FRAUD IN BANKING SECTOR

TEACHING NOTE:

SYNOPSIS:

Banks are the engines that drive the operations in the financial sector, money markets and
growth of an economy. With the growing banking industry in India, frauds in banks are also
increasing and fraudsters are becoming more sophisticated and ingenious. The RBI's annual
report paints a grim picture of the Indian economy's current state. The report says that despite
government's efforts the amount involved in frauds has gone up by a whopping 73.8 per cent.
Economic frauds continue to weaken the Indian economy. Despite the government's efforts

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towards speedy detection and accountability, the number of fraud cases reported in 2018-19

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by banks increased by 15 per cent compared to last year. The Reserve Bank of India (RBI), in

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its latest annual report, has indicated that the rate of growth of frauds maybe not substantial

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but the amount involved in frauds has gone up by a whopping 73.8 per cent. However, the
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RBI adds that the amounts and frauds are related to earlier years. RBI data shows that in
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FY19, banking sector reported 6,801 frauds involving a total Rs 71,542.93 crore as against
5,916 cases involving Rs 41,167.04 crore reported in 2017-18. As compared to this, state-run
banks reported 3,766 cases of frauds worth Rs 64,509.43 crore as against 2,885 cases
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involving Rs 38,260.8 crore.

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Bank fraud in India in last 11 years

Of over 50,000 frauds that hit banks in India in the last 11 fiscal years, the ICICI Bank, State
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Bank of India (SBI) and HDFC Bank reported highest number of cases, according to an RBI
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data.

Of the total 53,334 cases of frauds reported during 2008-09 and 2018-19 fiscal years,
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involving a whopping Rs 2.05 lakh crore, a highest of 6,811 were reported by the ICICI Bank
involving Rs 5,033.81 crore.
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The state-run State Bank of India (SBI) reported 6,793 fraud cases involving Rs 23,734.74
crore followed by HDFC Banks which recorded 2,497 such cases involving Rs 1,200.79
crore, according to the data given by the central bank in response to an RTI query filed by
this correspondent.

The Bank of Baroda reported 2,160 fraud cases (involving Rs 12,962.96 crore), Punjab
National Bank 2,047 frauds (Rs 28,700.74 crore) and Axis Bank had 1,944 fraud cases
involving RS 5,301.69 crore public money. As many as 1,872 frauds involving Rs 12,358.2
crore was reported by Bank of India, 1,783 by Syndicate Bank (Rs 5830.85 crore) and
Central Bank of India’s 1, 613 cases involving Rs 9041.98 crore, the data shows. IDBI Bank

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 Ltd reported 1,264 fraud cases involving Rs 5978.96 crore, Standard Chartered Bank 1,263
cases involving Rs 1221.41 crore, Canara Bank 1,254 cases of Rs 5553.38 crore, Union Bank
of India 1,244 frauds of Rs 11,830.74 crore and Kotak Mahindra 1,213 cases involving Rs
430.46 crore.

In that period, Indian Overseas Bank reported 1,115 frauds involving Rs 12,644.7 crore,
while Oriental Bank of Commerce 1040 cases of Rs 5,598.23 crore.

The United Bank of India reported 944 cases of frauds involving Rs 3052.34 crore, State
Bank of Mysore 395 cases of Rs 742.31 crore, State Bank of Patiala 386 cases (Rs 1178.77
crore), Punjab and Sind Bank 276 cases (Rs 1154.89 crore), UCO Bank 1081 frauds (Rs
7104.77 crore), Tamilnad Mercantile Bank Ltd 261 cases (Rs 493.92 crore) and Lakshmi
Vilas Bank Ltd reported 259 frauds (Rs 862.64 crore). Some of the foreign banks operating in
India also reported fraud cases worth crores during the last 11 fiscal years.

American Express Banking Corporation reported 1,862 fraud cases of Rs 86.21 crore, Citi

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Bank 1,764 cases of Rs 578.09 crore, Hongkong and Shanghai Banking Corporation (HSBC)
Ltd 1,173 frauds of Rs 312.1 crore and The Royal Bank of Scotland Plc reported 216 frauds

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involving Rs 12.69 crore, the RBI data said. A total of 274 cases of frauds were reported by

