercial bank, etc. what do these names stand for?
Did you ever try to know about them? If you ever enter such
building you will find some kind of a business office. You will
see some employees sitting behind counters dealing with
visitors standing in front of them you will find that some are
depositing money at one counter while some are receiving
money at other counter behind the counters of office you will
see tables and chairs occupied by officers. On one side of
the office you will also see a chamber (small partitioned
room) where the manager is sitting with papers on his tables
this is office of a ‘bank’.
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DEFINATION OF BANKING
‘Banking is defined in the Banking Regulation Act as

“the activity of acceptance of deposits of money from the
public repayable on demand or otherwise for the purpose of
lending or for investment’.
TYPES OF BANKS
Central bank Development Bank Specialised banks

(RBI, In India (EXIM Bank,
SIDBI, NABARD)
Commercial banks Co-operative banks

1. Public sector banks 1. Primary credit societies
2. Private sector banks 2. Central co-operative bank
3. Foreign banks 3. Sate co-operative banks
EVOLUTION OF BANKING SYSTEM IN INDIA
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Banking system occupies an important place in a nation's

economy. A banking institution is essential in a modern
society. It plays a pivotal role in economic development of a
country and forms the core of the money market in an
advanced country.
Banking industry in India has traversed a long way to
assume its present status. It has undergone a major
structural transformation after the nationalization of 14
major commercial banks in 1969 and 6 more on 15 April
1980. The Indian banking system is unique and perhaps has
no parallels in the banking history of any country in the
world.
Investment in India - Banking System
The central bank of the country is the Reserve Bank of India

(RBI). It was established in April 1935 with a share capital of
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Rs. 5 crores on the basis of the recommendations of the

Hilton Young Commission. The share capital was divided into
shares of Rs. 100 each fully paid which was entirely owned
by private shareholders in the begining. The Government
held shares of nominal value of Rs. 2, 20,000.
Reserve Bank of India was nationalized in the year 1949.
The general superintendence and direction of the Bank is
entrusted to Central Board of Directors of 20 members, the
Governor and four Deputy Governors, one Government
official from the Ministry of Finance, ten nominated Directors
by the Government to give representation to important
elements in the economic life of the country, and four
nominated Directors by the Central Government to represent
the four local Boards with the headquarters at Mumbai,
Kolkata, Chennai and New Delhi. Local Boards consist of five
members each Central Government appointed for a term of
four years to represent territorial and economic interests
and the interests of co-operative and indigenous banks
The Reserve Bank of India Act, 1934 was commenced on
April 1, 1935. The Act, 1934 (II of 1934) provides the
statutory basis of the functioning of the Bank.
The Bank was constituted for the need of following:
• To regulate the issue of banknotes
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• To maintain reserves with a view to securing monetary

stability and
• To operate the credit and currency system of the
country to its advantage.
Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the
important functions of a central bank the Reserve Bank of
India.
Bank of Issue
Under Section 22 of the Reserve Bank of India Act, the Bank

has the sole right to issue bank notes of all denominations.
The distribution of one rupee notes and coins and small
coins all over the country is undertaken by the Reserve Bank
as agent of the Government. The Reserve Bank has a
separate Issue Department which is entrusted with the issue
of currency notes. The assets and liabilities of the Issue
Department are kept separate from those of the Banking
Department. Originally, the assets of the Issue Department
were to consist of not less than two-fifths of gold coin, gold
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bullion or sterling securities provided the amount of gold

was not less than Rs. 40 crores in value. The remaining
three-fifths of the assets might be held in rupee coins,
Government of India rupee securities, eligible bills of
exchange and promissory notes payable in India. Due to the
Exigencies of the Second World War and the post-was

period, these provisions were considerably modified. Since
1957, the Reserve Bank of India is required to maintain gold
and foreign exchange reserves of Rs. 200 crores, of which at
least Rs. 115 crores should be in gold. The system as it
exists today is known as the minimum reserve system.
Banker to Government
The second important function of the Reserve Bank of India

is to act as Government banker, agent and adviser. The
Reserve Bank is agent of Central Government and of all
State Governments in India excepting that of Jammu and
Kashmir. The Reserve Bank has the obligation to transact
Government business, via. To keep the cash balances as
deposits free of interest, to receive and to make payments
on behalf of the Government and to carry out their exchange
remittances and other banking operations. The Reserve
Bank of India helps the Government - both the Union and
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the States to float new loans and to manage public debt.

The Bank makes ways and means advances to the
Governments for 90 days. It makes loans and advances to
the States and local authorities. It acts as adviser to the
Government on all monetary and banking matters.
Bankers' Bank and Lender of the Last Resort
The Reserve Bank of India acts as the bankers' bank.

According to the provisions of the Banking Companies Act of
1949, every scheduled bank was required to maintain with
the Reserve Bank a cash balance equivalent to 5% of its
demand liabilities and 2 per cent of its time liabilities in
India. By an amendment of 1962, the distinction between
demand and time liabilities was abolished and banks have
been asked to keep cash reserves equal to 3 per cent of
their aggregate deposit liabilities. The minimum cash
requirements can be changed by the Reserve Bank of India.
The scheduled banks can borrow from the Reserve Bank of
India on the basis of eligible securities or get financial
accommodation in times of need or stringency by
rediscounting bills of exchange. Since commercial banks can
always expect the Reserve Bank of India to come to their
help in times of banking crisis the Reserve Bank becomes
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not only the banker's bank but also the lender of the last
resort.
Controller of Credit
The Reserve Bank of India is the controller of credit i.e. it

has the power to influence the volume of credit created by
banks in India. It can do so through changing the Bank rate
or through open market operations. According to the
Banking Regulation Act of 1949, the Reserve Bank of India
can ask any particular bank or the whole banking system not
to lend to particular groups or persons on the basis of
certain types of securities. Since 1956, selective controls of
credit are increasingly being used by the Reserve Bank.
The Reserve Bank of India is armed with many more powers
to control the Indian money market. Every bank has to get a
license from the Reserve Bank of India to do banking
business within India, the license can be cancelled by the
Reserve Bank of certain stipulated conditions are not
fulfilled. Every bank will have to get the permission of the
Reserve Bank before it can open a new branch. Each
scheduled bank must send a weekly return to the Reserve
Bank showing, in detail, its assets and liabilities. This power
of the Bank to call for information is also intended to give it
effective control of the credit system. The Reserve Bank has
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also the power to inspect the accounts of any commercial

