“AN ANALYTIC STUDY ON BANK FRAUDS AND SCAMS”

CHAPTER 1:

1.1 INTRODUCTION
The Indian banking sector has experienced considerable growth and changes since
liberalisation of economy in 1991. Though the banking industry is generally well regulated
and supervised, the sector suffers from its own set of challenges when it comes to ethical
practices, financial distress and corporate governance. This study endeavours to cover issues
such as banking frauds and mounting credit card debt, with a detailed analysis using
secondary data (literature review and case approach) as well as an interview-based approach,
spanning across all players involved in reporting financial misconduct. The report touches
upon the case of rising NPAs in the past few years across various scheduled commercial
banks, especially public sector banks. The study finally proposes some recommendations to
reduce future occurrence of frauds in Indian banking sector. The credibility of third parties
such as auditing firms and credit rating agencies is also questioned in the study and is
believed to be a significant contributor amongst other causes, such as oversight by banks and
inadequate diligence.
Banks are considered as necessary equipment for the Indian economy. This particular
sector has been tremendously growing in the recent years after the nationalisation of Banks in
1969 and the liberalisation of economy in 1991.Due to the nature of their daily activity of
dealing with money, and even after having such a supervised and well-regulated system it is
very tempting for those who are either associated the system or outside to find faults in the
system and to make personal gains by fraud. A bank fraud includes a considerable proportion
of white-collar crimes being investigated by the authorities. These frauds, unlike ordinary
crimes, the amount misappropriated in these crimes runs into lakhs and crores of rupees.
Bank fraud is a federal crime in many countries, defined as planning to obtain property or
money from any federally insured financial institution. It is sometimes considered a white
collar crime.
In recent years, instances of financial fraud have regularly been reported in India. Although
banking frauds in India have often been treated as cost of doing business, post liberalisation
the frequency, complexity and cost of banking frauds have increased manifold resulting in a

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very serious cause of concern for regulators, such as the Reserve Bank of India (RBI). RBI,
the regulator of banks in India, defines fraud as - A deliberate act of omission or commission
by any person, carried out in the course of a banking transaction or in the books of accounts
maintained manually or under computer system in banks, resulting into wrongful gain to any
person for a temporary period or otherwise, with or without any monetary loss to the bank.
A well-organized and efficient banking system is an essential pre-requisite for the economic
growth of every country. In modern era, banking industry plays an important role in the
functioning of organized money markets, and also acts as a conduit for mobilizing funds and
channelizing them for productive purposes. It has been observed during the last 50 years that
even the sophisticated markets and long-functioning banking systems have had significant
bank failures and bank crisis on account of increasing magnitude of frauds and scams. Banks,
therefore, need to get their customers actively involved in their fraud prevention efforts as
customers may be willing to switch to competing banks if they feel left in the dark about
those efforts. Since banking industry is a highly-regulated industry, there are also a number of
external compliance requirements that banks must adhere to in the combat movement against
fraudulent and criminal activity
Fraud is defined as a criminal deception committed by a person who acts in a false and
deceitful way. There is a string of offences under a variety of legislation and essentially the
suspect will demonstrate some form of dishonesty and/or deception.
Fraud is an intentionally deceptive action designed to provide the perpetrator with an
unlawful gain or to deny a right to a victim. Fraud can occur in finance, real estate,
investment, and insurance. It can be found in the sale of real property, such as land, personal
property, such as art and collectibles, as well as intangible property, such as stocks and
bonds. Types of fraud include tax fraud, credit card fraud, identity theft, wire fraud, securities
fraud, and bankruptcy fraud. Counterfeit activity can be carried out by one individual,
multiple individuals or a business firm as a whole.
Many times, the perpetrator of fraud is aware of information that the intended victim is not
allowing the perpetrator to deceive the victim. The individual or company committing fraud
is taking advantage of information asymmetry specifically, that the resource cost of
reviewing and verifying that information can be significant enough to create a disincentive to
fully invest in fraud prevention.
Banking fraud occurs when someone attempts to take funds or other assets from a financial
institution or from customers of that institution by posing as a bank official.
One of the most important responsibilities that a bank or financial institution has is to protect

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the integrity of the institution by working hard to protect the financial assets that it holds. In
order to do so, the bank or financial institution must be certain to address the issue of bank
fraud. Bank fraud can be defined as an unethical and/or criminal act by an individual or
organization to illegally attempt to possess or receive money from a bank or financial
institution.

1.1 DEFINITION:

Bank fraud is defined as using deception to steal money or assets from a bank, financial
institution, or a bank’s depositors. For legal purposes, a financial institution includes
credit unions and banks that are federally insured. This includes Federal Reserve banks,
the Federal Deposit Insurance Corporation (FDIC), mortgage lending agencies, and other
institutions that accept deposits of money or other financial assets. In general, bank fraud
may involve any deliberate action aimed at defrauding a financial institution. It may
involve an intentional action aimed at receiving assets, money, securities, credits, or
property from a financial institution through the use of fake or false information. The law
provides a fairly broad definition of bank fraud, and there are several facets of this
offense that should be considered.
Banking has been defined under section 5(b) of the Banking Regulations Act 19491,
“According to it banking means accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise”.
To understand the concept of Bank Fraud, we need to understand the concept of fraud and
the various types of frauds and the ways to detect the same and the prevention of the same
It is the use of potentially illegal means to obtain money, assets, or other property owned
or held by a financial institution, or to obtain money from depositors by fraudulently
posing as a bank or other financial institution. In many instances, bank fraud is a criminal
offence. While the specific elements of particular banking fraud laws vary depending on
jurisdictions, the term bank fraud applies to actions that employ a scheme or artifice, as
opposed to bank robbery or identity theft. For this reason, bank fraud is sometimes
considered to be a white-collar crime. Trials in courts take place when such bank frauds
and crimes take place.
MEANING:
Fraud is a worldwide issue that affects all continents and all sectors of the economy. As

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per RBI, fraud can be described as – any conduct by which one person intends to gain a
dishonest advantage over another. Fraud encompasses a wide-range of illicit practices and
illegal acts involving intentional deception or misrepresentation. The Institute of Internal
Auditors- ‘International Professional Practices Framework
(IPPF) (2009) defines fraud as: ―Any illegal act characterized by deceit, concealment, or
violation of trust. These acts are not dependent upon the threat of violence or physical
force. Frauds are perpetrated by parties and organizations to obtain money, property, or
services; to avoid payment or loss of services; or to secure personal or business
advantage. Fraud affects organizations in several areas including financial, operational,
and psychological. While the monetary loss owing to fraud is significant, the full impact
of fraud on an organization can be staggering. In fact, the losses to reputation, goodwill,
and customer relations can be devastating. As fraud can be perpetrated by any employee
within an organization or by those from the outside, therefore, it is important to have an
effective fraud management program in place to safeguard your organization’s assets and
reputation
Bank fraud is a criminal act that occurs when a person uses illegal means to receive
money or assets from a bank or other financial institution. Bank fraud is distinguished
from bank robbery by the fact that the perpetrator keeps the crime secret, in the hope that
no one notices until he has gotten away. The term bank fraud also refers to attempts by a
person to obtain money from a bank’s depositors by falsely pretending to be a bank or
financial institution
Related Legal Terms and Issues
Assets – Property or finances owned by an individual or entity, and regarded as having
value.
Identity Theft – The illegal acquisition and use of an individual’s personal identifying
information, usually for financial gain.
Trial – A formal presentation of evidence before a judge and jury for the purpose of
determining guilt or innocence in a criminal case, or to make a determination in a civil
matter.

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1.2 HISTORICAL BACKGROUND

There are certain types of bank frauds and scam, let us have a look at some frauds and
scams:
Accounting fraud
In order to hide serious financial problems, some businesses have been known to use
fraudulent bookkeeping to overstate sales and income, inflate the worth of the company's
assets, or state a profit when the company is operating at a loss. These tampered records are
then used to seek investment in the company's bond or security issues or to make fraudulent
loan applications in a final attempt to obtain more money to delay the inevitable collapse of
an unprofitable or mismanaged firm. Examples of accounting frauds: Enron and World Com
and Ocala Funding. These companies manipulated the books in order to appear as though
they had profited each quarter, when in fact they were deeply in debt.

Demand draft fraud:

Demand draft fraud typically involves one or more corrupt bank employees. Firstly, such
employees remove a few demand drafts leaves or demand draft books from stock and write
them like a regular demand draft. Since they are insiders, they know the coding and punching
of a demand draft. Such fraudulent demand drafts are usually drawn payable at a distant city
without debiting an account. The draft is cashed at the payable branch. The fraud is
discovered only when the bank's head office does the branch-wise reconciliation, which
normally take six months, by the time the money is gone

Remotely created check fraud:

Remotely created checks are orders of payment created by the payee and authorized by the
customer remotely, using a telephone or the internet by providing the required information
including the MICR code from a valid check. They do not bear the signatures of the
customers like ordinary cheques. Instead, they bear a legend statement "Authorized by
Drawer". This type of instrument is usually used by credit card companies, utility companies,
or telemarketers. The lack of signature makes them susceptible to fraud. The fraud is
considered Demand Draft fraud in the US.

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Uninsured deposits:
A bank soliciting public deposits may be uninsured or not licensed to operate at all. The
objective is usually to solicit for deposits to this uninsured "bank", although some may also
sell stock representing ownership of the "bank". Sometimes the names appear very official or
very similar to those of legitimate banks. For instance, the unlicensed "Chase Trust Bank" of
Washington D.C. appeared in 2002, bearing no affiliation to its seemingly apparent
namesake; the real Chase Manhattan Bank is based in New York. Accounting fraud has also
been used to conceal other theft taking place within a company.

Bill discounting fraud:

Essentially a confidence trick, a fraudster uses a company at their disposal to gain the bank's
confidence, by posing as a genuine, profitable customer. To give the illusion of being a
desired customer, the company regularly and repeatedly uses the bank to get payment from
one or more of its customers. These payments are always made, as the customers in question
are part of the fraud, actively paying any and all bills the bank attempts to collect. After the
fraudster has gained the bank's trust, the company requests that the bank begin paying the
company up front for bills it will collect from the customers later. Many banks will agree, but
are not likely to go whole hog right away. So again, business continues as normal for the
fraudulent company, its fraudulent customers, and the unwitting bank. As the bank grows
more comfortable with the arrangement, it will trust the company more and more and be
willing to give it larger and larger sums of money up front. Eventually, when the outstanding
balance between the bank and the company is sufficiently large, the company and its
customers disappear, taking the money the bank paid up front and leaving no-one to pay the
bills issued by the bank.

Duplication or skimming of card information:

This takes a number of forms, ranging from merchants copying clients' credit card numbers
for use in later illegal activities or criminals using carbon copies from old mechanical card
imprint machines to steal the info, to the use of tampered credit or debit card readers to copy
the magnetic stripe from a payment card while a hidden camera captures the numbers on the
face of the card.
Some fraudsters have attached fraudulent card stripe readers to publicly accessible ATMs, to
gain unauthorised access to the contents of the magnetic stripe, as well as hidden cameras to

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illegally record users' authorisation codes. The data recorded by the cameras and fraudulent
card stripe readers are subsequently used to produce duplicate cards that could then be used
to make ATM withdrawals from the victims' accounts.

Cheque kiting:

Cheque kiting exploits a banking system known as "the float" wherein money is temporarily
counted twice. When a cheque is deposited to an account at Bank X, the money is made
available immediately in that account even though the corresponding amount of money is not
immediately removed from the account at Bank Y at which the cheque is drawn. Thus, both
banks temporarily count the cheque amount as an asset until the cheque formally clears at
Bank Y. The float serves a legitimate purpose in banking, but intentionally exploiting the
float when funds at Bank Y are insufficient to cover the amount withdrawn from Bank X is a
form of fraud.

Forged or fraudulent documents:

Forged documents are often used to conceal other thefts; banks tend to count their money
meticulously so every penny must be accounted for. A document claiming that a sum of
money has been borrowed as a loan, withdrawn by an individual depositor or transferred or
invested can therefore be valuable to someone who wishes to conceal the fact that the bank's
money has in fact been stolen and is now gone.

Forgery and altered cheques:

Fraudsters have altered cheques to change the name (in order to deposit cheques intended for
payment to someone else) or the amount on the face of cheques, simple altering can change
Rs.100.00 into Rs.100,000.00. (However, transactions for such large values are routinely
investigated as a matter of policy to prevent fraud.) In its place of tampering with a real
cheque, fraudsters may alternatively attempt to forge a depositor's signature on a blank
cheque or even print their own cheques drawn on accounts owned by others, non-existent
accounts, etc. They would subsequently cash the fraudulent cheque through another bank and
withdraw the money before the banks realise that the cheque was a fraud.

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Fraudulent loan applications:
These take a number of forms varying from individuals using false information to hide a
credit history filled with financial problems and unpaid loans to corporations using
accounting fraud to overstate profits in order to make a risky loan appear to be a sound
q1investment for the bank.

Fraudulent loans:
One way to remove money from a bank is to take out a loan, which bankers are more than
willing to encourage if they have good reason to believe that the money will be repaid in full
with interest. A fraudulent loan, however, is one in which the borrower is a business entity
controlled by a dishonest bank officer or an accomplice; t

e "borrower" then declares bankruptcy or vanishes and the money is gone. The borrower may
even be a non-existent entity and the loan merely an artifice to conceal a theft of a large sum
of money from the bank. This can also be seen as a component within mortgage fraud.

Empty ATM envelope deposits:

A criminal overdraft can result due to the account holder making a worthless or
misrepresented deposit at an automated teller machine in order to obtain more cash than
present in the account or to prevent a check from being returned due to non-sufficient funds.
United States banking law makes the first $100 immediately available and it may be possible
for much more uncollected funds to be lost by the bank the following business day before this
type of fraud is discovered. The crime could also be perpetrated against another person's
account in an "account takeover" or with a counterfeit ATM card, or an account opened in
another person's name as part of an identity theft scam. The emergence of ATM deposit
technology that scans currency and checks without using an envelope may prevent this type
of fraud in the future.