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the State Bank of Travancore involving Rs 694.61 crore, Jammu and Kashmir Bank Ltd
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reported 142 such cases of Rs 1639.9 crore, The Industrial Finance Corp of India had nine
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cases of Rs 671.66 crore, The Dhanlakshmi Bank Ltd 89 cases of Rs 410.93 crore and Vijaya
Bank reported 639 cases involving Rs 1,748.9 crore, it said. Yes Bank Ltd reported 102 fraud
cases involving Rs 311.96 crore and Paytm Payments Bank Limited reported two cases of Rs
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0.02 crore (or Rs 2 lakh). PTI had on June 3 reported that as many as 6,801 cases of fraud
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were reported by scheduled commercial banks and select financial institutions involving an
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amount of Rs 71,542.93 crore in the last fiscal, quoting data from the RBI. After the story
was published, the Congress party held a press conference the next day and demanded that
the BJP government issue a "White Paper" on rising bank frauds in the country.
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 During 2008-09, a total of 4,372 cases were reported involving an amount of Rs

1,860.09 crore. In 2009-10, Rs 1,998.94 crore worth fraud was reported in 4,669
cases.
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 A total of 4,534 and 4,093 such cases were reported in 2010-11 and 2011-12 involving
Rs 3,815.76 crore and Rs 4,501.15 crore, respectively.
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 In the 2012-13 fiscal, 4,235 fraud cases involving Rs 8,590.86 crore were reported by
banks as against 4,306 cases (involving Rs 10,170.81 crore) in 2013-14 and 4,639
cases (involving Rs 19,455.07 crore) in 2014-15.
 As many as 4,693 and 5,076 cases of fraud were reported in 2015-16 and 2016-17
involving Rs 18,698.82 crore and Rs 23,933.85 crore, respectively, it said.
 A total of 5,916 such cases were reported by banks in 2017-18 involving Rs 41,167.03
crore.

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 IMPORTANT GUIDELINES ON FRAUD –CLASSIFICATION
AND REPORTING
01. GUIDELINES

• RBI Guidelines on frauds insists, among others, that banks are required to introduce
necessary safeguards / preventive measures by way of appropriate procedures and internal
checks so as to prevent/minimize occurrence of frauds and resultant financial loss to the
banks.

• The CEOs of the banks are supposed to provide singular focus on the "Fraud Prevention and
Management Function" to enable, among others, effective investigation in fraud cases and
prompt as well as accurate reporting of fraud cases to appropriate regulatory and law
enforcement authorities including RBI.

• Banks are required to frame their internal policy for fraud risk management and fraud

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investigation function with the approval of their respective Boards.

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02. CLASSIFICATION OF FRAUDS

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Frauds are classified, mainly on the basis of the provisions of Indian Penal Code (IPC), as
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under:-
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a) Misappropriation and criminal breach of trust.
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b) Fraudulent encashment through forged instruments, manipulation of books of

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account or through fictitious accounts and conversion of property.

c) Unauthorized credit facilities extended for reward or for illegal gratification.

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d) Negligence and cash shortages.

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e) Cheating and forgery.

f) Irregularities in foreign exchange transactions.

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g) Any other type of fraud not coming under the specific heads as above.
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reporting to RBI.

03. REPORTING OF FRAUDS TO RBI (FMR-1)

*Frauds involving Rs. 1 lakh and above

• Fraud including subsidiaries and affiliates/joint ventures perpetrated through

misrepresentation, breach of trust, manipulation of books of account, fraudulent encashment
of instruments like cheques, drafts and bills of exchange, unauthorised handling of securities
charged to the bank, misfeasance, embezzlement, misappropriation of funds, conversion of
property, cheating, shortages, irregularities, etc.

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 • Cases under criminal proceedings initiated by central investigating agencies suo motto
and/or where RBI has directed to treat as frauds.

• For frauds involving Rs. 5 Lakh and above, banks are required to send Soft copy of the
reports (FMR-1/B) to the Central Office of the Department of Banking Supervision (DBS)
within three weeks of detection of fraud, etc.

a) Frauds committed by unscrupulous borrowers

Such frauds include:-

• Fraudulent discount of instruments or kite flying in clearing effects.

• Fraudulent removal of pledged stocks/disposing of hypothecated stocks without the bank’s

knowledge/inflating the value of stocks in the stock statements and drawing excess bank
finance.