bank.
As supreme banking authority in the country, the Reserve
Bank of India, therefore, has the following powers:
(a) It holds the cash reserves of all the scheduled banks.
(b) It controls the credit operations of banks through

quantitative and qualitative controls.
(c) It controls the banking system through the system of

licensing, inspection and calling for information.
(d) It acts as the lender of the last resort by providing

rediscount facilities to scheduled banks.
Custodian of Foreign Reserves
The Reserve Bank of India has the responsibility to maintain

the official rate of exchange. According to the Reserve Bank
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of India Act of 1934, the Bank was required to buy and sell
at fixed rates any amount of sterling in lots of not less than
Rs. 10,000. The rate of exchange fixed was Re. 1 = sh. 6d.
Since 1935 the Bank was able to maintain the exchange rate
fixed at lsh.6d. Though there were periods of extreme
pressure in favor of or against
The rupee. After India became a member of the
International Monetary Fund in 1946, the Reserve Bank has
the responsibility of maintaining fixed exchange rates with
all other member countries of the I.M.F.
Besides maintaining the rate of exchange of the rupee, the
Reserve Bank has to act as the custodian of India's reserve
of international currencies. The vast sterling balances were
acquired and managed by the Bank. Further, the RBI has
the responsibility of administering the exchange controls of
the country.
RESERVE BANK OF INDIA
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Supervisory functions
In addition to its traditional central banking functions, the

Reserve bank has certain non-monetary functions of the
nature of supervision of banks and promotion of sound
banking in India. The Reserve Bank Act, 1934, and the
Banking Regulation Act, 1949 have given the RBI wide
powers of supervision and control over commercial and co-
operative banks, relating to licensing and establishments,
branch expansion, liquidity of their assets, management and
methods of working, amalgamation, reconstruction, and
liquidation. The RBI is authorised to carry out periodical
inspections of the banks and to call for returns and
necessary information from them. The nationalization of 14
major Indian scheduled banks in July 1969 has imposed new
responsibilities on the RBI for directing the growth of
banking and credit policies towards more rapid development
of the economy and realization of certain desired social
objectives. The supervisory functions of the RBI have helped
a great deal in improving the standard of banking in India to
develop on sound lines.
RESERVE BANK OF INDIA
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Promotional functions
With economic growth assuming a new urgency since

Independence, the range of the Reserve Bank's functions
has steadily widened. The Bank now performs a variety of
developmental and promotional functions, which, at one
time, were regarded as outside the normal scope of central
banking. The Reserve Bank was asked to promote banking
habit, extend banking facilities to rural and semi-urban
areas, and establish and promote new specialized financing
agencies. Accordingly, the Reserve Bank has helped in the
setting up of the IFCI and the SFC; it set up the Deposit
Insurance Corporation in 1962, the Unit Trust of India in
1964, the Industrial Development Bank of India also in
1964, the Agricultural Refinance Corporation of India in
1963 and the Industrial Reconstruction Corporation of India
in 1972. These institutions were set up directly or indirectly
by the Reserve Bank to promote saving habit and to
mobilize savings, and to provide industrial finance as well as
agricultural finance. As far back as 1935, the Reserve Bank
of India set up the Agricultural Credit Department to provide
agricultural credit. But only since 1951 the Bank's role in
this field has become extremely important. The Bank has
developed the co-operative credit movement to encourage
saving, to eliminate moneylenders from the villages and to
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route its short term credit to agriculture. The RBI has set up
the Agricultural Refinance and Development Corporation to
provide long-term finance to farmers.
Classification of RBIs functions
The monetary functions also known as the central banking

functions of the RBI are related to control and regulation of
money and credit, i.e., issue of currency, control of bank
credit, control of foreign exchange operations, banker to the
Government and to the money market. Monetary functions
of the RBI are significant as they control and regulate the
volume of money and credit in the country.
Equally important, however, are the non-monetary functions

of the RBI in the context of India's economic backwardness.
The supervisory function of the RBI may be regarded as a
non-monetary function (though many consider this a
monetary function). The promotion of sound banking in
India is an important goal of the RBI, the RBI has been
given wide and drastic powers, under the Banking
Regulation Act of 1949 - these powers relate to licensing of
banks, branch expansion, liquidity of their assets,
management and methods of working, inspection,
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amalgamation, reconstruction and liquidation. Under the

RBI's supervision and inspection, the working of banks has
greatly improved. Commercial banks have developed into
financially and operationally sound and viable units. The
RBI's powers of supervision have now been extended to
non-banking financial intermediaries. Since independence,
particularly after its nationalization 1949, the RBI has
followed the promotional functions vigorously and has been
responsible for strong financial support to industrial and
agricultural development in the country.
India has a financial system that is regulated by independent

regulators in the sectors of banking, insurance, capital
markets, competition and various services sectors. In a
number of sectors
Government plays the role of regulator.
Ministry of Finance, Government of India looks after financial

sector in India. Finance Ministry every year presents annual
budget on February 28 in the Parliament. The annual budget
proposes changes in taxes, changes in government policy in
almost all the sectors and budgetary and other allocations
for all the Ministries of Government of India. The annual
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budget is passed by the Parliament after debate and takes

the shape of law.
Reserve bank of India (RBI) established in 1935 is the

Central bank. RBI is regulator for financial and banking
system, formulates monetary policy and prescribes
exchange control norms. The Banking Regulation Act, 1949
and the Reserve Bank of India Act, 1934 authorize the RBI
to regulate the banking sector in India.
India has commercial banks, co-operative banks and

regional rural banks. The commercial banking sector
comprises of public sector banks, private banks and foreign
banks. The public sector banks comprise the ‘State Bank of
India’ and its seven associate banks and nineteen other
banks owned by the government and account for almost
three fourth of the banking sector. The Government of India
has majority shares in these public sector banks.
India has a two-tier structure of financial institutions
with thirteen all India financial institutions and forty-six
institutions at the state level. All India financial institutions
comprise term-lending institutions, specialized institutions
and investment institutions, including in insurance. State
level institutions comprise of State Financial Institutions and
State Industrial Development Corporations providing project
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finance, equipment leasing, corporate loans, short-term

loans and bill discounting facilities to corporate. Government
holds majority shares in these financial institutions.
Non-banking Financial Institutions provide loans and hire-

purchase finance, mostly for retail assets and are regulated
by RBI.
Insurance sector in India has been traditionally
dominated by state owned Life Insurance Corporation and
General Insurance Corporation and its four subsidiaries.
Government of India has now allowed FDI in insurance
sector up to 26%. Since then, a number of new joint venture
private companies have entered into life and general
insurance sectors and their share in the insurance market in
rising. Insurance Development and Regulatory Authority
(IRDA) is the regulatory authority in the insurance sector
under the Insurance Development and Regulatory Authority
Act, 1999.
RBI also regulates foreign exchange under the Foreign

