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’.


Banking System Frauds And Legal Control

‘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’.


Central bank (RBI, In India

Development Bank

Specialised banks (EXIM Bank, SIDBI, NABARD)

Commercial banks 1. Public sector banks 2. Private sector banks 3. Foreign banks

Co-operative banks 1. Primary credit societies 2. Central co-operative bank 3. Sate co-operative banks



Banking System Frauds And Legal Control

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

Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control
• •

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

Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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.



Banking System Frauds And Legal Control

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 cooperative 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.



Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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 banks, wide and drastic expansion, and methods


under of

the their

Banking assets,

Regulation Act of 1949 - these powers relate to licensing of branch liquidity of management working, inspection,

Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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. banks, The co-operative banks and






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


Banking System Frauds And Legal Control

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 hirepurchase 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


Banking System Frauds And Legal Control

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 premier and public limited companies. the The Stock of deExchange, Mumbai and National Stock Exchange are the stock exchanges. Under process 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.








Banking System Frauds And Legal Control

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.








Banking System Frauds And Legal Control

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 payments and regulation are of electronically-based the focus of policy system becoming

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.


Banking System Frauds And Legal Control


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;


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

rightful owner according to the procedure established by law.


Banking System Frauds And Legal Control

Banking 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 Indian's development, banking customer has services several and credit management as well. system 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


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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.

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


Banking System Frauds And Legal Control

mass banking. The challenge in management of social responsibility with economic viability has increased.

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:

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.


Banking System Frauds And Legal Control

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.

Banking System Frauds And Legal Control

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.

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.


Banking System Frauds And Legal Control

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.

Banking System Frauds And Legal Control

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: 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.



Banking System Frauds And Legal Control

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 various on cross-checking as well as regarding persons identity, in genuineness, verification of particulars, etc. in respect of instruments involved encashment or dealing with the property of the bank.


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.


Banking System Frauds And Legal Control

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.


Banking System Frauds And Legal Control

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

Banking System Frauds And Legal Control

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.






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.


Banking System Frauds And Legal Control

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;


Banking System Frauds And Legal Control

(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

Refers to email scams from fraudsters to obtain your banking and personal information and here is how it works:


Banking System Frauds And Legal Control

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 • Your credit card numbers • Your account number • Your passport or Civil ID numbers and so forth Once you provide this information the

such as:

fraudsters will have the necessary information on you to conduct a fraud.


Banking System Frauds And Legal Control

Here is an example of an email 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.


Banking System Frauds And Legal Control

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 Do not keep your ATM Pin number in your Never provide personal information on the

in a safe and secure place.


phone or emails to anyone who calls or emails you.


Banking System Frauds And Legal Control

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 Read the terms and conditions when you install free Use up to date anti spyware programs on a regular

may appear.

programs or subscribe to services from the Internet.

basis to scan you computer.

Credit card and debit card fraud is a crime where your credit


Banking System Frauds And Legal Control

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:

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.


Banking System Frauds And Legal Control

Contact NBK immediately on 801801 if you feel there is something fraudulent or strange about your credit card activity or on your account statement.

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.


Banking System Frauds And Legal Control

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.

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.


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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.


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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.


Banking System Frauds And Legal Control

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 ;


Banking System Frauds And Legal Control

the adequacy between the resources and objectives of the establishment to be created ; the quality of shareholders ; The worthiness and experience of managers.

• •

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 appropriate analyze to all strata of the staff organization managers through should means. Before




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.

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


Banking System Frauds And Legal Control

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.


Banking System Frauds And Legal Control

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. 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.



Banking System Frauds And Legal Control

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.





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).


Banking System Frauds And Legal Control

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

Banking System Frauds And Legal Control

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.


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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.

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


Banking System Frauds And Legal Control

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


Banking System Frauds And Legal Control

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


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