The fictitious 'bank inspector':

This is an old scam with a number of variants; the original scheme involved claiming to be a
bank inspector, claiming that the bank suspects that one of its employees is stealing money
and that to help catch the culprit the "bank inspector" needs the depositor to withdraw all of
his or her money. At this point, the victim would be carrying a large amount of cash and can

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be targeted for the theft of these funds.
Other variants included claiming to be a prospective business partner with "the opportunity of
a lifetime" then asking for access to cash "to prove that you trust me" or even claiming to be a
new immigrant who carries all their money in cash for fear that the banks will steal it from
them – if told by others that they keep their money in banks, they then ask the depositor to
withdraw it to prove the bank hasn't stolen it.

Money laundering:
The term "money laundering" dates back to the days of Al Capone; Money laundering has
since been used to describe any scheme by which the true origin of funds is hidden or
concealed. Money laundering is the process by which large amounts of illegally obtained
money (from drug trafficking, terrorist activity or other serious crimes) is given the
appearance of having originated from a legitimate source.

Wire transfer fraud:

Wire transfer networks such as the international SWIFT interbank fund transfer system are
tempting as targets as a transfer, once made, is difficult or impossible to reverse. As these
networks are used by banks to settle accounts with each other, rapid or overnight wire
transfer of large amounts of money are commonplace; while banks have put checks and
balances in place, there is the risk that insiders may attempt to use fraudulent or forged
documents which claim to request a bank depositor's money be wired to another bank, often
an offshore account in some distant foreign country. There is a very high risk of fraud when
dealing with unknown or uninsured institutions.
The risk is greatest when dealing with offshore or Internet banks (as this allows selection of
countries with lax banking regulations), but not by any means limited to these institutions.
There is an annual list of unlicensed banks on the US Treasury Department web site which
currently is fifteen pages in length. Also, a person may send a wire transfer from country to
country. Since this takes a few days for the transfer to "clear" and be available to withdraw,
the other person may still be able to withdraw the money from the other bank. A new teller or
corrupt officer may approve the withdrawal since it is in pending status which then the other
person cancels the wire transfer and the bank institution takes a monetary loss.

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TOP FIVE BANK SCAM:

Bank of India: Rs 754.77 crore.

Indian Overseas Bank: Rs 771.07 crore.
Union Bank of India: Rs 458.95 crore.
Bank of Baroda: Rs 456.53 crore.
Allahabad Bank: Rs. 330.68 crore.

1.3 STATEMENT OF THE PROBLEM AND ISSUES

With various measures initiated by the RBI, numbers of banking fraud cases have declined,
but amount of money lost has increased in these years. Prima facie, an initial investigation in
these cases has revealed involvement of not only mid-level employees, but also of the senior
most management as was reflected in the case of Syndicate Bank and Indian Bank. This
raises serious concern over the effectiveness of corporate governance at the highest echelons
of these banks. In addition, there has been a rising trend of non-performing assets (NPAs),
especially for the PSBs, thereby severely impacting their profitability. Several causes have
been attributed to risky NPAs, including global and domestic slowdown, but there is some
evidence of a relationship between frauds and NPAs as well. The robustness of a country’s
banking and financial system helps determine its production and consumption of goods and
services. It is a direct indicator of the well-being and living standards of its citizens.
Therefore, if the banking system is plagued with high levels of NPAs then it is a cause of
worry, because it reflects financial distress of borrower clients, or inefficiencies in
transmission mechanisms. Indian economy suffers to a great extent from these problems, and
this served as the prime motivation for the authors to carry out this detailed study of frauds in
the Indian banking system and examining frauds from different angles.
Banks are the engines that drive the operations in the financial sector, money markets and
growth of an economy. With the rapidly growing banking industry in India, frauds in banks
are also increasing very fast, and fraudsters have started using innovative methods. In the
modern era, there is ―no silver bullet for fraud protection. The use of neural network-based

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behaviour models in real-time has changed the face of fraud management all over the world.
Banks that can leverage advances in technology and analytics to improve fraud prevention
will reduce their fraud losses. Recently, forensic accounting has come into limelight due to
rapid increase in financial frauds or white-collar crimes. Fraud is a “serious problem” for the
banks. Fraud has quickly become a multibillion-dollar problem for the banking and finance
industry. A report by The Association of Certified Fraud Examiners (ACFE, 2018) found that
organizations lose approximately 5% of their annual revenues to fraud. To put this in
perspective, according to a business insider article (2019) the top five banks in the world
reported revenues of just over $1300 trillion, this would equate to over $65 billion in fraud
losses for these companies alone. The emergence of fast fraud, which is where cybercriminals
exploit weaknesses in digital fraud prevention systems to steal customer assets, is a major
contributor to the fraud losses banks experience daily.
The banking industry is undergoing a radical shift, one driven by new competition from Fin-
Techs, changing business models, mounting regulation and compliance pressures, and
disruptive technologies. The emergence of Fin-Tech/non-bank starts up is changing the
competitive landscape in financial services, forcing traditional institutions to rethink the way
they do business. As data breaches become prevalent and privacy concerns intensify,
regulatory and compliance requirements become more restrictive as a result. And, if all of
that wasn’t enough, customer demands are evolving as consumers seek round-the-clock
personalized service. these and other banking industry challenges can be resolved by the very
technology that’s caused this disruption, but the transition from legacy systems to innovative
solutions hasn’t always been an easy one. That said, banks and credit unions need to embrace
digital transformation if they wish to not only survive but thrive in the current landscape.

PROBLEMS SUCH AS:

1. Increasing Competition
The threat posed by Fin Techs, which typically target some of the most profitable areas in
financial services, is significant. These new industry entrants are forcing many financial
institutions to seek partnerships and/or acquisition opportunities as a stop-gap measure; in
fact, Goldman Sachs, themselves, recently made headlines for heavily investing in FinTech.
In order to maintain a competitive edge, traditional banks and credit unions must learn from
Fin Techs, which owe their success to providing a simplified and intuitive customer

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experience. Also, the competition nowadays has increased in numbers and with a rapid
growth and the number of fraud cases are increasing day by day with new technologies
updates and new techniques.

2. A Cultural Shift
From artificial intelligence (AI)-enabled wearables that monitor the wearer’s health to smart
thermostats that enable you to adjust heating settings from internet-connected devices,
technology has become ingrained in our culture — and this extends to the banking industry.
In the digital world, there’s no room for manual processes and systems. Banks and credit
unions need to think of technology-based resolutions to banking industry challenges.
Therefore, it’s important that financial institutions promote a culture of innovation, in which
technology is leveraged to optimize existing processes and procedures for maximum
efficiency. This cultural shift toward a technology-first attitude is reflective of the larger
industry-wide acceptance of digital transformation.

3. Regulatory Compliance
Regulatory compliance has become one of the most significant banking industry challenges
as a direct result of the dramatic increase in regulatory fees relative to earnings and credit
losses since the 2008 financial crisis. From Basel’s risk-weighted capital requirements to the
Dodd-Frank Act, and from the Financial Account Standards Board’s Current Expected Credit
Loss (CECL) to the Allowance for Loan and Lease Losses (ALLL), there are a growing
number of regulations that banks and credit unions must comply with; compliance can
significantly strain resources and is often dependent on the ability to correlate data from
disparate sources. Overcoming regulatory compliance challenges requires banks and credit
unions to foster a culture of compliance within the organization, as well as implement formal
compliance structures and systems.
Technology is a critical component in creating this culture of compliance. Technology that
collects and mines data, performs in-depth data analysis, and provides insightful reporting is
especially valuable for identifying and minimizing compliance risk. In addition, technology
can help standardize processes, ensure procedures are followed correctly and consistently,
and enables organizations to keep up with new regulatory/industry policy changes.

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4. Changing Business Models
The cost associated with compliance management is just one of many banking industry
challenges forcing financial institutions to change the way they do business. The increasing
cost of capital combined with sustained low interest rates, decreasing return on equity, and
decreased proprietary trading are all putting pressure on traditional sources of banking
profitability. In spite of this, shareholder expectations remain unchanged. This culmination of
factors has led many institutions to create new competitive service offerings, rationalize
business lines, and seek sustainable improvements in operational efficiencies to maintain
profitability. Failure to adapt to changing demands is not an option; therefore, financial
institutions must be structured for agility and be prepared to pivot when necessary.

5. Rising Expectations
Today’s consumer is smarter, savvier, and more informed than ever before and expects a high
degree of personalization and convenience out of their banking experience. Changing
customer demographics play a major role in these heightened expectations: With each new
generation of banking customer comes a more innate understanding of technology and, as a
result, an increased expectation of digitized experiences. Millennials have led the charge to
digitization, with five out of six reporting that they prefer to interact with brands via social
media; when surveyed, millennials were also found to make up the largest percentage of
mobile banking users, at 47%. Based on this trend, banks can expect future generations,
starting with Gen Z, to be even more invested in omnichannel banking and attuned to
technology. By comparison, Baby Boomers and older members of Gen X typically value
human interaction and prefer to visit physical branch locations. This presents banks and credit
unions with a unique challenge: How can they satisfy older generations and younger
generations of banking customers at the same time? The answer is a hybrid banking model
that integrates digital experiences into traditional bank branches. Imagine, if you will, a
physical branch with a self-service station that displays the most cutting-edge smart devices,
which customers can use to access their bank’s knowledge base. Should a customer require
additional assistance, they can use one of these devices to schedule an appointment with one
of the branch’s financial advisors; during the appointment, the advisor will answer any of the
customer’s questions, as well as set them up with a mobile AI assistant that can provide them
with additional recommendations based on their behaviour. It might sound too good to be
true, but the branch of the future already exists, and it’s helping banks and credit unions meet

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and exceed rising customer expectations.
Investor expectations must be accounted for, as well. Annual profits are a major concern -
after all, stakeholders need to know that they’ll receive a return on their investment or equity
and, in order for that to happen, banks need to actually turn a profit. This ties back into
customer expectations because, in an increasingly constituent-centric world, satisfied
customers are the key to sustained business success - so, the happier your customers are, the
happier your investors will be.

6. Customer Retention
Financial services customers expect personalized and meaningful experiences through simple
and intuitive interfaces on any device, anywhere, and at any time. Although customer
experience can be hard to quantify, customer turnover is tangible and customer loyalty is
quickly becoming an endangered concept. Customer loyalty is a product of rich client
relationships that begin with knowing the customer and their expectations, as well as
implementing an ongoing client-centric approach.
In an Accenture Financial Services global study of nearly 33,000 banking customers
spanning 18 markets, 49% of respondents indicated that customer service drives loyalty. By
knowing the customer and engaging with them accordingly, financial institutions can
optimize interactions that result in increased customer satisfaction and wallet share, and a
subsequent decrease in customer churn.
Bots are one new tool financial organizations can use to deliver superior customer service.
Bots are a helpful way to increase customer engagement without incurring additional costs,
and studies show that the majority of consumers prefer virtual assistance for timely issue
resolution. As the first line of customer interaction, bots can engage customers naturally,
conversationally, and contextually, thereby improving resolution time and customer
satisfaction. Using sentiment analysis, bots are also able to gather information through
dialogue, while understanding context through the recognition of emotional cues. With this
information, they can quickly evaluate, escalate, and route complex issues to humans for
resolution.

7. Outdated Mobile Experiences

These days, every bank or credit union has its own branded mobile application — however,
just because an organization has a mobile banking strategy doesn’t mean that it’s being

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leveraged as effectively as possible. A bank’s mobile experience needs to be fast, easy to use,
fully featured (think live chat, voice-enabled digital assistance, and the like), secure, and
regularly updated in order to keep customers satisfied. Some banks have even started to
reimagine what a banking app could be by introducing mobile payment functionality that
enables customers to treat their smart phones like secure digital wallets and instantly transfer
money to family and friends.

8. Security Breaches
With a series of high-profile breaches over the past few years, security is one of the leading
banking industry challenges, as well as a major concern for bank and credit union customers.
Financial institutions must invest in the latest technology-driven security measures to keep
sensitive customer safe, such as:
Address Verification Service (AVS)
AVS “checks the billing address submitted by the card user with the cardholder’s billing
address on record at the issuing bank” in order to identify suspicious transactions and prevent
fraudulent activity.
End-to-End Encryption (E2EE)
E2EE “is a method of secure communication that prevents third-parties from accessing data
while it’s transferred from one end system or device to another.” E2EE uses cryptographic
keys, which are stored at each endpoint, to encrypt and decrypt private messages.
Banks and credit unions can use E2EE to secure mobile transactions and other online
payments, so that funds are securely transferred from one account to another, or from a
customer to a retailer.

Authentication
Biometric authentication “is a security process that relies on the unique biological
characteristics of an individual to verify that he is who he says he is. Biometric authentication
systems compare a biometric data capture to stored, confirmed authentic data in a database.”
Common forms of biometric authentication include voice and facial recognition and iris and
fingerprint scans. Banks and credit unions can use biometric authentication in place of PINs,
as it’s more difficult to replicate and, therefore, more secure.
Location-based authentication (sometimes referred to as geolocation identification) “is a
special procedure to prove an individual’s identity and authenticity on appearance simply by

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detecting its presence at a distinct location.” Banks can use location-based authentication in
conjunction with mobile banking to prevent fraud by either sending out a push notification to
a customer’s mobile device authorizing a transaction, or by triangulating the customer’s
location to determine whether they’re in the same location in which the transaction is taking
place.
Out-of-band authentication (OOBA) refers to “a process where authentication requires two
different signals from two different networks or channels by using two different channels,
authentication systems can guard against fraudulent users that may only have access to one of
these channels.” Banks can use OOBA to generate a one-time security code, which the
customer receives via automated voice call, SMS text message, or email; the customer then
enters that security code to access their account, thereby verifying their identity.
Risk-based authentication (RBA) - also known as adaptive authentication or step-up
authentication - “is a method of applying varying levels of stringency to authentication
processes based on the likelihood that access to a given system could result in its being
compromised.” RBA enables banks and credit unions to tailor their security measures to the
risk level of each customer transactions.