Exchange Management Act (FERA). India has liberalized its
foreign exchange controls. Rupee is freely convertible on
current account. Rupee is also almost fully convertible on
capital account for non-residents. Profits earned, dividends
and proceeds out of the sale of investments are fully
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repatriable for FDI. There are restrictions on capital account

for resident Indians for incomes earned in India.
Securities and Exchange Board of India (SEBI) established

under the Securities and Exchange aboard of India Act, 1992
is the regulatory authority for capital markets in India. India
has 23 recognized stock exchanges that operate under
government approved rules, bylaws and regulations. These
exchanges constitute an organized market for securities
issued by the central and state governments, public sector
companies and public limited companies. The Stock
Exchange, Mumbai and National Stock Exchange are the
premier stock exchanges. Under the process of de-
mutualization, these stock exchanges have been converted
into companies now, in which brokers only hold minority
share holding. In addition to the SEBI Act, the Securities
Contracts (Regulation) Act, 1956 and the Companies Act,
1956 regulates the stock markets.
RESERVE BANK OF INDIA-ECONOMIC AND

SOCIAL OBJECTIVE
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The Reserve Bank of India has an important role to

play in the maintenance of the exchange value of the
rupee in view of the close interdependence of
international trade and national economic growth
and well being. This aspect is of the wider
responsibly of the central bank for the maintenance
of economic and financial stability. For this the bank
is entrusted with the custody and the management
of country's international reserves; it acts also as the
agent of the government in respect of India's
membership of the international monetary fund. With
economic development the bank also performs a
variety of developmental and promotional functions
which in the past were registered being outside the
normal purview of central banking. It also acts an
important regulator.
RECENT TRENDS OF BANKING SYSTEM IN

INDIA
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In the banking and financial sectors, the introduction of

electronic technology for transactions, settlement of
accounts, book-keeping and all other related functions is
now an imperative. Increasingly, whether we like it or not,
all banking transactions are going to be electronic. The
thrust is on commercially important centers, which account
for 65 percent of banking business in terms of value. There
are now a large number of fully computerized branches
across the country.
A switchover from cash-based transactions to paper-based
transactions is being accelerated. Magnetic Ink character
recognition clearing of cheques is now operational in many
cities, beside the four metro cities. In India, the design,
management and regulation of electronically-based
payments system are becoming the focus of policy
deliberations. The imperatives of developing an effective,
efficient and speedy payment and settlement systems are
getting sharper with introduction of new instruments such as
credit cards, telebanking, ATMs, retail Electronic Funds
Transfer (EFT) and Electronic Clearing Services (ECS). We
are moving towards smart cards, credit and financial
Electronic Data Interchange (EDI) for straight through
processing.
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ATM
Financial Fraud (Investigation, Prosecution, Recovery and

Restoration of property) Bill, 2001
Further the Financial Fraud (Investigation, Prosecution,
Recovery and Restoration of property) Bill, 2001 was
introduced in Parliament to curb the menace of Bank Fraud.
The Act was to prohibit, control, investigate financial frauds;
recover and restore properties subject to such fraud;
prosecute for causing financial fraud and matters connected
therewith or incidental thereto.
Under the said act the term Financial Fraud has been defined
as under: Section 512 - Financial Fraud Financial frauds
means and includes any of the following acts committed by a
person or with his connivance, or by his agent, in his
dealings with any bank or financial institution or any other
entity holding public funds;
1. The suggestion, as a fact, of that which is not true, by
one who does not believe it to be true;
2. The active concealment of a fact by one having
knowledge or belief of the fact;
3. A promise made with out any intention of performing it;
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4. Any other act fitted to deceive;

5. Any such act or omission as the law specially declares to
be fraudulent.
Provided that whoever acquires, possesses or transfers any
proceeds of financial fraud or enters into any transaction
which is related to proceeds of fraud either directly or
indirectly or conceals or aids in the concealment of the
proceeds of financial fraud, commits financial fraud.
513(a) - Punishment for Financial Fraud
Whoever commits financial fraud shall be:

(a) Punished with rigorous imprisonment for a term, which
may extend to seven years and shall also be liable to fine.
(b)Whoever commits serious financial fraud shall be

punished with rigorous imprisonment for a term which may
extend to ten years but shall not be less than five years and
shall also be liable for fine up to double the amount involved
in such fraud.
Provided that in both (a) and (b) all funds, bank accounts
and properties acquired using such funds subjected to the
financial fraud as may reasonably be attributed by the
investigating agency shall be recovered and restored to the
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rightful owner according to the procedure established by

law.
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Banking Fraud - Prevention and

