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PROJECT REPORT ON BANKING FRAUDS

Submitted To Submitted By
Mr. Sumit Bajaj Puneet
Mathur
Asst. Vice President IBS Mumbai
Delhi

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Page
S.No Contents
No

1 Introduction 3

Evolution of Banking
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System

3 Bank Frauds: Concept & 4


Dimensions

4 Different Banking Frauds 5

5 Prevention & Detection 6

Legal Regime to Control


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Bank Frauds

7 Conclusion 16

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Category Of Banking Related Frauds

The Reserve Bank of India – RBI Maintains Data on Frauds on the basis of area of operation
under which the frauds have been perpetrated.

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.5 an increase of 38% 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
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. These 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 from 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.

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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 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.

EVOLUTION OF BANKING SYSTEM IN INDIA

Banking system occupies an important place in a nation's economy. A banking institution is


indispensable 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 stature. 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.

RESERVE BANK OF INDIA-ECONOMIC AND SOCIAL OBJECTIVE

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.

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

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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; and

4. It must induce another to act upon the assertion in question or to do or not to do certain act.

BANK FRAUDS

Losses sustained by banks as a result of frauds exceed the losses due to robbery, dacoity,
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 meticulously laid down instructions and
guidelines.

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3. External elements perpetuating 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.

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.

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:

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1. Laxity 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 clients by taking advantages of the laxity 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.
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.

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.

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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.

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 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 Cognizable Offences under Section 2(c) of the Code of
Criminal Procedure, 1973.

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FRAUD PRONE AREAS IN DIFFERENT ACCOUNTS

The following are the potential fraud prone areas in Banking Sector. In addition to those areas I
have also given kinds of fraud that are common in these areas.

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 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;

(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.

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(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.

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".-

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"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.

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 personation.

OFFENCES RELATING TO DOCMENTS

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

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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

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.

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,

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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. Dishonour 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 insufficient to honour 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) Offences 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.

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 adopted to deter,

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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 an other 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.

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 pilfer proof. It should be unique
and available to the banks only.

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

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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).

RECENT TRENDS OF BANKING SYSTEM IN INDIA

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.

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.

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 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.

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The important recommendations of the Committee include:

o A need for including financial fraud as a criminal offence;

o Amendments to the IPC by including a new chapter on financial fraud;

o Amendments to the Evidence Act to shift the burden of proof on the accused person;

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 is important that
sufficient efforts should be taken in this regard.

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