9. Antiquated Applications
According to the 2019 Gartner CIO Survey, over 50% of financial services CIOs believe that
a greater portion of business will come through digital channels, and digital initiatives will
generate more revenue and value. However, organizations using antiquated business
management applications or siloed systems will be unable to keep up with this increasingly
digital-first world. Without a solid, forward-thinking technological foundation, organizations
will miss out on critical business evolution. In other words, digital transformation is not just a
good idea - it’s become imperative for survival.
While technologies such as block chain may still be too immature to realize significant
returns from their implementation in the near future, technologies like cloud computing, AI,
and bots all offer significant advantages for institutions looking to reduce costs while
improving customer satisfaction and growing wallet share.
Cloud computing via software as a service and platform as a service solution enable firms
previously burdened with disparate legacy systems to simplify and standardize IT estates. In
doing so, banks and credit unions are able to reduce costs and improve data analytics, all
while leveraging leading edge technologies. AI offers a significant competitive advantage by

16
providing deep insights into customer behaviours and needs, giving financial institutions the
ability to sell the right product at the right time to the right customer. Additionally, AI can
provide key organizational insights required to identify operational opportunities and
maintain agility.

10. Continuous Innovation

Sustainable success in business requires insight, agility, rich client relationships, and
continuous innovation. Benchmarking effective practices throughout the industry can provide
valuable insight, helping banks and credit unions stay competitive. However, benchmarking
alone only enables institutions to keep up with the pack — it rarely leads to innovation. As
the cliché goes, businesses must benchmark to survive, but innovate to thrive; innovation is a
key differentiator that separates the wheat from the chaff. Innovation stems from insights, and
insights are discovered through customer interactions and continuous organizational analysis.
Insights without action, however, are impotent — it’s vital that financial institutions be
prepared to pivot when necessary to address market demands while improving upon the
customer experience.
Financial service organizations leveraging the latest business technology, particularly around
cloud applications, have a key advantage in the digital transformation race: They can
innovate faster. The power of cloud technology is its agility and scalability. Without system
hardware limiting flexibility, cloud technology enables systems to evolve along with your
business.

17
1.4 HISTORY OF BANKING AND FRAUDS

Modern banking in India originated in the last decade of the 18th century. Among the first
banks were the Bank of Hindustan, which was established in 1770 and liquidated in 1829-32;
and the General Bank of India, established in 1786 but failed in 1791.
Banking system is considered as backbone of a nation’s economy. Banking procedures were
carried by informal methods in ancient world. However, formal banking has been developed
as the “LIFE BLOOD” of the trade and commerce from 20th century. In India, banking has
developed from the primitive to modern stage of banking in a fashion that has no parallel in
the world history.
Today, India banking system into commercial banks (Both public, private banks, schedules
and non-scheduled), Regional rural banks, cooperative banks etc.
The largest and the oldest bank which is still in existence is the State Bank of India (S.B.I). It
originated and started working as the Bank of Calcutta in mid-June 1806. In 1809, it was
renamed as the Bank of Bengal. This was one of the three banks founded by a presidency
government, the other two were the Bank of Bombay in 1840 and the Bank of Madras in
1843. The three banks were merged in 1921 to form the Imperial Bank of India, which upon
India's independence, became the State Bank of India in 1955. For many years the presidency
banks had acted as quasi-central banks, as did their successors, until the Reserve Bank of
India was established in 1935, under the Reserve Bank of India Act, 1934.
Information Technology had a great impact on the Indian banking system. The use of
computers led to the introduction of online banking in India. The use of computers in the
banking sector increased many folds after the economic liberalisation of 1991 as the country's
banking sector has been exposed to the world's market. Indian banks were finding it difficult
to compete with the international banks in customer service without the use of information
technology. The RBI set up a number of committees to define and co-ordinate banking -
technology. These have included:
In 1984 was formed the Committee on Mechanisation in the Banking Industry (1984) whose
chairman was Dr.C. Rangarajan Deputy Governor, Reserve Bank of India. The major
recommendations of this committee were introducing MICR technology in all the banks in
the metropolises in India [41] This provided for the use of standardised cheque forms and
encoders.
In 1988, the RBI set up the Committee on Computerisation in Banks (1988) headed by Dr C

18
Rangarajan. It emphasised that settlement operation must be computerised in the clearing
houses of RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and Thiruvananthapuram. It further
stated that there should be National Clearing of inter-city cheques at Kolkata, Mumbai, Delhi,
Chennai and MICR should be made operational. It also focused on computerisation of
branches and increasing connectivity among branches through computers. It also suggested
modalities for implementing on-line banking. The committee submitted its reports in 1989
and computerisation began from 1993 with the settlement between IBA and bank employees'
associations.
In 1994, the Committee on Technology Issues relating to Payment systems, Cheque Clearing
and Securities Settlement in the Banking Industry (1994) was set up under Chairman W S
Saraf. It emphasised Electronic Funds Transfer (EFT) system, with the BANKNET
communications network as its carrier. It also said that MICR clearing should be set up in all
branches of all those banks with more than 100 branches.
In 1995, the Committee for proposing Legislation on Electronic Funds Transfer and other
Electronic Payments (1995) again emphasised EFT system.
In July 2016, Deputy Governor Rama Gandhi of the Central Bank of India "urged banks to
work to develop applications for digital currencies and distributed ledgers."
LIBERALISATION IN 1990’S
In the early 1990s, the then government embarked on a policy of liberalisation, licensing a
small number of private banks. These came to be known as New Generation tech-savvy
banks, and included Global Trust Bank (the first of such new generation banks to be set up),
which later amalgamated with Oriental Bank of Commerce, IndusInd Bank, UTI Bank (since
renamed Axis Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth
in the economy of India, revitalised the banking sector in India, which has seen rapid growth
with strong contribution from all the three sectors of banks, namely, government banks,
private banks and foreign banks.
The next stage for the Indian banking has been set up, with proposed relaxation of norms for
foreign direct investment. All foreign investors in banks may be given voting rights that
could exceed the present cap of 10% at present. In 2019, Bandhan bank specifically,
increased the foreign investment percentage limit to 49%. It has gone up to 74% with some
restrictions.
The new policy shook the Banking sector in India completely. Bankers, till this time, were
used to the 4–6–4 method (borrow at 4%; lend at 6%; go home at 4) of functioning. The new
wave ushered in a modern outlook and tech-savvy methods of working for traditional banks.

19
All this led to the retail boom in India. People demanded more from their banks and received
more.
For bankers, bad loans due to an economic downturn is par for the course. Bigger worry is
corporate fraud. With ‘extend and pretend’ coming to an end, banks are hesitant to report
frauds. For a better system, banking industry needs to be prompt in reporting and action.
As per the latest Reserve Bank of India (RBI) data, an unprecedented 6,801 frauds, totalling
Rs 71,500 crore, were detected in FY19. That amounts to a 15% rise in volume and 80%
climb in value from last year. This rise eclipses the FY18 banking fraud at Punjab National
Bank NSE 0.45 % (PNB), the most infamous in India’s history when it was revealed that over
the course of 7-8 years, fugitive diamond merchants Nirav Modi and Mehul Choksi allegedly
siphoned off nearly Rs 13,000 crore from the lenders.
Many recent fraud incidents reported are related to fix deposits, loan disbursements, and
credit and debit card frauds and ATM based frauds. All these frauds show that not only they
undermine the profits, reliability of services and operating efficiencies but can also have an
impact on the society and the organisation itself. With the increase in the gravity of such
instances it is impacting the profitability of the sector and there is an increase in the NPAs.
This rise in the NPA is a serious threat to the Indian Banking Industry as the sturdiness of a
country’s banking and financial sector determines the quality of products and services. It is
also a direct indicator of the living standards and well-being of people. Thus, if there is high
level of NPAs in the banking system, then it reflects the distress of borrower and the
inefficiencies in the transmission mechanism. The Indian economy suffers greatly due to
these incidents.
Fraud has also hampered the growth of this establishment/ industry. It is a huge killer for the
business sector and underlying factor to all human endeavours. It also increases the
corruption level of a country. Even after there are various measures taken by the RBI to limit
or decrease the frequency of frauds, the amount of money lost is still on the rise.
In order for it to be fraud in the legal sense the person on whom the fraud was sought to be
committed should have necessarily fallen prey to it. If an attempt of fraud is made but the
person concerned was not actually deceived, it is not ‘fraud’ as understood legally. Bank
fraud is a fraud committed on banks mainly by fraudulent representations using false
documents. Bank fraud concerns all citizens. It is a very sensitive issue as it affects the public
faith on which the whole Banking system is pre-dominantly based.
Bank fraud includes all sorts of misappropriations, embezzlements, manipulations of
negotiable instruments like cheques, bank drafts, bills or statements of accounts, securities

20
etc. With the boom in banking business, bank frauds are also on the rise. Bank fraud is
covered under Indian Penal Code. Cheques are a major area where frauds are committed by
putting counterfeit signature on the cheque. This is probably the most common bank fraud
committed. Another kind of fraud is the hypothecation fraud, wherein money is fraudulently
obtained against some kind of security. A fair economic system requires a fair financial
system with public confidence bestowed on it. Several preventive measures can be taken to
avoid it e.g., Right recruitment, Eternal alertness, adherence to rules, training courses etc.
In the present-day economic system, banks play a very important role in the economic
development of the country. Nowadays, banks have diversified their activities and are getting
into new schemes and services that create opportunities for financial inclusion. As the
banking sector is flourishing, it is getting plagued by some operational problems such as
frauds etc
Financial Stability Report of the Reserve Bank of India (RBI) shows, that the Indian banking
system reported about 6,500 instances of fraud involving over ₹30,000 crore in 2017-18.
Central Vigilance Commission (CVC) analysed the top 100 banking frauds in different
sectors and has also suggested some measures that will help avoid such unethical activities in
the future.
Banking frauds attracted national attention when the Punjab National Bank reported earlier
this year that it had been defrauded by companies related to jeweller Nirav Modi and Mehul
Choksi. Several other cases of large banking frauds were reported subsequently, which raised
questions about the ability of banks to contain them.
Let us have a look at some biggest scams in India (1990-2010)
1. Harshad Mehta & Ketan Parekh Stock Market Scam (1992)-Harshad Mehta siphoned lump
sum money from the banking system and raised a large fund for himself by producing
seamlessly original looking fake bank receipts, many banks lent him huge amounts of money
assuming that they were doing this in return of government securities.
Ketan Parekh also executed similar scam and looted Bank of India of around $30 million.
Investigated by: Securities Exchange Board of India.
2. The Hawala Scandal (1996)-The major political players were accused of having accepted
hefty bribes from the hawala brokers who basically fund terrorism around the globe and also
alleged connections about payments being channelled to Hizbul Mujahideen militants in
Kashmir. This scam was an evidence of open political loot taking place in the country.
Investigated by: Central Bureau of Investigation (CBI).
3. Bihar fodder scam (1996)-Popularly known as the ‘Chara Ghotala’, Bihar’s most famous

21
scam involved the fabrication of “vast herds of fictitious livestock” for which fodder,
medicine and animal husbandry equipment was allegedly procured.
4. Stamp paper Scam (2002)-Popularly referred to as the Telgi Scam involved printing &
selling of forged/duplicate stamp papers to banks and other financial institutions. Investigated
by: Special Investigation Team.
5. Satyam Scam (2009)-The biggest corporate scam in the history of India that shattered the
peace of Indian investors. The account books were fudged & the profit figures and revenues
were falsely inflated for years by the Founder & Chairman of Satyam. The company was
taken over by Tech Mahindra. Investigated by: Central Bureau of Investigation (CBI).
6. Commonwealth Games Scam (2010)-Took place during the Commonwealth Games, 2010
in New Delhi. Out of the estimated amount, only half was actually spent for the event.
Various hefty payments were made in the name of non-existent parties. Investigated by:
Central Bureau of Investigation (CBI).
Here are some of the biggest scams that disturbed the country's banking system post 2010:
In 2011, investigative agency CBI revealed that executives of certain banks such as the Bank
of Maharashtra, Oriental Bank of Commerce and IDBI created almost 10,000 fictitious
accounts, and an amount of Rs 1,500 crore worth loans were transferred.
Another scam that was unfolded in 2014 was the bribe-for-loan scam involving ex-chairman
and MD of Syndicate Bank SK Jain for involvement in sanctioning Rs R. 8,000 crore.
In 2014, Vijay Mallya was also declared a wilful defaulter by Union Bank of India, following
which other banks such as SBI and PNB followed suit.
In 2015, another fraud that raised eyebrows involved employees of Jain Infra projects, who
defrauded Central Bank of India to the tune of over Rs 2,000 crore.
One of the biggest banking frauds of 2016 is the one involving Syndicate Bank, where almost
380 accounts were opened by four people, who defrauded the bank of Rs 10 billion using
fake cheques, Letter of Undertakings (Lou’s) and LIC policies.
The fresh bank fraud to the tune of Rs 11,450 crore involving diamond merchant Nirav Modi.
It has come to light that the company, in connivance with retired employees of PNB, got at
least 150 Lou’s, allowing Nirav Modi Group to defraud the bank and many other banks who
gave loans to him.