Control
Banking Fraud is posing threat to Indian Economy. Its
vibrant effect can be understood be the fact that in the year
2004 number of Cyber Crime were 347 in India which rose
to 481 in 2005 showing an increase of 38.5% while I.P.C.
category crime stood at 302 in 2005 including 186 cases of
cyber fraud and 68 cases cyber forgery. Thus it becomes
very important that occurrence of such frauds should be
minimized. More upsetting is the fact that such frauds are
entering in Banking Sector as well.
In the present day, Global Scenario Banking System has
acquired new dimensions. Banking did spread in India.
Today, the banking system has entered into competitive
markets in areas covering resource mobilization, human
resource development, customer services and credit
management as well.
Indian's banking system has several outstanding
achievements to its credit, the most striking of which is its
reach. In fact, Indian banks are now spread out into the
remotest areas of our country. Indian banking, which was
operating in a highly comfortable and protected environment
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till the beginning of 1990s, has been pushed into the choppy
waters of intense competition.
A sound banking system should possess three basic
characteristics to protect depositor's interest and public
faith. Theses are (i) a fraud free culture,
(ii) A time tested Best Practice Code, and
(iii) An in house immediate grievance remedial system.
All these conditions are their missing or extremely weak in
India. Section 5(b) of the Banking Regulation Act, 1949
defines banking... "Banking is the accepting for the purpose
of lending or investment, deposits of money for the purpose
of lending or investment, deposits of money from the public,
repayable on demand or otherwise and withdraw able by
cheque, draft, order or otherwise." But if his money has
fraudulently been drawn from the bank the latter is under
strict obligation to pay the depositor. The bank therefore has
to ensure at all times that the money of the depositors is not
drawn fraudulently. Time has come when the security
aspects of the banks have to be dealt with on priority basis.
The banking system in our country has been taking care of
all segments of our socio-economic set up. The Article
contains a discussion on the rise of banking frauds and
various methods that can be used to avoid such frauds.
A bank fraud is a deliberate act of omission or commission
by any person carried out in the course of banking
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transactions or in the books of accounts, resulting in

wrongful gain to any person for a temporary period or
otherwise, with or without any monetary loss to the bank.
The relevant provisions of Indian Penal Code, Criminal
Procedure Code, Indian Contract Act, and Negotiable
Instruments Act relating to banking frauds have been cited
in the present Article.
BANK FRAUDS: CONCEPT AND DIMENSIONS

Banks are the engines that drive the operations in the
financial sector, which is vital for the economy. With the
nationalization of banks in 1969, they also have emerged as
engines for social change. After Independence, the banks
have passed through three stages. They have moved from
the character based lending to ideology based lending to
today competitiveness based lending in the context of
India's economic liberalization policies and the process of
linking with the global economy.
While the operations of the bank have become increasingly
significant banking frauds in banks are also increasing and
fraudsters are becoming more and more sophisticated and
ingenious. In a bid to keep pace with the changing times,
the banking sector has diversified it business manifold. And
the old philosophy of class banking has been replaced by
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mass banking. The challenge in management of social

responsibility with economic viability has increased.
DEFINITION OF FRAUD
Fraud is defined as "any behavior by which one person

intends to gain a dishonest advantage over another". In
other words , fraud is an act or omission which is intended
to cause wrongful gain to one person and wrongful loss to
the other, either by way of concealment of facts or
otherwise.
Fraud is defined u/s 421 of the Indian Penal Code and u/s 17
of the Indian Contract Act. Thus essential elements of frauds
are:
1. There must be a representation and assertion
2. It must relate to a fact
3. It must be with the knowledge that it is false or without

belief in its truth
4. It must induce another to act upon the assertion in

question or to do or not to do certain act.
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BANK FRAUDS
Losses sustained by banks as a result of frauds exceed the

losses due to robbery, dacoit, burglary and theft-all put
together. Unauthorized credit facilities are extended for
illegal gratification such as case credit allowed against
pledge of goods, hypothecation of goods against bills or
against book debts. Common modus operandi are, pledging
of spurious goods, inletting the value of goods,
hypothecating goods to more than one bank, fraudulent
removal of goods with the knowledge and connivance of in
negligence of bank staff, pledging of goods belonging to a
third party. Goods hypothecated to a bank are found to
contain obsolete stocks packed in between goods stocks and
case of shortage in weight is not uncommon.
An analysis made of cases brings out broadly the under
mentioned four major elements responsible for the
commission of frauds in banks.
1. Active involvement of the staff-both supervisor and

clerical either independent of external elements or in
connivance with outsiders.
2. Failure on the part of the bank staff to follow exactly

laid down instructions and guidelines.
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3. External elements cause to continue indefinitely frauds

on banks by forgeries or manipulations of cheques, drafts
and other instruments.
4. There has been a growing collusion between business,

top banks executives, civil servants and politicians in
power to defraud the banks, by getting the rules bent,
regulations flouted and banking norms thrown to the
winds.
FRAUDS-PREVENTION AND DETECTION
A close study of any fraud in bank reveals many common

basic features. There may have been negligence or
dishonesty at some stage, on part of one or more of the
bank employees. One of them may have colluded with the
borrower. The bank official may have been putting up with
the borrower's sharp practices for a personal gain. The
proper care which was expected of the staff, as custodians
of banks interest may not have been taken. The bank's rules
and procedures laid down in the Manual instructions and the
circulars may not have been observed or may have been
deliberately ignored.
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Bank frauds are the failure of the banker. It does not mean
that the external frauds do not defraud banks. But if the
banker is upright and knows his job, the task of defrauder
will become extremely difficult, if not possible.
Detection of Frauds
Despite all care and vigilance there may still be some frauds,
though their number, periodicity and intensity may be
considerably reduced. The following procedure would be
very helpful if taken into consideration:
1. All relevant data-papers, documents etc. Should be

promptly collected. Original vouchers or other papers
forming the basis of the investigation should be kept
under lock and key.
2. All persons in the bank who may be knowing something

about the time, place a modus operandi of the fraud
should be examined and their statements should be
recorded.
3. The probable order of events should thereafter be

reconstructed by the officer, in his own mind.
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4. It is advisable to keep the central office informed about

the fraud and further developments in regard thereto.
Classification of Frauds and Action Required by Banks
The Reserve Bank of India had set-up a high level
committee in 1992 which was headed by Mr. A.Ghosh, the
then Dy. Governor Reserve Bank of India to inquire into
various aspects relating to frauds malpractice in banks.
The committee had noticed/observed three major causes
for perpetration of fraud as given hereunder:
1. Lenient in observance of the laid down system and

procedures by operational and supervising staff.
2. over confidence reposed in the clients who indulged in

breach of trust.
3. Unscrupulous (dishonest) clients by taking advantages

of the lenient in observance of established, time tested
safeguards also committed frauds.
In order to have uniformity in reporting cases of frauds, RBI
considered the question of classification of bank frauds on
the basis of the provisions of the IPC.
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Given below are the Provisions and their Remedial
measures that can be taken.
1. Cheating (Section 415, IPC)