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• Diversion of funds outside the borrowing units, lack of interest or criminal neglect on the
part of borrowers, their partners, etc. leading to the unit becoming sick as also due to laxity in

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effective supervision over the operations in borrowable accounts on the part of the bank
functionaries rendering the advance difficult to recover. Banks are supposed to exercise due

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diligence while appraising the credit needs of unscrupulous borrowers, borrower companies,
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partnership/ proprietorship concerns and their directors, partners and proprietors, etc. as also
their associates who have defrauded the banks. Besides the borrower fraudsters, other third
parties such as builders, vehicle/tractor dealers, warehouse/cold storage owners, etc. and
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professionals are also to be held accountable if they have played a vital role in credit
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sanction/disbursement or facilitated the perpetration frauds. Banks are required to report to

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Indian Banks Association (IBA) the details of such third parties involved in frauds.

b) Frauds in borrowable accounts having multiple banking arrangements (MBA)

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• All banks under MBA arrangement are required to evolve a system of exchanging
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information on fraud committed by the borrower so as to take appropriate action including

criminal action against the borrower.
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• Banks are required to evolve an operating framework for tracking frauds and dealing with
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them.

*Frauds involving Rs. 100.00 lakh and above

• Banks are required to report frauds involving Rs. 100 Lakh and above to Central Office,
RBI, by way of D.O. letter giving the details such as amount involved, nature of fraud, modus
operandi in brief, name of the branch/office, parties involved, etc. within a week of notice of
the fraud at the bank’s H.O. duly marking copy to R.O., RBI under whose jurisdiction the
bank’s branch, where the fraud has been perpetrated, is functioning.

*Cases of attempted fraud

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 • Banks are required to report the cases of attempted fraud involving likely loss which would
have been Rs. 1.00 crore or more had the fraud taken place to the Central Office, RBI giving
the full details including the modus operandi within 2 weeks of the bank coming to know that
the attempt to fraud has failed or foiled.

Impact of frauds on Indian banking sector:

Bank frauds numbers may not be startling, but the way they are reported is. In a staggering
revelation indicating that Indian banks have been under-reporting frauds, the Reserve Bank of
India has revealed that 90.6 percent of the frauds reported by banks in 2018-19 occurred
between 2000 to 2018.

Data released by the banking regulator in its latest edition of the Financial Stability Report,
suggests that nearly 40 percent of the under-reported frauds actually took place in three years

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between 2013 to 2016.

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As a fallout of this, the RBI is now reviewing its master direction on frauds and considering
additional measures for timely recognition of frauds and enforcement action against

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violations, it added. With regard to frauds reported, the relative share of state-run banks in the
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overall fraud amount reported in 2018-19 was in excess of their relative share in the credit. At
the end of March 2019, share of PSU banks in overall fraud amounts reported was a
whopping 96 percent against a banking industry average of 60.9 percent.
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RBI also said that as on December 31, 204 borrowers who had been reported as fraudulent by
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one or more banks were not classified fraud by other banks despite having exposure to the
same borrower.

Rising volume of Bank frauds is swallowing all the economic development and is causing
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financial indiscipline in the country. One big defaulter like Vijay Malya, Nirav Modi, Mehul
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Choksi usurps thousands of crores which not only adds to sharp increase in the quantum of
Non-Performing Assets (NPAs) but takes out the sizable funds that could have otherwise been
used for economic well being of thousands of poor willing to become entrepreneurs with
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banks’ help and plan to start up their small businesses.

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In the Reserve Bank of India (RBI) annual report 2019, the apex bank said that frauds
reported by banks increased by 15 per cent on a year-on-year basis in 2018-19. The amount
involved increased by a significant 73.8 per cent to Rs 52,200 crore - although most of this
amount related to erstwhile occurrences. "The number of cases of frauds reported by banks
increased by 15 per cent in 2018-19 on a year-on-year basis, with the amount involved rising
by 73.8 per cent, though mostly related to occurrences in earlier years," the report mentioned.

The report further highlighted that the average lag between the date of occurrence and its
detection by the banks was 22 months. It also added that for large frauds of Rs 100 crore and
above, the average lag was 55 months. "The average lag for large frauds, i.e. Rs 100 crore

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 and above, amounting to Rs 52,200 crore reported during 2018-19, was 55 months," the
report adds.

The RBI stated that public-sector banks accounted for the bulk of frauds. "Among bank
groups, PSBs, which constitute largest market share in bank lending, have accounted for the
bulk of frauds reported in 2018-19. It was followed by private sector banks and foreign
banks," the RBI annual report stated.

"In terms of area of operations, frauds related to advances constituted the preponderant share
of the total amount involved in frauds in 2018-19, while the share of frauds in off-balance
sheet items declined from a year ago. In terms of the number of frauds too, those related to
advances were predominant followed by card/internet related frauds and deposits related
frauds. Frauds relating to card/internet and deposits constituted only 0.3 per cent of the total
value of frauds in 2018-19," the report stated.

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