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1.5 IMPORTANCE OF BANK AND PROBLEMS, IMPACT AND
GOVERNANCE ON BANK FRAUDS.
The banking sector was always deemed to be one of the most vital sectors for the economy to
be able to function. Its importance as the “lifeblood” of economic activity, in collecting
deposits and providing credits to states and people, households and businesses is
undisputable.
In all economic systems, banks have the leading role in planning and implementing financial
policy. The difference lies with prioritizing goals and their way of achievement. Based on the
neo-liberal model, achieving greater profits by using all means is an end in itself, while in the
socialistic systems bank operations also aim at improving economy in general and at
satisfying social needs.
Banks are one of the important financial pillars and the oldest financial intermediaries in the
financial system. India has adopted a system of planning. In the First Five Year Plan, the
importance of banking system for economic development was recognized in which it was
emphasized that the banking system should be fitted into the scheme of development and
growth of saving and their utilization. The steps were also taken to confirm the social
purposes. Contribution of banking system on economic development is depends upon the
governing policy. Banks are essential for all type of economic systems whether they are
developed or developing. In the case of developing country, it cannot progress without setting
a sound banking system.
In developing country banking is most important because these countries are generally
facing the problems like shortage of capital, mobilization of resources, channelizing those to
priority sectors etc.
The financial crisis of 2008, and the way the governments chose to save the banks by laying
the burden on taxpayer shoulders while exercising austerity policies, triggered a cycle of
discussion over many crucial issues
Frauds take place when someone tries to conceal or hide the facts. Deliberate deception,
tricking, intended cheating to gain advantage and so on. Such frauds mainly occur in banking
sector with huge amounts in a very deceitfully way. While there are many types of frauds,
there are five major frauds that can cause most damage:
1. Financial statement fraud.
2. Asset misappropriation.

23
3. Theft of intellectual property and trade secrets.
4. Healthcare, Insurance and Banking.
5. Consumer fraud.
Frauds can take many shapes and can impact organisation in many ways-not just financially.
There are few proper steps and measures to protect the bank against vulnerabilities. Let us
focus on banking frauds, its detection and prevention.

RBI GUIDELINES

Reserve bank of India (RBI) is the apex body. It is India’s central bank, which controls the
issue and supply of the Indian rupee. It is the regulatory body of the entire banking system in
India. Also, RBI plays an important role in the development strategy of Government of India.
The precautions and prevention from fraudsters are issued by the RBI guidelines. Here are
the guidelines regarding reporting of frauds to RBI:
Frauds involving Rs. 1 lakh and above
Fraud reports should be submitted in all cases of fraud of Rs. 1 lakh and above 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.
Fraud reports should also be submitted in cases where central investigating agencies have
initiated criminal proceedings Suo motto and/or where the Reserve Bank has directed that
they be reported as frauds.
Banks may also report frauds perpetrated in their subsidiaries and affiliates/joint ventures.
Such frauds should, however, not be included in the report on outstanding frauds and the
quarterly progress reports refer below.
The fraud reports in soft copy format involving all categories of frauds and hard copy format
involving frauds of Rs. 5 lakh and above should be sent to the Central Office (CO) as also the
concerned Regional Office of RBI, Department of Banking Supervision, under whose
jurisdiction the Head Office of the bank falls, in the format given in FMR – 1, within three
weeks from the date of detection. However, fraud reports in hard copy format involving
frauds of Rs. 1.00 lakh and above and less than Rs. 5.00 lakh should be sent to the concerned
Regional Office of RBI, Department of Banking Supervision only.

24
It is evident that post liberalization era has showered new colours of growth upon the Indian
banking sector but simultaneously it has also posed some serious challenges. One of them
being rise in frauds and NPAs. Thus, proper measures should be taken beforehand to stop
such frauds in future and prevent crisis in banks.

VARIOUS REASONS BEHIND FRAUDS:

1.Poor banking governance: Most frauds show that banks did not observe due diligence, both
before and after disbursing loans. Poor level of checks and balances in the banking system is
one of the reasons.

2.Poor monitoring: Lack of technology and fraud monitoring agencies to detect frauds makes
the problem more complex. There is an absence of an effective mechanism to monitor the
credit flow. Flawed risk-mitigation design, which creates an excessive focus on credit or
market risks, but focuses less on operational risks also leading to more breaches.

3.Technological backwardness: Excessive dependence on manual supervision, at both

external and internal levels makes it impossible to manually control and supervise the sheer
volume of transactions.

4.Immoral behaviour: The disintegrating moral fibre of Indian businessmen, bankers and
other white-collar professionals, nepotism in internal committees of banks, unnecessary
political interventions lead to increased frauds.

5.Political interference: The political pulls and pressures on investigating agencies, and long-
drawn processes of legal system act less as a deterrent.

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IMPACT OF SUCH FRAUDS:
1. This unhealthy development of rising fraudulent activities afflicting the banking sector
impinges their credibility adversely.
2. Frauds add to Non-Performing Assets and lead to loss of banks and economy. The Gross
NPAs to Gross Advances Ratio has shown a rising trend over the years
3. Frauds and fraudulent activities wreak severe financial dilemmas on banks and their
clients, as well as cause a significant reduction in the quantum of money accessible for
economic development.
4. Frauds have a significant impact on profitability of the Indian banking sector. Profitability
of banks is on a steady decline which needs to be an eye opener as it poses a threat to the
economy.
GOVERNANCE AND MEASURES:
1. Banking governance need an overhaul with proper checks and balance in places. Indian
banks need significant improvements in operation and governance standards to work in an
effective manner, by constantly working on the loopholes so that the banking sector can
contribute more to the growth of the economy.
2. Accountability need to be established among the bank managers and other administrators.
3. While it may not probable for banks to conduct their operations in a zero-fraud milieu,
proactive measures, such as conduct of risk assessment of policies and procedures can aid
banks to circumvent their risk of contingent losses resulting from frauds.
4. The data analysis technology can be leveraged by banks to detect frauds at the incipient
stage itself and reduce their loss causing impact significantly.
5. Law enforcement agencies should work in such a way that they don’t end up creating an
environment of fear, affecting the flow of credit to productive sectors.
6. Apart from improving capabilities in the banking system, accountability of third-party
service providers such as auditors and lawyers should also be fixed.
7. Assessment of working capital limit should be done before the flow of credit.
8. Awareness should be created about loop holes, consequences of bypassing procedural
aspects and benchmarks should be provided for evaluating genuineness of various essential
documents.
9. The investigation should be done to find out the trail of diversion of funds and whether any
money has been remitted abroad.
10. The Banks should pay the required attention to the area of internal control system and the
fraud prevention measures to ensure compliance of instructions issued by them from time.

26
 Chapter 2

Research and methodology

2.1 Objective of the study:

The objective IS TO aims to identify the procedural lapses and various other causes
responsible for bank frauds. The study seeks to know the perception of bank employees
towards bank frauds and their compliance towards implementation of preventive mechanism.
It also evaluates the factors that influence the degree of compliance.

The objective of the policy, namely "State Bank of India Compensation Policy (Banking
Services)" (hereinafter called the Policy), is to establish a system whereby the Bank
compensates the customer due to deficiency in service on the part of the Bank or any act of
omission or commission, directly attributable to the Bank.

Fraud is the worldwide phenomenon that affects all continents and all sector of the economy.
With the rapidly growing banking industry in India, frauds increasing fast, and fraudsters
have started using innovative methods. Shockingly, banking industry in India dubs rising
frauds as in inevitable cause of business. one of the most challenging aspects in the Indian
aspects into make banking transactions free from electronic crime. There is no “once silver
bullet” to stop all frauds forever. While leveraging the power of data analysis software, banks
can detect frauds owner and reduce the negative impact of significant losses owing to frauds.

A bank is a financial institution which is involved in borrowing and lending

money. Banks take customer deposits in return for paying customers an annual interest
payment. The bank then uses the majority of these deposits to lend to other customers for a
variety of loans.

Many a time, the borrowers are not traceable. ATM: Money is withdrawn using cloned ATM
cards. Cash credit: Frauds involve falsification of the books of accounts and removal of
goods and property hypothecated to the banks without their knowledge. Term loan: This is
the biggest contributor to the frauds.

Total frauds at banks rise 74 per cent to Rs 71,543 crore in 2018-19: RBI

27
2.2 Hypothesis:

The number of studies on fraud and fraud detection methods has grown in management
literature, especially since the occurrence of corporate scandals in the 1990s. These studies
include those that investigate the probability of occurrence of accounting and corporate fraud.

In the studies mentioned, one point of interest can be verified: banking institutions have not
been analysed in isolation. Because of the importance of these institutions for the economic
context, it is clear that the losses from a fraud in a large bank will be felt by the economy in
general, since these institutions act as financial intermediaries and providers of external
capital for other economic activities. Therefore, understanding and finding ways of
preventing and detecting corporate fraud in banking institutions is crucial for society as a
whole.

In light of this, the hypothesis created by Cressey (1953) stands out, enabling fraudulent
behaviour by managers in corporations to be examined using an analysis with three
dimensions: pressure, opportunity, and rationalization. This hypothesis reports that
individuals who occupy positions of trust in the financial area (financial trust) can violate this
trust if they have some particular financial problem that cannot be shared. These individuals,
in their capacity as agents of the corporation, believe that this particular problem can be
resolved secretly, even if for this they have to violate the trust placed in them. By justifying
the breaking of trust as a means of resolving their financial problems, these individuals may
use financial resources to their own benefit, even if they self-sustain a false feeling of
seriousness in their actions Cressey (1953).

Cressey’s hypothesis (1953), which is also known as the fraud triangle, considers three
dimensions of fraudulent behaviour: pressure, opportunity, and rationalization. Pressure, also
known as motivation, requires the existence of financial problems that cannot be shared;
opportunity would be to secretly resolve these problems by violating financial trust; and
rationalization of the fraudulent act would be viewing it as necessary and justifiable for
resolving the financial problems. Cressey’s fraud triangle (1953) has been used both by the
literature and in accounts auditing practice to investigate the occurrence of accounting and
corporate fraud. In the literature, the studies by Brazel et al. (2009), Lou and Wang (2009),
and Troy et al. (2011) stand out, which manage to elaborate econometric models based
on Cressey’s triangle (1953) to detect fraud. In practical terms, Cressey’s hypothesis (1953)
has been used by standardizing organizations as a tool for detecting fraud (Higson & Kassem,

28
2013), as can be observed in the rules of the American Institute of Certified Public
Accountants (AICPA, 2002) - Statement on Auditing Standards n. 99 (SAS n. 99) -, of the
Federal Accounting Council (CFC, 2009) - Resolution n. 1.207 of 2009 -, and of the
International Accounting Standards Board (IASB) - ISA 240 of 2009.

It bears mentioning that Brazilian studies on corporate fraud are still in their infancy (Murcia
& Borba, 2005; Silva, 2007). Most of the Brazilian studies have different scopes from that of
this paper, concentrating on analysing red flags, whether via auditor perception or via the
creation of new structures (Murcia & Barba, 2007; Murcia, Barba, & Schmehl, 2008), using
data on international companies to calculate the probability of fraud (Wuerges & Borba,
2014) or mapping patterns of corporate fraud (Imoniana & Murcia, 2016). Therefore,
carrying out studies to calculate the probability of corporate fraud occurring in the Brazilian
context is of academic relevance.

In light of this theoretical gap and of the importance of the Cressey fraud triangle in the
theoretical and empirical contexts, the general aim of this study is established, which is to
investigate the occurrence of corporate fraud, as well as indications of fraud, in Brazilian
banking institutions, by using detection variables from agency theory, criminology, and the
economics of crime.

This article fills a technical-scientific gap that currently exists in the Brazilian literature on
corporative fraud, by combining the theoretical framework of agency theory, of criminology,
and of the economics of crime. In addition, it focuses on a sector that is usually excluded
from analyses due to its specific characteristics and shows the application of multinomial
logit panel data regression with random effects, which is rarely used in studies in the area of
accounting. The aim of this study is to investigate the occurrence of corporative fraud, as well
as cases of fraud in Brazilian banking institutions, by using detection variables related to the
Cressey fraud triangle. Research into fraud and methods of detecting fraud has grown in
management literature, especially after the occurrence of various corporative scandals in the
1990s. Although regulatory agencies have increased their investments in monitoring and
control, fraud investigations and convictions are still common in the day-to-day
administration of banks, as can be seen in the Brazilian Central Bank and the National
Financial System Resource Council’s databases of punitive proceedings. We believe that this
article will have a positive impact in the area of accounting sciences, since it involves
corporative fraud in a multidisciplinary form and because it provides the incentive to use a

29
quantitative tool that can help increase the development of similar studies in the area. This
study tested the theory that the dimensions of the fraud triangle condition the occurrence of
corporative fraud in Brazilian banking institutions. Thirty-two representative variables of
corporative fraud were identified in the theoretical-empirical review, which were reduced to
seven latent variables by the principal component analysis. Finally, the seven factors formed
the independent variables in the multinomial logit models used in the hypothesis tests, which
presented promising results.

* THEORETICAL BACKGROUND

Agency Theory

The agency relationship is one of the oldest and most common forms of codified social
interactions (Ross, 1973) and is present in complex societies. Examples of agency
relationships include: boss-worker, doctor-patient, adviser-administrator, and relationships
between parents and children. Functional dependency, among other reasons, determines that
agency relationships are extremely common (Mitnick, 1975). These relationships include
those of the owners and managers of corporations, derived from the separation between
ownership and control, which is the object of study of agency theory.

According to Demsetz (1983) and Veblen (2001/1921), the separation between ownership
and control sought greater management efficiency. The delegation of decision-making
authority, according to Barnea, Haugen, and Senbet (1985), is an essential characteristic of
modern corporations, in which shareholders delegate their authority to a professional who has
managerial skills. However, as Berle and Means (1932) and Demsetz (1983) observe, one of
the main problems with regards to the relationship derived from the separation between
ownership and control is that of ensuring that managers in fact work towards the aim of
achieving the owners’ objectives, since their interests are not always convergent.