Remedial Measures.
The preventive measures in respect of the cheating can be
concentrated on cross-checking regarding identity,
genuineness, verification of particulars, etc. in respect of
various instruments as well as persons involved in
encashment or dealing with the property of the bank.
2. Criminal misappropriation of property

(Section 403 IPC).
Remedial Measure
Criminal misappropriation of property, presuppose the
custody or control of funds or property, so subjected, with
that of the person committing such frauds. Preventive
measures, for this class of fraud should be taken at the level
the custody or control of the funds or property of the bank
generally vests. Such a measure should be sufficient, it is
extended to these persons who are actually handling or
having actual custody or control of the fund or movable
properties of the bank.
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3. Criminal breach of trust (Section 405, IPC)

Remedial Measure
Care should be taken from the initial step when a person
comes to the bank. Care needs to be taken at the time of
recruitment in bank as well.
4. Forgery (Section 463, IPC)

Remedial Measure
Both the prevention and detection of frauds through forgery
are important for a bank. Forgery of signatures is the most
frequent fraud in banking business. The bank should take
special care when the instrument has been presented either
bearer or order; in case a bank pays forged instrument he
would be liable for the loss to the genuine costumer.
5. Falsification of accounts (Section 477A)

Remedial Measure
Proper diligence is required while filling of forms and
accounts. The accounts should be rechecked on daily basis.
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6. Theft (Section 378, IPC)

Remedial Measures
Encashment of stolen' cheque can be prevented if the bank
clearly specify the age, sex and two visible identify action
marks on the body of the person traveler's cheques on the
back of the cheque leaf. This will help the paying bank to
easily identify the cheque holder. Theft from lockers and
safe deposit vaults are not easy to commit because the
master-key remains with the banker and the individual key
of the locker is handed over to the costumer with due
acknowledgement.
7. Criminal conspiracy (Section 120 A, IPC)

In the case of State of Andhra Pradesh v. IBS Prasad Rao
and Other, the accused, who were clerks in a cooperative
Central Bank were all convicted of the offences of cheating
under Section 420 read along with Section 120 A. all the
four accused had conspired together to defraud the bank by
making false demand drafts and receipt vouchers.
8. Offences relating to currency notes and

banks notes
(Section 489 A-489E, IPC)
These sections provide for the protection of currency-notes
33
and bank notes from forgery. The offences under section

are:
(a) Counterfeiting currency notes or banks.
(b) Selling, buying or using as genuine, forged or counterfeit
currency
Notes or bank notes. Knowing the same to be forged or
Counterfeit.
(c) Possession of forged or counterfeit currency notes or
bank-notes, knowing or counterfeit and intending to use the
same as genuine.
(d) Making or passing instruments or materials for forging or
counterfeiting currency notes or banks.
(e) Making or using documents resembling currency-notes
or bank notes.
Most of the above provisions are recognizable Offences
under Section 2(c) of the Code of Criminal Procedure, 1973.
FRAUD PRONE AREAS IN DIFFERENT

ACCOUNTS
The following are the potential fraud prone areas in Banking
Sector. In addition to those areas and also have kinds of
fraud that are common in these areas.
34
Savings Bank Accounts
The following are some of the examples being played in

respect of savings bank accounts:
(a) Cheques bearing the forged signatures of depositors may
be presented and paid.
(b) Specimen signatures of the depositors may be changed,
particularly after the death of depositors,
(c) Dormant (inactive) accounts may be operated by
dishonest persons with or without collusion of bank
employees, and
(d) Unauthorized withdrawals from customer's accounts by
employee of the bank maintaining the savings ledger and
later destruction of the recent vouchers by them.
Current Account Fraud

The following types are likely to be committed in case of
current accounts. (a) Opening of frauds in the names of
limited companies or firms by unauthorized persons;
(b) Presentation and payment of cheques bearing forged
signatures;
(c) Breach of trust by the employees of the companies or
firms possessing cheque leaves duly signed by the
authorized signatures;
35
(d) Fraudulent alteration of the amount of the cheques and

getting it paid either at the counter or though another bank.
Frauds In Case Of Advances
Following types may be committed in respect of advances:

(a) Spurious gold ornaments may be pledged.
(b) Sub-standard goods may be pledged with the bank or
their value may be shown at inflated figures.
(c) Same goods may be hypothecated in favour of different
banks.
Types of Fraud
• Electronic Fraud
• Identity Fraud
• Spy ware and Ad ware
• Debit/Credit Card Fraud
ELECTRONIC FRAUD
Refers to email scams from fraudsters to obtain your

banking and personal information and here is how it works:
36
• You will receive an email appearing to be

from NBK or another legitimate company in or out
of Kuwait
• The email may claim a number of different
things such as:
• There is a problem with your account
• Ask you to enter a contest to win a prize
• Ask you to subscribe to a service that will
provide you with prizes and etc
• You are then asked to provide your personal
and financial information by completing an online
form.
• The form requests a variety of information
such as:
• Your credit card numbers
• Your account number
• Your passport or Civil ID numbers and so
forth
• Once you provide this information the
fraudsters will have the necessary information on
you to conduct a fraud.
37
Here is an example of an email fraud:
IDENTITY FRAUD
Identity fraud is where a dishonest person will gather your

personal details in order to conduct a fraud which will
financially hurt you. These fraudsters can obtain your
personal information in a number of ways, via telephone
scams or on the internet.
38
The following can be used to assume your identity:
• Your date of birth
• Your address
• Your Civil ID number or other identification numbers
• Your mobile phone number
• Your banking information
To protect your identity we recommend the following:

• Immediately report any loss or theft of your
important documents such as your Civil ID,
passport, driver’s license, credit card etc.
• Keep your financial and personal documents
in a safe and secure place.
• Do not keep your ATM Pin number in your
wallet.
• Never provide personal information on the
phone or emails to anyone who calls or emails
you.
39
SPYWARE AND ADWARE
Spyware is a type of software that secretly collects your

personal and user information while on the Internet.
Adware is a type of spyware used to track visitors' habits

and interests on the Internet. Adware can monitor the types
of sites you visit, the articles read or the types banners you
click on and so forth. Many times this information is sold to a
third party for the purpose of marketing.
You can minimize your chances of downloading spyware

onto your computer by:
• Never click on banners no matter how enticing they
may appear.
• Read the terms and conditions when you install free
programs or subscribe to services from the Internet.
• Use up to date anti spyware programs on a regular
basis to scan you computer.
DEBIT/CREDIT CARD FRAUD
Credit card and debit card fraud is a crime where your credit
40
or debit cards are reproduced by criminals. This type of

crime is known as 'skimming'.
Credit or debit card fraud can also occur when your card is
lost or stolen and used by fraudster to purchase goods or
remove cash from ATMs or other locations.
Here are some guidelines to protect your debit and credit

card information:
• Always sign your credit card in ink as soon as you

receive it.
• Memorize your ATM and/or credit card Pin numbers and
never write them down.
• Do not let your credit card out of you sight. Even when
paying with it at a store or restaurant go with the card.
• Tear up all credit card and debit card receipts into small
pieces before throwing them away.
• If you use your credit card online make sure you are on
a secure site:
o Always look for the lock pad symbol at the bottom
right of your browser's window
• Never give your ATM card or credit card numbers to
strangers or telemarketers who call you on the phone
or send you an email.
41
Contact NBK immediately on 801801 if you feel there is

something fraudulent or strange about your credit card
activity or on your account statement.
LEGAL REGIME TO CONTROL BANK FRAUDS
Frauds constitute white-collar crime, committed by

unscrupulous persons deftly advantage of loopholes existing
in systems/procedures. The ideal situation is one there is no
fraud, but taking ground realities of the nation's
environment and human nature's fragility, an institution
should always like to keep the overreach of frauds at the
minimum occurrence level.
Following are the relevant sections relating to Bank Frauds
Indian Penal Code (45 of 1860)
(a) Section 23 "Wrongful gain".-
"Wrongful gain" is gain by unlawful means of property to
which the person gaining is not legally entitled.
(b) "Wrongful loss"

"Wrongful loss" is the loss by unlawful means of property
to which the person losing it is legally entitled.
(c) Gaining wrongfully.
42
Losing wrongfully-A person is said to gain wrongfully

when such person retains wrongfully, as well as when
such person acquires wrongfully. A person is said to lose
wrongfully when such person is wrongfully kept out of any
property, as well as when such person is wrongfully
deprived of property.
(d) Section 24. "Dishonestly"

Whoever does anything with the intention of causing
wrongful gain to one person or wrongful loss to another
person, is said to do that thing "dishonestly".
(e) Section 28. "Counterfeit"

A person is said to "counterfeit" who causes one thing to
resemble another thing, intending by means of that
resemblance to practice deception, or knowing it to be
likely that deception will thereby be practiced.
BREACH OF TRUST
1. Section 408- Criminal breach of trust by clerk or
servant.
2. Section 409- Criminal breach of trust by public servant,
or by banker, merchant or agent.
3. Section 416- Cheating by personating
4. Section 419- Punishment for cheating by personating.
43
OFFENCES RELATING TO DOCUMENTS

1) Section 463-Forgery
2) Section 464 -Making a false document
3) Section 465- Punishment for forgery.
4) Section 467- Forgery of valuable security, will, etc
5) Section 468- Forgery for purpose of cheating
6) Section 469- Forgery for purpose of harming reputation
7) Section 470- Forged document.
8) Section 471- Using as genuine a forged document
9) Section 477- Fraudulent cancellation, destruction, etc.,
of will, authority to adopt, or valuable security.
10) Section 477A- Falsification of accounts.
THE RESERVE BANK OF INDIA ACT, 1934

Issue of demand bills and notes Section 31
Provides that only Bank and except provided by Central

Government shall be authorized to draw, accept, make or
issue any bill of exchange, hundi, promissory note or
engagement for the payment of money payable to bearer on
demand, or borrow, owe or take up any sum or sums of
money on the bills, hundis or notes payable to bearer on
demand of any such person
44
THE NEGOTIABLE INSTRUMENTS ACT, 1881

Holder's right to duplicate of lost bill Section 45A.
1. The finder of lost bill or note acquires no title to it. The

title remains with the true owner. He is entitled to recover
from the true owner.
2. If the finder obtains payment on a lost bill or note in due

course, the payee may be able to get a valid discharge for it.
But the true owner can recover the money due on the
instrument as damages from the finder.
Section 58
When an Instrument is obtained by unlawful means or for
unlawful consideration no possessor or indorse who claims
through the person who found or so obtained the instrument
is entitled to receive the amount due thereon from such
maker, acceptor or holder, or from any party prior to such
holder, unless such possessor or indorse is, or some person
through whom he claims was, a holder thereof in due
course.
45
Section 85:
Cheque payable to order.
1. By this section, bankers are placed in privileged position.
It provides that if an order cheque is indorsed by or on
behalf of the payee, and the banker on whom it is drawn
pays it in due course, the banker is discharged. He can debit
his customer with the amount so paid, though the
endorsement of the payee might turn out to be a forgery.
2. The claim protection under this section the banker has to

prove that the payment was a payment in due course, in
good faith and without negligence.
Section 87. Effect of material alteration
Under this section any alteration made without the consent

of party would be void. Alteration would be valid only if is
made with common intention of the party.
Section 138. Dishonor of cheque for insufficiency, etc., of
funds in the account.
Where any cheque drawn by a person on an account
maintained by him with a banker for payment of any amount
of money to another person from out of that account for the
discharge, in whole or in part, of any debt or other liability,
is returned by the bank unpaid. Either because of the
amount of money standing to the credit of that account is
46
insufficient to honor the cheque or that it exceeds the

amount arranged to be paid from that account by an
agreement made with that bank, such person shall be
deemed to have committed an offence and shall, without
prejudice.
Section 141(1) Offence by companies.