Agency theory seeks to analyse the relationship between agents and principals. For this, a
contract metaphor is used, in which the relationship between agents and principals is
formalized in contractual terms (Jensen & Meckling, 1976) that can contain clauses to outline
the agent’s behaviour, with the intention that he/she acts to fulfil the principals’ expectations.
The differences between the parties’ aims give rise to the conflicts known as agency

30
problems. Clearly, agency problems emerge when the conflicts of interest between agents and
principals, or between the principals themselves, affect the operation of the company’s
businesses (Barnea et al., 1985).

These agency problems, whatever the relationship, can damage the efficient functioning of a
company. In order to minimize these problems, the owners incur agency costs, which can be
subdivided into manager monitoring costs, spending on contractual guarantees from the
agent, and residual losses (Jensen & Meckling, 1976; John & Senbet, 1998).

Monitoring costs consist of limiting divergences from the principal, via the creation of
appropriate incentives for the agent, which will limit any abnormal activities. These costs can
be subdivided into mechanisms for incentivizing and monitoring agents’ actions.

Incentive costs involve the agents’ remuneration structure and system of financial incentives,
while monitoring mechanisms are related to the corporate governance system, including the
use of internal and external audits and formal systems of controls (Jensen & Meckling, 1976).

Commitment expenses are resources that agents will receive in the form of a guarantee that
they will not make decisions that damage the principal, as well as for guaranteeing that the
principal will be compensated if the agent makes such decisions (Jensen & Meckling, 1976).

The residual cost/loss is the monetary value resulting from the reduction in the principal’s
well-being which occurs in situations in which of the agent’s decisions present divergences
with regards to the decisions that would maximize the principal’s well-being. This loss occurs
when the cost of the total execution of a contract exceeds its benefits (Fama & Jensen, 1983).

However, even with the occurrence of the agency costs described above, and with the
creation of contracts with restriction clauses and incentives for managers’ actions, monitoring
of managers’ behavior is imperfect, due to the fact that managerial actions are not observable
(Denis, Denis, & Sarin, 1999). Like Denis et al. (1999), Jensen and Meckling (1976)
observed that the management literature indicates the existence of imperfect monitoring in
the agency relationship, resulting from the failure of monitoring costs to resolve agency
problems. Thus, even with monitoring mechanisms, agents may not work in favor of the
principals’ interests.

31
Economics of Crime

The first indications of the application of economic concepts in the area of criminology were
observed in the studies by Cesare Beccaria (1819/1764) and Jeremy Bentham (2000/1781),
which were forgotten until the 1960s. Gary Becker (1968), a Nobel Prize laureate in 1992,
reignited the discussion on the theory of crime via the economic prism and emphasized that
his effort in determining an economic structure for criminal behaviour can be seen as a
resurrection and modernization of the pioneering studies.

Becker (1968) revitalized the main idea from Bentham (2000/1781) by suggesting that a
useful theory on criminal behaviour can dispense with special anomie theories, psychological
inadequacies, or the inheritance of special characteristics, and he extended the usual choice
analysis of economists. For the author, criminals are like any other person and behave as
rational utility maximisers. Thus, a person becomes “criminal” when the function between
cost and benefit of illicit activities is greater than other activities involving legal alternatives
(Becker, 1968).

Based on the work of Becker (1968), economists have invaded the field of criminology, using
the comprehensive individual rational behaviour model. This model, assuming that individual
preferences are constant, can be used to predict how alterations in the probability of the
severity of sanctions and socioeconomic factors can affect the amount of crime (Eide, Rubin,
& Shepherd, 2006).

In the literature on the economics of crime, studies are observed that analyse the relationship
between previous performances and corporate crimes (Alexander & Cohen, 1996), the effect
of gender on corporate crimes (Steffensmeier, Schwartz, & Roche, 2013), and a verification
of the impact of psychological variables on white collar crime, using individuals who have
not committed crimes as a control sample in their experiment ( Blicket , Schlegel,
Fassbender, & Klein, 2006). These studies, and others related to corporate fraud and agency
theory, will enable variables to be identified to measure the probability of corporate fraud.

32
Corporate Fraud

Fraud, in its wider sense, can cover any gains obtained through crime, which uses error as its
main modus operandi (Wells, 2011). However, although all fraud involves some type of
error, not all errors are necessarily frauds.

Conan (2008) observed that the legal definition of fraud is generally presented as false
intentional representation regarding a material point and which causes a loss to a victim.

Corporate fraud is related to the corporate environment and can be conceptualized as fraud
committed by or against a corporation (Singleton & Singleton, 2010). Costa and Wood Jr.
(2012, p. 465) conceptualize corporate fraud as

a series of illicit actions and conducts carried out in a conscious and premeditated manner by
members of an organization’s senior management, which take place in a process, aiming to
serve own interests and with the intention of harming third-parties.

The United States Justice Department defines corporate fraud in three main areas: accounting
fraud or financial fraud, insider trading, and obstructive conduct (American Institute of
Certified Public Accountants, 2006, cited by Rezaei & Riley, 2010).

Fraud in financial statements can be conceptualized as the deliberate misrepresentation of a

company’s financial conditions, carried out by distorting or intentionally omitting values or
disclosure in the accounting statements in order to mislead the users of this information
(Association of Certified Fraud Examiners, 2008, cited by Singleton & Singleton, 2010).
With regards to corporate insider trading, this is mainly related to the improper appropriation
of corporate assets by senior executives. As for obstruction of justice conduct, this refers to
criminal convictions for giving a false testimony at the Securities and Exchange Commission
(SEC) and influencing or threatening other witnesses.

In this study, the type of fraud addressed is corporate, whose areas are related to financial
fraud and insider trading. Conan (2008) argues that fraud constitutes the intentional neglect of
a system and a deliberate attempt to violate this system to make personal gains, and that most
company systems are not created to detect and prevent fraud. Thus, in an attempt to
contribute by showing ways to detect corporate fraud, the Cressey fraud triangle (1953) will
be used, which is detailed in the next item.

33
Cressey’s fraud triangle.

One of the most brilliant students of Sutherland, Donald R. Cressey studied at the University
of Indiana during the 1940s (Wells, 2011). At this teaching institution he took a doctorate in
criminology and became interested in the behaviour of fraudsters. This interest led him to
write his doctoral thesis, for which he used interviews carried out with 200 prisoners
convicted of fraud. With the results of the research, Cressey (1953, p.30) formulated a final
hypothesis, known today as the fraud triangle. This hypothesis assumes that:

Trusted persons become trust violators when they conceive of themselves as having a
financial problem that is non-shareable and are aware this problem can be secretly resolved
by violation of the position of financial trust, and are able to apply to their own conduct in
that situation verbalizations which enable them to adjust their conceptions of themselves as
users of the entrusted funds and properties.

The elements of this triangle are shown in Figure 1.

Figure 1 The Cressey fraud triangle

34
Pressure, also known as incentive or motivation, refers to something that happens in the
personal life of the fraudster and that creates a stressful need, thus motivating the fraudster
(Conan, 2008; Singleton & Singleton, 2010). Cressey (1953) showed that in all of the cases
found in the interviews, non-shareable problems precede the criminal violation of financial
trust. For the author, the violator considers various different situations to produce problems
that are structured as non-shareable. These problems are related with the status required by
the offender or with maintaining his/her status.

The analysis carried out by Cressey (1953) is consistent with the literature on fraud by
indicating that the conditions related to immorality, emergencies, increased needs, reversals
in the business environment, and a high standard of living are important for violations of
trust. However, relevance only verifies whether these conditions produce non-shareable
problems for people that occupy a position of trust. This situation will only have the effect of
creating, in the person of trust, the desire for specific results - the pressure -, related with the
solution to the problem, and which can be produced by the criminal violation of financial
trust (Cressey, 1953).

Opportunity presupposes that fraudsters have the knowledge and chance to commit fraud.
The logic is that the individual will commit fraud as soon as he/she holds a position of trust,
knows the weaknesses in the internal controls, and obtains sufficient knowledge regarding
how to successfully commit the crime (Singleton & Singleton, 2010).

For Cressey (1953), technical knowledge is acquired before the existence of the non-
shareable problems and, consequently, the individual’s ability to perceive that the non-
shareable problem can be resolved by violating the position of trust involves the application
of general information to specific situations. Thus, when pressure, which is the existence of
non-shareable problems, is added to such opportunities derived from the individual’s
knowledge, the potential for fraud is greater (Singleton & Singleton, 2010).

Rationalization is a cognitive process of self-justification (Marcin, 1979; Rahm, Krosnick, &

Breuning, 1994; Scheufele, 2000). This concept is widely discussed by sociologists,
psychologists, and psychiatrists. In his hypothesis, Cressey (1953) perceived that fraudsters
rationalize their trust-violating conduct as acceptable and justifiable behaviours by the
intention to resolve a given problem classified as non-shareable. So, rationalization is the
process in which an employee mentally determines that fraudulent behaviour is the correct

35
attitude, considering that the company can absorb the consequences of this act or that no
shareholder or stakeholder will be materially affected by the execution of the fraud (Conan,
2008; Singleton & Singleton, 2010). According to Cressey (1953), the rationalization used by
violators is necessary and essential for the criminal violation of financial trust, as it is by way
of this that the individuals find pertinent and real reasons to act; that is, they convince
themselves that carrying out the violation of financial trust is a justifiable and acceptable act.

Thus, according to Cressey (1953), the occurrence of fraud is conditioned by the joint
existence of three dimensions: pressure, opportunity, and rationalization. In accordance
with that assumption, this study used Cressey’s hypothesis (1953) to elaborate and test
hypothesis 1.

the three dimensions of the fraud triangle together condition the occurrence of corporate
fraud in Brazilian banking institutions.

EMPIRICAL ANALYSIS METHODOLOGY

The study is classified as empirical with a quantitative approach. To carry out the work, the
first step was to identify the banking institutions for which the Brazilian Central Bank (CB)
made available data involving quarterly financial information (QFI). Two hundred thirty-one
institutions were found with data from January 2001 to December 2012. It bears mentioning
that from December 2012 the CB ceased to publish quarterly information on the institutions
under its supervision, following Circular letter n. 3,630 of 2013 (Brazilian Central Bank
[CB], 2013).

As there was the need to also collect data from the Annual Information Forms (AIFs) and the
Reference Forms made available to the market, the decision was made to work with only
publicly-held banking institutions with AIFs covering no fewer than three whole years. Due
to this limitation, 44 banking institutions composed the research sample. As the data were
gathered and organized quarterly, a panel of 2,112 lines of observations was obtained.

In order to identify the existence or not of corporate frauds, the decisions reported by the CB
and by the National Financial System Resource Council (NFSRC) were adopted. The former
issues first instance decisions while the latter is tasked with judging, in the second and third
instance, the punitive administrative proceedings applied by the CB. In the period from 2001

36
to 2012, 123 punitive proceedings were found, spread over 27 banking institutions and
corresponding to 61.36% of the 44 in the sample. The organizations that did not form part of
the offender’s report formed the control sample for the study, therefore enabling different
patterns to be identified between two groups of institutions: with and without corporate
frauds.

It is worth mentioning that the choice of punitive administrative proceedings was based on
internationally published empirical studies on corporate/accounting frauds, such as those
by Beasley (1996), Brazel et al. (2009), Erickson et al. (2006), Lennox and Pittman
(2010), Troy et al. (2011), and Wang et al. (2010). In these articles, the authors used the
Accounting and Auditing Enforcement Releases, published by the SEC, which contemplate
press releases on administrative and/or civil proceedings.

Note that for the classification of the proceedings the concept of corporate fraud was
observed, which is fraud committed by or against a corporation (Singleton & Singleton,
2010). This concept enables the analysis of each sentence imposed on the banking institutions
analysed. So, cases were analysed in which the claim was related with foreign exchange
operations, rural credit and debts, investment funds, share repurchases, and the accounting of
these institutions.

*Econometric Modelling

The economic modelling developed is based on the empirical analysis procedures proposed in
the studies by Beasley (1996), Brazil et al. (2009), Crutchley et al. (2007), Erickson et al.
(2006), Lennox and Pittman (2010), and Wang et al. (2010), which were previously cited in
this study and are geared towards measuring the probability of occurrence of corporate fraud.
The calculation of this probability derives from qualitative choice econometric models, such
as logit and probity, in which the dependent variable is binary, with 1 referring to the
presence of the attribute and 0 referring to the absence of the attribute, and the attribute being
defined by the occurrence of the event, in this case corporate fraud. The logit and probity
qualitative choice models can also be extended to multinomial approaches, in which the
dependent variable can take one of several attributes in order to cover a greater number of
possible occurrences for the studied phenomenon.

37
This possibility of greater detailing of the dependent variable enables a better adjustment of
the data collected in this research to the empirical analysis methodology, since the occurrence
of corporate fraud associated with the administrative proceedings of banking institutions is
characterized by the existence of intermediary behaviours, given that an institution that is
being investigated can be convicted or cleared in the administrative proceeding. In summary,
the dependent variable can assume the following behaviours:

Absence of the attribute: banking institution without administrative proceeding;

Presence of the attribute: banking institution investigated in an administrative proceeding;

Presence of the attribute: banking institution cleared in an administrative proceeding;

Presence of the attribute: banking institution convicted in an administrative proceeding.

Figure 2 clarifies the three different categories of the dependent variable:

Qualitative
choice vriable

withh adm. with

without punitive
prceedig - adm.proceedg -
adm. proceedig
wihout convictio with coviction

Figure 2 Characterization of the dependent variable

38
According to Hilbe (2009), the multinomial probability distribution is an extension of the
binomial distribution. The multinomial model to test the functional relationship between
corporate fraud and the independent variables can be specified as:

LnΩ m\b(x)=lnPr(y=m\x)Pr(y=b\x)=xβm/b,form=1toj

(1)

In which

x= f (pressure, opportunity, rationalization, controlvariables)

where the set of variables x will be represented by the elements of the fraud triangle
and by the control variables, which will be subsequently described.