If the person committing an offence under Section 138 is a
company, every person who, at the time the offence was
committed, was in charge of, and was responsible to, the
company for the conduct of the business of the company, as
well as the company, shall be deemed to be guilty of the
offence and shall be liable to be proceeded against and
punished accordingly.
Banking legislation
Banking supervision is exerted on the basis of laws which

are applicable throughout the Union. As a matter of fact, the
solidarity existing between the member States of the Union
is materialized, as far as the banking system is concerned,
by the adoption of a common law which is inserted into the
legal system of each State. This law which is commonly
referred to as Banking Law entered into force on 1st October
1990.
47
The Banking Law provides for an exact definition of banks

and financial institutions, and of the credit and investment
activities conducted by the latter. It specifies the conditions
of entry and of exercise of the banking profession, and
determines the obligations which must be met by banks and
financial institutions in the execution of their operations. The
Banking Law defines the scope of the control exerted by the
Central Bank and the Banking Commission, and spells out
the rules governing the Monetary Union and the sanctions
applicable in case these rules are not respected.
Banks and financial institutions must be authorized and

registered on the list of banks and financial institutions to be
able to operate. This authorization is granted by the Minister
of Finance after BCEAO has examined the application and
the WAMU Banking Commission has certified its conformity
with applicable laws.
The conditions of approval are mainly based on :
The name;
• the legal status of the establishment ;

• the minimum capital which stands at 1 billion for banks
throughout the States, whereas that of financial
institutions is 300 million in Côte d'Ivoire and Senegal,
and 100 million in the other States ;
48
• the adequacy between the resources and objectives of

the establishment to be created ;
• the quality of shareholders ;
• The worthiness and experience of managers.
SECURITY REGIME IN BANKING SYSTEM

Security implies sense of safety and of freedom from danger
or anxiety. When a banker takes a collateral security, say in
the form of gold or a title deed, against the money lent by
him, he has a sense of safety and of freedom from anxiety
about the possible non-payment of the loan by the borrower.
These should be communicated to all strata of the
organization through appropriate means. Before staff
managers should analyze current practices. Security
procedure should be stated explicitly and agreed upon by
each user in the specific environment. Such practices ensure
information security and enhance availability. Bank security
is essentially a defense against unforced attacks by thieves,
dacoits and burglars.
PHYSICAL SECURITY MEASURES-CONCEPT

A large part of banks security depends on social security
measures. Physical security measures can be defined as
those specific and special protective or defensive measures
49
adopted to deter, detect, delay, defend and defeat or to

perform any one or more of these functions against culpable
acts, both covert and covert and acclamations natural
events. The protective or defensive, measures adopted
involve construction, installation and deployment of
structures, equipment and persons respectively.
The following are few guidelines to check malpractices:
1. To rotate the cash work within the staff.
2. One person should not continue on the same seat for

more than two months.
3. Daybook should not be written by the Cashier where

another person is available to the job
4. No cash withdrawal should be allowed within passbook

in case of withdrawal by pay order.
5. The branch manager should ensure that all staff

members have recorder their presence in the attendance
registrar, before starting work.
50
Execution of Documents
1. A bank officer must adopt a strict professional approach

in the execution of documents. The ink and the pen
used for the execution must be maintained uniformly.
2. Bank documents should not be typed on a typewriter

for execution. These should be invariably handwritten
for execution.
3. The execution should always be done in the presence

of the officer responsible for obtain them,
4. The borrowers should be asked to sign in full

signatures in same style throughout the documents.
5. Unless there is a specific requirement in the document,

it should not be got attested or witnessed as such
attestation may change the character of the instruments
and the documents may subject to ad volrem stamp duty.
6. The paper on which the bank documents are made

should be pilfering proof. It should be unique and
available to the banks only.
51
7. The printing of the bank documents should have highly

artistic intricate and complex graphics.
8. The documents executed between Banker and

Borrowers must be kept in safe custody.
CHANGES IN LEGISLATIONS AFTER

ELECTRONIC TRANSACTIONS
1. Section 91 of IPC shall be amended to include

electronic documents also.
2. Section 92 of Indian Evidence Act, 1872
Shall be amended to include commuter based
communications
3. Section 93 of Bankers Book Evidence Act, 1891 has
been amended to give legal sanctity for books of account
maintained in the electronic form by the banks.
4. Section 94 of the Reserve Bank of India Act, 1939
shall be amended to facilitate electronic fund transfers
between the financial institutions and the banks. A new
clause (pp) has been inserted in Section 58(2).
52
CONCLUSION
The Indian Banking Industry has undergone tremendous

growth since nationalization of 14 banks in the year 1969.
There has an almost eight times increase in the bank
branches from about 8000 during 1969 to mote than 60,000
belonging to 289 commercial banks, of which 66 banks are
in private sector.
It was the result of two successive Committees on
Computerization (Rangarajan Committee) that set the tone
for computerization in India. While the first committee drew
the blue print in 1983-84 for the mechanization and
computerization in banking industry, the second committee
set up in 1989 paved the way for integrated use of
telecommunications and computers for applying technogical
breakthroughs in banking sector.
However, with the spread of banking and banks, frauds have
been on a constant increase. It could be a natural corollary
to increase in the number of customers who are using banks
these days. In the year 2000 alone we have lost Rs 673
crores in as many as 3,072 number of fraud cases. These
are only reported figures. Though, this is 0.075% of Rs
8,96,696 crores of total deposits and 0.15% of Rs 4,44,125
crores of loans & advances, there are any numbers of cases
that are not reported. There were nearly 65,800 bank
53
branches of a total of 295 commercial banks in India as on

June 30, 2001 reporting a total of nearly 3,072 bank fraud
cases. This makes nearly 10.4 frauds per bank and roughly
0.47 frauds per branch.
An Expert Committee on Bank Frauds (Chairman:
Dr.N.L.Mitra) submitted its Report to RBI in September
2001. The Committee examined and suggested both the
preventive and curative aspects of bank frauds.
The important recommendations of the Committee include:
• A need for including financial fraud as a criminal offence;
• Amendments to the IPC by including a new chapter on

financial fraud;
• Amendments to the Evidence Act to shift the burden of

proof on the accused person;
• Special provision in the Cr. PC for properties involved in

the Financial Fraud.
• Confiscating unlawful gains; and preventive measures

including the development of Best Code Procedures by banks
and financial institutions.
54
Thus it can be concluded that following measures should

necessarily be adopted by the Ministry of Finance in order to
reduce cases of Fraud.
• There must be a Special Court to try financial fraud cases

of serious nature.
• The law should provide separate structural and recovery

procedure. Every bank must have a domestic enquiry officer
to enquire about the civil dimension of fraud.
• A fraud involving an amount of ten crore of rupees and

above may be considered serious and be tried in the Special
Court.
The Twenty-ninth Report of the Law Commission had dealt
some categories of crimes one of which is "offences
calculated to prevent and obstruct the economic
development of the country and endanger its economic
health." Offences relating to Banking Fraud will fall under
this category. The most important feature of such offences is
that ordinarily they do not involve an individual direct victim.
They are punishable because they harm the whole society. It
is clear that money involved in Bank belongs to public. They
deposit there whole life' security in Banks and in case of
Dacoity or Robbery in banks the public will be al lost. Thus it
55
is important that sufficient efforts should be taken in this

regard.
There exists a new kind of threat in cyber world. Writers are
referring it as "Salami Attack" under this a special software
is used for transferring the amount from the account of the
individual. Hence the culprits of such crimes should be found
quickly and should be given strict punishment. Moreover
there is requirement of more number of IT professionals who
will help in finding a solution against all these security
threats.
PRESS RELEASE
Seminar on Strategies for Prevention of Frauds in Banks and
Money Laundering
“Banks in India should take proactive steps to implement
strategies for preventing frauds in Banks and money
laundering” said Shri M S Sundara Rajan, Chairman and
Managing
Director, Indian Bank. Inaugurating a one day seminar on
“Strategies for Prevention of
Frauds in Banks and Money Laundering” at IMAGE, Chennai
today, Shri Sundara Rajan
Said that the quantum of frauds in India was nearly to the
tune of Rs.400 crores in 2002
56
And had mounted to around Rs.1400 crores in 2006 and

there was an urgent need for the
Banking Industry in coordination with the law enforcement
authorities to completely
Eliminate banking fraud. Indian Bank had organized the
seminar with an objective to
Benefit all the banks and the banking community through
the direct interaction and
Sharing of knowledge between the bankers and the law
enforcement authorities in finding
Ways and means to prevent frauds in banks, he added.
Shri G.Nanchil Kumaran, IPS, Commissioner of Police,
Chennai City Police in his key
Note address lauded Indian Bank for its initiative in
organizing the seminar. The
Interaction between bank officials and police officers would
not only help detect frauds
But also prevent frauds, he said. He also stressed the need
to revamp the law in tune with
The changing times and enable speedy disposal of cases. in
courts.
Shri P.K.Das, Special Director, Enforcement Directorate in
his special address
Emphasized the need for banks and law enforcement
authorities to make optimum use of
57
The latest technologies to prevent frauds in banks and

money laundering.
The technical sessions included paper presentations on the
following
“Robbery and Theft” by Shri J.K.Tripathy, IPS, Inspector
General of Police, CB CID
“Frauds in Credit Cards, ATMs and Debit Cards” by Shri
S.Murugan, Dy. Commissioner
of Police, Madhavaram, Chennai City Police
“Money Laundering” by Shri Sanjeev Singh, Addl Director,
FIU-IND, Delhi
“FEMA & Customs” by Shri Mohan Das, Dy Director,
Enforcement Directorate
“Strategies to be adopted to prevent cyber crimes in Banks”
by Shri Rajendran, Chief
Manager, Technology Dept, IOB and
“Fake currency” by Shri D Sethi, DGM, Issue Department,
RBI, Chennai
58

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Banking System Frauds and Legal Control

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Banking System Frauds And Legal Control

‘Banking is defined in the Banking Regulation Act as

Central bank Development Bank Specialised banks

Commercial banks Co-operative banks

EVOLUTION OF BANKING SYSTEM IN INDIA

Banking system occupies an important place in a nation's

Investment in India - Banking System

The central bank of the country is the Reserve Bank of India

Rs. 5 crores on the basis of the recommendations of the

The Bank was constituted for the need of following:

• To regulate the issue of banknotes

• To maintain reserves with a view to securing monetary

Functions of Reserve Bank of India

Under Section 22 of the Reserve Bank of India Act, the Bank

bullion or sterling securities provided the amount of gold

Exigencies of the Second World War and the post-was

The second important function of the Reserve Bank of India

the States to float new loans and to manage public debt.

Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank.

The Reserve Bank of India is the controller of credit i.e. it

also the power to inspect the accounts of any commercial

(a) It holds the cash reserves of all the scheduled banks.

(b) It controls the credit operations of banks through

(c) It controls the banking system through the system of

(d) It acts as the lender of the last resort by providing

Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain

RESERVE BANK OF INDIA

In addition to its traditional central banking functions, the

RESERVE BANK OF INDIA

With economic growth assuming a new urgency since

Classification of RBIs functions

The monetary functions also known as the central banking

Equally important, however, are the non-monetary functions

amalgamation, reconstruction and liquidation. Under the

India has a financial system that is regulated by independent

Government plays the role of regulator.

Ministry of Finance, Government of India looks after financial

budget is passed by the Parliament after debate and takes

Reserve bank of India (RBI) established in 1935 is the

India has commercial banks, co-operative banks and

finance, equipment leasing, corporate loans, short-term

Non-banking Financial Institutions provide loans and hire-

RBI also regulates foreign exchange under the Foreign

repatriable for FDI. There are restrictions on capital account

Securities and Exchange Board of India (SEBI) established

RESERVE BANK OF INDIA-ECONOMIC AND

The Reserve Bank of India has an important role to

RECENT TRENDS OF BANKING SYSTEM IN

In the banking and financial sectors, the introduction of

Financial Fraud (Investigation, Prosecution, Recovery and

4. Any other act fitted to deceive;

513(a) - Punishment for Financial Fraud

Whoever commits financial fraud shall be:

(b)Whoever commits serious financial fraud shall be

rightful owner according to the procedure established by

Banking Fraud - Prevention and

transactions or in the books of accounts, resulting in

BANK FRAUDS: CONCEPT AND DIMENSIONS

mass banking. The challenge in management of social

Fraud is defined as "any behavior by which one person

2. It must relate to a fact

3. It must be with the knowledge that it is false or without