Equation 1 : presents the relationship between the dependent variable, y, and the independent
variables, x. The attribute in reference, which will be compared to the others, is represented
by b, while the number of categories is presented as m. To solve the equations j, the following
equation is used to calculate the predicted probabilities:

(2)

The collected data present the behaviours of the banking institutions studied over the
years, forming transversal and longitudinal cross-sections. These cross-sections can be
analysed by forming a simple pooling, when the estimated parameters are constant for all for
all the observation units and for all the periods, or by forming a panel of data, when the
estimated parameters are variables for each observation unit over time, which in the
multinomial case are estimated by random effects. A study conducted by Karlson (2011)
compared the two approaches and found that the simple pooling tend to underestimate the

39
parameter estimates compared to the random effects models. It bears mentioning that in both
models the estimation method used is maximum likelihood.

In light of this, in order to test the established hypotheses, we opted for the estimation of the
two types of multinomial logit models: the simple pooled one and the random effects one, so
as to then compare them. In order to provide an overview of how this study was
operationalized in terms of econometric modelling,

Figure 3 was elaborated.

Figure 3 Flowchart to determine the most appropriate econometric modelling

40
As in the flowchart shown in Figure 3, depending on the specificity of the dependent variable
and in light of the layout of the research data, the pooling of 44 banking institutions in
accordance with their longitudinal data series was considered, in order to verify whether the
model should following simple pooling or panel data under random effects.

The first step in applying the methodology was to calculate the Cramer and Ridder (1991) test, with
the aim of verifying whether this model can be used as simple pooling. This test assumes a
high multinomial logit with (S +1) states and two pooling candidate
states/levels, s 1 and s 2The null hypothesis assumes that s 1 and s 2have the same regressor
coefficients, except the effect; that is:

βs1=βs2=βs

(3)

Thus, for the models in which the Cramer and Ridder (1991) test indicated that the multinomial logit
model could be analysed, the irrelevant alternatives hypothesis was tested. In this hypothesis
(IIA), the appropriateness of using the multinomial model is ensured. Thus, the Hausman-McFadden
(1984
) test and the Small-Hsiao (1985) test were applied, and alternatively, the suest-base Hausman
test to verify the independence of the irrelevant alternatives, and consequently, the
assumption of independence between the error terms.

For the models in which the Cramer and Ridder (1991) test indicated that simple pooling was not the
best alternative, a multinomial logit model with random effects was used. For this model, the
Stata v.13 program was used, which made it possible to measure the multinomial logit
models with random effects using the gsem command. This command enables models with
multilevel data to be adjusted. The adjustment of these models makes it possible to
simultaneously treat the level effect in groups, for example by including random effects such
as non-observable effects in the group of companies.

An additional comparison between the multinomial logit, traditional, and with random effects
models was carried out by analysing the information criteria - Akaike information criterion
(AIC), Schwartz Bayesian information criterion (BIC), and likelihood ratio test (LR) -, with
the aim of guaranteeing the choice of that which best adjusts to the data.

41
It is important to highlight that the multinomial logit model with fixed effects was not
considered in the analysis because up to the final date of carrying out this study its integration
into the program used - Stata v.13 - had not been concluded, although in 2011 the researcher
Klaus Pforr submitted the programming for this insertion. Other statistical software was not
studied, with the exception of SPSS and Gretl. So, it cannot be affirmed that the multinomial
model with fixed effects has not been implemented in different programs.

Independent variables

The set of independent variables, X i,t was mostly defined with the help of the literature on
agency theory and the economics of crime and empirical studies on fraud and earnings
management in banking institutions. The description of these variables, of the data collection
and research sources, as well as the control variables used, are presented in tables 1, 2, and 3.

Table 1 shows the independent variables used to measure the pressure dimension of the Cressey
(1953
) fraud triangle:

Table 1 Variables used - pressure dimension

Dimension of the fraud triangle: pressure

NO. Variable Description and data collection source
1 FIR_ASS Financial intermediation revenue divided by total assets. Source: QFI.
2 VAR_NI Variation in net income. Source: QFI.
The bank’s operating income divided by the operating income of the
3 SHARE_MARK market leader bank. Source: QFI.
4 ROA Operating income divided by total assets. Source: QFI.
5 ROE Net income divided by net equity. Source: QFI.
Dummy to indicate whether the directors receive a share in the
6 SHARE_NI company’s profit. Source: AIFs and RFs.
Value of quarterly remuneration divided by total assets. Source: board
7 QUART_REM of directors minutes, AIFs, and RFs.
Deviation in quarterly fixed remuneration. Source: board of directors
8 DEV_REM minutes, AIFs, and RFs.
Dummy for remuneration received below the average remuneration
9 D_DEV_REM paid by the market of publicly-traded banks.

42
RFs = Reference Forms; AIFs = Annual Information Forms; QFI = quarterly financial
information.

The auditing rules, Resolution n. 1,207 of 2008 ( CFC, 2009), and SAS n. 99 (AICPA, 2002),

elaborated in accordance with the Cressey fraud triangle (1953), establish two types of sources

of incentive or pressure that produce fraudulent financial information when management is

under pressure - external and internal sources - to achieve earnings targets or expected
financial results.

As internal and external sources of pressure, two items stand out that can serve as indicators
of the pressure dimension: the performance to be achieved by the agents and perceived
remuneration, which influences the standard of living of these agents. As internal sources of
pressure, the studies by Alexander and Cohen (1996) and Macey (1991) are used, which originate from the
area of criminology and the economics of crime. According to Macey (1991), self-interested
managers become involved in criminal conduct in the name of their organizations not to
benefit the shareholders but to maintain their positions. Also according to the author, the
threat of a lower than ideal performance can lead to managers preferring a higher level of risk
in order to increase the company’s performance. This can lead the manager to manipulate the
financial statements with the aim of increasing the institution’s performance, thus achieving
the performance targets set by the owners and resulting in them maintaining their current
position. Thus, in order to measure the institutions’ performance, the financial intermediation
revenue was used, as well as the variation in the institution’s net income, the return on assets
and on investments, and the level of market share in relation to the leading banking
institution. For these variables, a positive and significant behaviour is expected in relation to
the probability of fraud; the higher its value, the greater the possibility of fraud occurring. As
external sources of pressure, variables related to the structure of the managers’ remuneration
were used, since this is interconnected with their personal standard of living.

The managers’ remuneration structure, or compensation policies, according to agency theory,

aims to give incentives for the agent to select and plan actions that increase the wealth of
shareholders (Jensen & Murphy, 1990). Thus, using articles on this theory, the following variables
were outlined: fixed remuneration, profit share, and an indicator of remuneration perceived
below the market average. Fixed remuneration and profit share, as well as remuneration
policies, could indicate an inverse relationship with the probability of fraud. As remuneration

43
perceived below the market average, a positive relationship with the probability of fraud is
expected, given that managers can use fraudulent means to “correct” perceived economic
inequality. It bears mentioning that as a pressure point Cressey (1953) highlighted the relationship
between employees and employers, in which the former can feel undervalued in relation to
their status in the organization. This feeling can derive from perceived economic inequalities,
such as payment and a feeling of being overloaded with tasks or being undervalued (Wells,
2011
).

Table 2 presents the independent variables used to measure the opportunity dimension.

Table 2 Variables used - opportunity dimension

NO. Variable Description and data collection source

Number of independent board of director members squared.
10 IBM2 Source: AIFs and RFs.
Number of board of director members squared. Source:
11 TBD2 AIFs and RFs.
Number of fiscal council members squared. Source: AIFs
12 TFC2 and RFs.
13 SIZE_DIR Number of company directors.
Dummy for companies that are listed in the corporate
governance segments of the BM&FBOVESPA. Source:
14 SEAL_GOV BM&FBOVESPA Daily Bulletin.
Dummy to indicate whether the auditing company is one of
15 BIG_FIVE the Big Five or not. Source: CB auditing reports.
16 ADA_EXP Allowance for doubtful accounts. Source: QFI.
17 TTOT_ASS Value of total assets. Source: QFI.

CB = Brazilian Central Bank; RFs = Reference Forms; AIFs = Annual Information Forms;
QFI = quarterly financial information.

The opportunity dimension includes weak corporate governance structure as well as other
working conditions that enable the manager to commit fraud (Brazel et al., 2009).

44
Corporate governance mechanisms enable the owners of a corporation to exercise control
over the activities of insiders and managers, so that their objectives are protected ( John & Senbet,
1998
). Thus, if these mechanisms are not adequate and present fragilities, the possibilities of
corporate fraud occurring is increased. To measure such mechanisms, the number of
independent board members was used, as well as the size of the fiscal council, the size of the
board of directors, the auditing firms considered as Big Five, company seals of corporate
governance issued by the São Paulo Stock, Commodities, and Futures Exchange
(BM&FBOVESPA), and the size of the institution’s executive board.

It bears mentioning that Arthur Andersen, Deloitte, Ernst & Young, KPMG, and Price were
considered as the Big Five. Currently the auditing companies are called the Big Four, as a
result of the demise of Arthur Andersen in 2002. As the period of this study covers that year,
the decision was made to follow the same treatment given by Lennox and Pittman (2010), by
including this company and using the original denomination - Big Five.

Note that the independent members, board of directors size, and fiscal council size variables
were squared to capture the fact that coordination, communication, and decision-making
problems make the board’s performance difficult when the number of directors increases
(Yermack, 1996). Thus, the size of the board of directors and the number of independent members
help in the effectiveness of the corporate governance up to a certain point, since as the board
grows the incremental cost of adding members will be greater than the monitoring benefit,
thus constituting a convex function.

Also, as independent variables, the allocation for doubtful accounts and company size were
included. Lou and Wang (2009) found that complex transactions are accompanied by a high inherent
risk due to the involvement of a high degree of management judgment and subjectivity.

The allowance for doubtful accounts will identify earnings management opportunities for the
manager, given the use of subjective criteria in its accounting. This variable is used to detect
earnings management in banking institutions (Deboskey & Jiang, 2012), precisely because of the
discretion and subjectivity that managers have to estimate it and the difficulty involved in the
auditing of this variable (Deboskey & Jiang, 2012).

When the size of the organization increases, managers have a greater amount of resources at
their disposal, as well as there being an increase in the complexity of operations and in the

45
agency conflicts between owners and managers (Ryan & Wiggins, 2001). Thus, when the size of the
company increases together with the complexity of its operations and the conflicts derived
from the agency relationship, managers can use this environment to execute corporate fraud.

Table 3 shows the independent variables used to measure the rationalization dimension of
the Cressey fraud triangle (1953) and also those used as control variables.

Table 3 Variables used - rationalization dimension

NO. Variable Description and data collection source

18 AGE CEO age. Source: AIFs and RFs.
19 DEGREE_MAN Dummy for CEO with degree. Source: AIFs and RFs.
20 SP_MAN Dummy for CEO with specialization. Source: AIFs and RFs.
Dummy for CEO with strict sensu post-graduation. Source:
21 STRICTU_MAN AIFs and RFs.
Dummy for CEO with degree in the business area. Source: AIFs
22 CDAB and RFs.
Dummy for CEO with lato sensu post-graduation in the
23 CLSPAB business area. Source: AIFs and RFs.
Dummy for CEO with strict sensu post-graduation in the
24 CSSPAB business area. Source: AIFs and RFs.
Percentage of the number of female directors over the total
number of members of the fiscal council. Source: AIFs and
25 PERC_WOM_FC RFs.
Percentage of the number of female directors over the total
PERC_WOM_BD number of members of the board of directors. Source: AIFs and
26 RFs.
Percentage of the number of female directors over the total
number of members of the executive board. Source: AIFs and
27 PERC_WOM_EB RFs.
Dummy to indicate alterations in the legislation with the aim of
increasing the punishment for financial crimes. Law n. 12,683
28 PUNI of 2012 (Brazil, 2012).
Control variables

46
 Dummy for multiple and commercial banks. Source: CB
29 TYP_BK registration data.
Dummy for the international accounting standards convergence
30 CONVERG period.
Dummy for state controlled banks (federal, state, and municipal
31 STATE government). Source: AIFs and RFs
Dummy to indicate the subprime crisis period (July 2007 to
32 CRISIS April 2009)

CB = Brazilian Central Bank; CEO = chief executive officer; RFs = Reference Forms; AIFs =
Annual Information Forms.

In an attempt to measure the rationalization dimension, the demographic characteristics of the

executives were used. These characteristics, although considered incomplete and imprecise
proxies of the executives’ cognitive structures, are taken as valid because of the difficulty in
obtaining conventional psychometric data on senior executives (Hambrick, 2007). For this, the
following demographic variables were used: age of the chief executive officer (CEO), his/her
training in any area, his/her training on courses related to the area of business, the
predominance of females on the fiscal council, on the board of directors, and in management,
and a punishment factor.

For Troy et al. (2011), younger managers are more likely to rationalize accounting fraud as an
acceptable decision. Thus, Zahara et al. (2007) emphasize that younger managers tend to take risks
as a way of more quickly achieving career progression. As for older ones, they tend to be
more analytical in their decision making, executing decisions with more care, seeking more
information, and carrying out a more precise diagnosis of the information gathered.
Therefore, age appears to be an indicator of an individual/manager’s moral development.

With regards to educational training, studies such as those by Gioia (2002), Hambrick and Mason (1984),
and Rest and Thoma (1985) recognize the role of education in the ethical behavior of managers, as
well as empirically proving this relationship has a positive association with moral
development (Rest & Thoma, 1985). Also, Troy et al. (2011) affirm that managers without knowledge in
the area of business will tend to rationalize fraud as an acceptable decision, unlike those

47
trained in the area of business, who will be more aware of potential repercussions and
penalties of unethical behaviour. In light of the claims of the various authors, it is perceived
that managers’ educational training can be directly associated with the act of committing
fraud.

To analyse managers’ gender, support was sought from the studies by Kelley et al. (1990), Reynolds
(2006
), and Zahra et al. (2007), which indicate that male managers are more likely to accept unethical
behaviour to achieve their objectives. Moreover, Steffensmeier et al. (2013) determined that female
executives can be more ethical in their decision making. Therefore, it can be inferred that a
female predominance can negatively influence in the probability of corporate fraud occurring.

The use of a punitive factor was derived from the studies by Cressey (1953) and Becker (1968). In his
model, the latter pondered that criminal individuals consider the effect of punishment in their
decision to commit a crime or not. Thus, the effect of an increase in punishment is expected
to negatively impact the probability of corporate fraud.

In order to measure the effect of punishment on the probability of corporate fraud occurring,
the decision was made to use the normative alterations that increased the punishments applied
to crimes against the National Financial System (NFS). The alterations in the legislation were
qualified by a dummy. It bears mentioning that the legal instruments that discipline crimes
against the NFS were researched and of these only Law n. 9,613 of 1998 (Brazil, 1998) against
crimes of money and illicit laundering in the financial system was altered. The alteration
occurred via Law n. 12,683 of July 2012 (Brazil, 2012), which raised the penalties applied to
institutions involved in crimes and their representatives.

For the model, four control variables were also defined: type of bank, convergence with the
international accounting rules, state control, and subprime crisis. The first variable was used
to identify the type of bank classified by the CB according to their activities - multiple or
commercial bank.

The second variable was employed with the aim of distinguishing the period in which the
conversion to the international accounting rules came into effect, in accordance with
Resolution n. 3,786 of 2009 (CB, 2009). It bears mentioning that, according to CB information,
the accounting norms established by the National Monetary Council and by the CB,
embodied in the Accounting Plan for Institutions of the National Financial System (COSIF),

48
present divergences in relation to the international accounting rules issued by the IASB,
representing partial convergence with the international accounting rules.

In order to moderate the effect of the control and ownership of the banking institutions, the
inclusion of variables that identify whether the control is state or foreign was considered.
These two types of categories have different characteristics from the other banking
institutions. Foreign banks need to deal with different environments and regulations:
regulations in their country of origin and those of the foreign institution. State banks can
operate with government subsidies, besides having a more complex governance due to the
presence of one more agent: the politician (Silva, 2004). However, in this study foreign control
was not differentiated, given that for the banking sector, 87.38% of total assets in 2012 are of
banks with Brazilian capital, besides the limited number of banking institutions with foreign
control, corresponding to six of the 44 institutions analysed.

The fourth control variable was included to analyse the effect of the subprime crisis. Thus,
the variable will indicate the crisis period occurring from mid-2007 to April of 2009 (Maciel et
al., 2012
).

It is worth noting that in light of the research period, January 2001 to December 2012, the
variables derived from the financial statements and the fixed remuneration of management
were monetarily corrected. For this, the monetary correction index was used, as well as the
general index of prices-internal availability (IGP-DI), calculated monthly by the Getúlio
Vargas Foundation. This procedure enabled an analysis of the impact of these variables in a
space of time without the influence of inflation.

It is perceived that the number of independent variables presented in tables 1, 2, and 3 is too
high, totalling 32, and this number of variables may have an impact on the accuracy of the
model to be estimated for hypothesis 1, due to the problems derived from the
multicollinearity of the independent variables. One option for minimizing this problem is the
application of data reduction techniques, such as factor analysis.

Factor analysis is a multivariate technique that provides tools for examining the structure of
the inter-relationships in a large number of variables, defining sets of strongly inter-related
variables, known as factors (Hair Jr., Black, Robin, Anderson, & Tatham, 2009). To apply this technique, first
the following tests were carried out: (i) Bartlett sphericity, to analyse whether the variables

49
are intercorrelated, and (ii) Kaiser-Meyer-Olkin (KMO), to measure the adequacy of the
sample. For Hair Jr. et al. (2009), the closer to 1 the KMO value is, the better the sample will fit the
factor analysis. The author states that the researcher should consider a general value above
0.50 to apply the factor analysis.

The technique applied enabled the generation of components, called factors, which were
rotated by the orthogonal varimax method to simplify their analysis. These factors were
allocated instead of the 32 variables reported in tables 1, 2, and 3 and used to test hypothesis
1 of this study, via the application of the multinomial logit model.

It is important to mention that the logit model to be estimated can lose its predictive character
due to the application of the factor analysis technique. The inclusion of new observations in
the database will imply the need to employ the technique again, whose action can alter the
parameters estimated in this study. However, it is worth highlighting that the results of the
study enable important variables to be identified to calculate the probability of fraud
occurring. These variables can be used both in new academic studies and by market
professionals, such as regulators, auditors, and investors.

50
4. EMPIRICAL ANALYSIS

The use of factor analysis to reduce the data resulted in the data in Table 4.

Table4 Factor analysis: hypothesis 1

As the results of Table 4 show, the Bartlett sphericity test indicates that the null hypothesis
was rejected at a 1% level of significance, therefore the analysed variables are correlated. The
KMO test statistic, with a value of 0.718, shows that the proportion of the variance in the data
can be considered as common to all of the variables, thus validating the use of the factor
analysis in this study. Note that the subprime crisis variable was removed from the sample as
it did not present a high correlation with any other variable used. The variable for CEO with
a stricto sensu post-graduation course in any area was also excluded as it presented a
correlation of 100% with the variable for CEO with stricto sensu post-graduation in the area
of business, in order to avoid redundancy. As observed in Table 4, seven factors were

51
extracted as they presented Eigen values above 1.00. These factors, in their totality, are able
to explain 69.91% of the cumulative variance.

In Table 4 it is verified that the variables from each dimension - pressure, opportunity, and
rationalization -, numbered in tables 1, 2, and 3, were distributed between the factors, except
factors 3 and 6, in which variables from the rationalization dimension were grouped. Due to
this dispersion of variables, it was decided not to rename them, thus preserving the individual
characteristics of the variables with high factor loads, grouped in the different factors.
Therefore, factor 1 contemplates variables from the pressure and opportunity dimensions;
factor 2 contains variables from the opportunity and rationalization dimensions and control
variables; factor 4 contains variables from the pressure and opportunity dimensions; factor 5
contemplates variables from the three dimensions and one control variable; and factor 7 is
composed of variables related to the pressure and rationalization dimensions.

The factors presented in Table 4 were used as independent variables to process equations
1 and 2, which were previously described and whose results are available in Table 5. Note
that the multinomial logit panel model was operationalized by the Stata v.13 software.
Table 5 Relationship between corporate factors and frauds: hypothesis
1

52
1: proxy for indications of corporate fraud; 2: proxy for occurrence of corporate fraud; AIC =
Akaike information criterion; BIC = Bayesian information criterion; LR = likelihood ratio.

**: p < 0.01; **: p < 0.05; * p < 0.1.

From examining the results in Table 5, it is verified that the results of the Cramer and Riddler test
(1991
) indicate that the groupings among the alternatives cannot be carried out at a 1% level of
significance. Thus, the econometric analysis of hypothesis 1 cannot be carried out via simple
pooling of the data and it is necessary to treat them as a panel and consider the existence of
non-observed heterogeneity between the banking institutions. That is, the banks present
peculiar characteristics that differentiate them over time. So, the multinomial logit model
with random effects represents the most appropriate model for estimating the parameters of
the functional relationships established in the study.

The additional comparison tests also indicate that the logit model with random effects best
adjusts to the data. This can be observed in the results of the LR test and via the AIC and BIC
information criteria. The LR test shows a p-value of less than 0.05, implying that the
constrained model is more adequate. The values of the AIC and BIC information criteria for
the multinomial logit model with random effects were lower than those of the traditional logit
model, which enables it to be inferred that the model with random effects appear to be more
adjusted to the data in the study.

Considering the probability of indications of corporate fraud, in Table 5 (column B1) it is

observed that factor 1 presents a positive and significant relationship. In this factor, the
variables with the highest factor load are: level of market share, size of the executive board,
size of the institution, quarterly remuneration, and deviation from remuneration paid by the
market, in that order, and with a factor load above 0.85 (Table 4, column A). It bears
mentioning that these variables were characterized as representative of the pressure and
opportunity dimensions. The level of market share and the variables interlinked with
remuneration represent measures for company performance and compensation structure,
which denotes elements of the pressure dimension. As for the size of the executive board and
the size of the institution, these can be considered as explaining the opportunity dimension.

Due to factor 1 having indicated a positive behaviour with the probability of indications of
fraud, it is perceived that the variables derived from the pressure dimension present a

53
coherent behaviour with the findings of Alexander and Cohen (1996) and Macey (1991), both from the area
of criminology. In these, below-ideal performance can lead managers to prefer a higher level
of risk to increase company performance, such as by manipulating results. With regards to the
variables classified as remuneration items, Macey (1991) argues that in order to achieve their
objective of satisfying or maintaining a particular level of income, managers can achieve this
either through work and ability, or by becoming involved in criminal activities.

For the size of the executive board variable, it is verified that an executive board with a
greater number of members can represent a measure of power compared with board of
directors (Brazel et al., 2009) and can also imply an increase in monitoring costs and problems for
the board of directors to coordinate these directors. As for the size of the institution, this can
result in an environment that is more conducive to indications of corporate fraud. According
to Alexander and Cohen (1996), what promotes an environment with a greater number of opportunities
for committing fraud is the size of the organization. Thus, for the variables that denote
measured items of the opportunity dimension in factor 1, it is observed that given that its
factor loads are positive and the factor is positively and significantly related with the
probability of indications of fraud, the results are consistent with the empirical results of
studies on accounting fraud, agency theory, and criminology.

For the probability of corporate fraud occurring, it is verified that factor 2 (Table 5, column
B2) shows a positive and significant relationship with the occurrence of corporate fraud. For
this factor, it is observed that the variables with the highest factor load, above 0.84 (Table 4,
column B), are the size of the fiscal council and companies under state control. With these,
the former was considered as an element of the opportunity dimension and the latter as a
control variable. The behaviour of the size of the fiscal council was expected to be the
opposite to that of factor 2. However, given the positive factor load, this was not found. This
variable aims to monitor management acts, offer an opinion on particular issues, and express
the shareholders’ position (Trapp, 2009). It would therefore be an element of monitoring
management actions.

As for the factor load for the state control variable, this shows an interesting result. Because it
is positive, it is consistent with the relationship between factor 2 and the probability of
corporate fraud occurring, which is positive and significant. This result is consistent with the
most recent cases of corporate fraud in Brazil, such as those of Petrobrás and Correios ( Brito,

54
2014 Ministério Público Federal, 2014
; ), indicating that these companies provide greater opportunities to
execute corporate fraud.

Also, for the probability of occurrence of corporate fraud, it is observed that factors 4 and 5
indicate negative and significant behaviour in relation to this probability.

As variables with loads higher than 0.62 (Table 5, column D), factor 4 presents the return on
the assets of the banking institution and the size of the board of directors. As this factor is
negatively related with the probability of fraud occurring, an alignment is perceived between
the result obtained with the size of the board of directors, given that it is positively correlated
with this factor. This result is consistent with agency theory, in that the composition of the
board of directors is a fundamental corporate governance mechanism in market economies, as
it exercises control over the executive board (Byrd, Parrino, & Pritsch, 1998; John & Senbet, 1998). As for
return on assets, this indicated an unexpected behavior. Classified as a pressure element and
especially as a measure of the institution’s performance, its influence was expected to be
inverse to the probability of fraud, however this did not occur. The financial intermediation
revenue variable presented an expected result, consistent with factor 4 and therefore not
contributing with its negative relationship to the probability of fraud occurring, which
supports the writings of Alexander and Cohen (1996) and Macey (1991).

Finally, factor 5 gathered the following variables of the opportunity and rationalization
dimensions of the Cressey fraud triangle (1953), as well as a control variable: independent members,
predominance of females on the executive board, punishment, and convergence with the
international accounting rules. Factor 5 presented a negative and significant relationship for
the probability of occurrence of corporate fraud. In this, the variables with a factor load above
0.50 (Table 4, column E) showed a positive correlation with the factor, therefore contributing
to the negative relationship found for the probability of corporate fraud occurring. Note that
the results obtained for independent members are consistent with agency theory, given that a
greater proportion of independent members - outsiders - on the board of directors reduces the
probability of corporate fraud occurring, as seen in Beasley (1996).

As for the predominance of females on the executive board and punishment, these are in
accordance with the writings from the area of criminology. The results for females are similar
to those of Steffensmeier et al. (2013) and the claims of Kelley et al. (1990), Reynolds (2006) and Zahra et al. (2007)
concerning the behaviour of females with regards to fraud. According to these authors,

55
female managers are less susceptible to committing fraudulent acts than male managers. The
results for punishment are bolstered by the studies by Becker (1968), Eide et al. (2006), and Murphy (2012)
in the area of criminology and the economics of crime. According to these studies,
punishment is an important situational factor in the decision-making process with regards to
committing a criminal act or not.

As it was observed in the results of the research, variables from the three dimensions of
the Cressey fraud triangle (1953), even when grouped in factors, were significant for measuring the
probability of corporate fraud. This is consistent with the arguments of Cressey (1953), in which
the absence of any one of the dimensions would prevent the violation of financial trust; that
is, committing fraud. Therefore, because of the results obtained with factors 2, 4, and 5,
hypothesis 1, which states that the three dimensions of the fraud triangle together condition
the occurrence of corporate fraud in Brazilian banking institutions, cannot be rejected.

Based on the results put forward in Table 5, which were discussed in the previous paragraphs,
an econometric model is presented for measuring the probability of corporate fraud occurring
in banking institutions, in its final specification:

2.3 Scope

• The Policy is based on principles of transparency and fairness in the treatment of

customers.

56
 • It is designed to cover deficiency in service in areas relating to account operations,
collections and remittances etc., as specified in this Policy.
• Grant of compensation under this Policy is without prejudice to the Bank's rights in
defending its position before any Court of Law, Tribunal or any other forum duly
constituted to adjudicate banker-customer disputes and does not constitute admission
of liability or any other issue, of any nature whatsoever for the purposes of
Adjudicatory proceedings.

Non-submission of control returns to controlling authorities in respect of loans sanctioned

/ purchase of bill/ excess drawing permitted etc by the branches. Submission of stock
statements at periodical intervals, as provided in the bank’s manual is not insisted upon.
This should be done always. 63.46% of respondents take stock statement always while
36.54% do it often or occasionally. The physical inspection of the quantity and quality of
goods is not conducted by a surprise check to examine and verify the goods. Inspection of
hypothecated stocks conducted by the branch officials is tardy and indifferent. Only
51.92% of respondents always inspect the quantity and quality of goods pledged
periodically. The banks prescribed rules and procedures are not strictly followed in the
matter of control of security represented by hypothecation charges. Security documents
are often found seriously short and the unscrupulous borrower takes full advantage of it.
The bank does not ensure that its name boards are prominently displayed at the place
where the hypothecated goods are stored. Hypothecated stocks are not adequately insured
against proper risk. It should be always ensured by the officer in charge that there is
proper the security and suitability of the goods pledged through periodic inspection. But
only 48.72% respondents do inspect always while rest deviate from such practice more or
less. It is not ensured that the borrower is dealing exclusively with the lending bank. No
such undertaking is obtained nor is such exclusive dealing ensured subsequently from
time to time. Only 48.72% of the respondents always ensure that the borrower is dealing
exclusively with the lending bank. (Refer to Appendix II).
No serious attempt is initially made to verify the character and antecedents of the borrower, in
particular the individual borrower. The end use of funds withdrawn is not verified. Prescribed
margins are not kept while calculating the drawings power. Undue haste is shown in cases of
takeover of borrower accounts from other banks. (Refer to Case 3 and Case 4 in Appendix I)
The bank does not obtain periodical statements of party wise, age wise, outstanding debts and

57
continues to allow drawing power on the basis of all entries. But only 42.31% take periodic
statement of party wise and age wise outstanding debt always. (Refer to Appendix II)
Spurious letter of credit apparently opened by the other banks, are tendered to the branches
concerned with bills of discounting under them. The branches do not follow elementary
precautions of having signatures appearing in the letter of credit verified by the official of
branch. (Refer to Case 5 in Appendix I)
Discussion on frauds cannot be complete without analysis of human behaviour. An employee
in an organization is like a fish in an ocean. Nobody can determine when and how much water
a fish has consumed.
Likewise, a corrupt and dishonest person in an organization can commit frauds with impunity.
Bank management in India has its own recruitment boards. The usual modus operandi of the
boards is to give a general ability test, hold an interview and the selection is complete after
medical examination. Psychiatric and Psychological revaluation for banking services is not
being done at all in India. The respondents have given 4.31-weight age to corrupt officer in
charge as a reason responsible for bank frauds. The total number of bank employees against
whom the action has been taken for their involvement in cases of bank fraud during 2002, 2003
and 2004 were 5459, 5237 and 4311 respectively.

2.4 LIMITATION

Misconduct by bank traders could persist as a problem if fraud cases are treated as the actions
of an individual ‘bad apple’. Improving the team climate is what is really needed to reduce
the likelihood of fraud. This is according to psychologists Wienke Scholten (until recently
Behaviour & Culture Supervisory Officer at De Nederlandsche Bank/DNB) and Naomi
Ellemers (Distinguished Professor of Utrecht University) in an academic article.

Bad apple
In cases of fraud, banks often depict the perpetrator as a bad apple. Most banks believe that
their eradication will solve the problem. Scholten: “That approach means that there is no
further investigation of the conditions that enabled this misconduct. It is also why these kinds
of fraudulent practices continue to happen at banks.” As long as banks cling to the ‘bad apple
theory’ and act accordingly, misconduct by traders will remain a persistent problem. “The

58
removal of a single fraudster does not solve the problem. The overall team culture plays a
major role in misconduct by a trader.”

Combating unethical conduct

Using a socio-psychological model, dubbed the ‘Corrupting Barrels Model’, that outlines
how misconduct emerges and is perpetuated within teams, the psychologists present tips on
combating it in their article. According to Scholten, improvements to the team climate reduce
the likelihood of unethical conduct. “In the team, you need to investigate how traders and
managers handle mistakes made, whether there is a culture of envy caused by pay inequality
or favouritism, and whether team members are actually aware of the moral implications of
their activities.”

Five ways to combat bank frauds are highlighted below as:

1. Adopt appropriate technologies:
An inclusive mix of strong authentication systems; analytics software; and bank services,
positive pay and payee verification, for example, can greatly reduce an organization’s
exposure to fraud. It is important to have layers of protection.
2. Beef up your internal controls:
Sarbanes Oxley mandates that companies pay strict attention to their internal controls. But
even the most thorough Sarbanes-Oxley compliance effort cannot provide comprehensive
protection against fraud. Proactive organizations will want to put additional controls in
place, including rigorous approval procedures and careful separation of duties. That is
especially true of disbursement processes, such as wire transfers.
3. Screen job applicants carefully:
One of the biggest security problems company’s face is fraud perpetrated by trusted
insiders. Key finance functions such as treasury must conduct background checks on
potential hires, and companies should also consider drug testing and honesty testing. It is
the first line of defence.
4. Educate your workforce:
Employees need to understand how damaging fraud can be to the organization. They must
be able to recognize signs of fraudulent activity and know how to report it. In addition,

59
 treasury employees will need to be trained in the correct use of the company's fraud
protection tools and technologies.
5. Prosecute thieves:
Many organizations fire employees who are caught stealing but avoid prosecuting them for
fear of bad publicity. A zero-tolerance policy goes a long way toward reducing the risk of
illegal activity. Likewise, managers should immediately turn over any evidence of suspected
fraud to law enforcement agencies.

2.5 DATA COLLECTION

A look at the data on banking frauds detected indicates that the number has exponentially
risen in the past decade. Loan frauds constituted the highest percentage of frauds in FY
2019according to RBI data

More frauds under lens

While the number of bank frauds detected rose by 45% in FY '19 compared to FY '09, the
amount of money involved spiked 35 times in the same period. The average quantum of a
fraud has increased over the past decade, from ₹0.4 crore in FY09 to ₹10 crores in FY '19 ‘

60
PSB’S I pickle

Public Sector Banks accounted for the highest number of frauds and quantum (90.2%). In the
chart on the right, each circle represents a type of banking institution, while the size indicates
average amount

per
fraudulent transaction in FY '19

61
2.4 Techniques and tools

Many a time, the borrowers are not traceable. ATM: Money is withdrawn using cloned ATM
cards. Cash credit: Frauds involve falsification of the books of accounts and removal of
goods and property hypothecated to the banks without their knowledge. Term loan: This is
the biggest contributor to the frauds.

Measures to control banking frauds

Some of other promising steps to control frauds are: educate customers
about fraud prevention, make application of laws more stringent, leverage the power of data
analysis technologies, follow fraud mitigation best practices, and employ multipoint
scrutiny.

8 most common methods that fraudsters use to steal your online banking details

Online banking frauds are on the rise. With fraudsters using various channels to trap users, it
becomes necessary to take preventive measures to avoid such frauds. In one of the biggest
online fraud in the country, a man recently lost Rs 11 crore. Little doubt then that on their
part, banks too keep warning their customers about such frauds. Here are 9 most common
ways that fraudsters use to steal online banking details and dupe people of their money.

62
1 Online shopping refund
2 Online banking details
3 Online scams
4 Online KYC
5 Online frauds
6 KYC
7 Fraudsters
8 Banking

This fraud is related to online shopping. Customer receives an SMS in context of

online shopping or cashback. He/she is asked to share confidential details such as grid
card details, ATM card PIN, UPI PIN, debit card number and CVV. Under this
method, fraudster installs malware/spyware using chip embedded in public charging
spots. This chip copies your sensitive data and installs malware on your smartphone,
whenever connected. Under this fraud, the customer receives a call and is asked for
transaction banking details such as OTPs or user ID delivered on your registered
mobile number. The fraudster then forwards activation SMS on your phone which is
later used to gain access of your bank account. Using this method, the caller asks to
install system assistance apps such as TeamViewer, Quick Support and Any Desk.
These apps give the fraudster your smartphone's complete access. In this method,
fraudsters send malicious link via SMS or emails that asks recipient to share his/her
confidential details such as grid card details, ATM card PIN, UPI PIN, debit card
number and CVV. These usually come via WhatsApp or SMS offering cashbacks on
online shopping. These messages are usually phishing attempts which try to lure
people into sharing their online banking details. In this, fraudsters claim to be calling
from a popular e-commerce platform (say Amazon or Flipkart) and offer refund on
any recent online transaction made. They try to trap the online shopper by promise of
refund and take his/her bank or credit/debit card details. This is another common
online fraud that many people have fallen to. In fact, Paytm has warned its users
against KYC fraud. This scam starts with a call from someone claiming to be a
customer service officer from your bank or Paytm KYC executive. The callers try to
scare by saying that your bank, card or Paytm account will be blocked or something
similar. The entire aim is to convince you to download remote access apps like Any
Desk or TeamViewer. Not really new, this fraudulent method is used by criminals to

63
 trick gullible smartphone users who end up losing money in matter of minutes. SIM
swap or simply SIM card exchange is basically registering a new SIM card with your
phone number. Once this is done, your old SIM card becomes invalid and your phone
will stop receiving signal. Now, once the fraudsters have your phone number, they
will get OTPs on their SIM card. With this they can initiate bank transfer and even opt
to shop online after getting OTPs. This fraud too starts with a call from a person who
pose as an executive from Airtel, Vodafone or Jio. He or she then asks you that it's a
routine call to improve call drop problem, signal reception or promise to help you
increase mobile internet speeds.

Device fingerprinting tracks a series of identifiable hardware and software attributes to

recognize a user’s (or fraudster’s) device.

• Behavioural analytics monitor navigation techniques and other aspects of a user’s online
behaviour to search for anomalies or suspicious activity.

• Malware detection searches for potentially fraudulent changes to a user’s Web browser to
assess whether it's been compromised.

• Knowledge-based authentication presents a series of static or dynamic and supposedly

secret questions to establish a user’s identity.

• Password tokens give a user a one-time only password that must be entered before it
expires.

• Out-of-band authentication challenges a user to access a one-time-only password or code

that is sent to another device, such as a mobile phone or land line.

• Transaction signing requires a user to digitally sign each transaction.

• Endpoint protection requires a user to download a one-time-only, secure browser to access

a website.

64
• Voice printing records attributes of a caller’s speech over time and matches those attributes
against subsequent calls. Voice printing is an example of biometrics, which use unique
physical traits, or characteristics to identify individuals.

However, as technology advances, we are seeing a distinct proliferation of more complex

fraud schemes. At the same time, we are seeing more breakthroughs in the use of technology
to detect fraud. Strategies that we have used in just the past few years will become
completely outdated, as a fresh set of tactics will debut.50 To minimize the potential damage
of fraud, companies need to invest not just in more advanced technology but in people and
policies for detecting attacks as quickly as possible. While the networks are just too large to
prevent every attack from occurring, detection is crucial. Most companies do not have
adequate protocols and staff in place to deal with incidents of fraud. While advanced
technology serves as a great tool to combat fraud, the issue should be viewed as more than
just an IT problem and looked at as a business problem. Remember, the cost of trying to
prevent fraud is far less expensive to a business than the cost of fraud committed on a
business.

Chapter 3:

Literature review:

Brief Literature Review

The aftermath of the great depression in 1930s in the USA saw enforcement of Glass-Stage
all act (GSA) with an objective to reduce risks to financial system and tackle conflict of
interests that exist in banking, by separating commercial banking functions from ‘risky’
investment banking functions. However, over time, a series of dilutions gradually rendered
GSA ineffective which was finally repealed in 1999. With globalization, Kohler (2002) in his
speech at a conference on humanizing the global economy stressed the need to increase
transparency of financial structures as well as to raise

the surveillance of international capital markets. In mid-1990’s, World Bank laid out a well-
defined strategy to combat different types of frauds and corruption, and jointly with the IMF
created financial sector assessment program (FSAP), to assess, diagnose and address
potential financial vulnerabilities. FSAP has undergone several transformations and wider

65
acceptance over the years, since its inception in 1999. Mergers of giants in the banking
industry gave birth to the concept of “too big to fail”, which eventually led to highly risky
financial objectives and financial crisis of 2008. In response to the 2008 crisis, Dodd-Frank
wall-street reform and consumer protection act (DFA) was enacted in 2010. DFA gave birth
to various new agencies to help monitor and prevent fraudulent practices. Volcker rule, a part
of DFA, banned banks from engaging in proprietary trading operations for profit. Post crisis,
IMF has worked towards making risk and vulnerabilities assessment framework effective, by
advocating greater transparency and information sharing, along with empowered supervisory
and regulatory bodies, as well as greater international collaboration towards regulation and
supervision of financial institutions. Gaps were identified under financial surveillance as well
as on the frequency of such surveillance especially in economies with truly systemic financial
sectors, whose failure might trigger a financial crisis. According to literature, approximately
one in three banking crises followed a credit boom, which shows a correlation between
relaxed credit expansion policies by banks and crises. Another major sector distraught with
fraudulent practices is the credit card market. However, given that credit card usage in India
is predominantly for transactional purposes, the macroeconomic impact of fraudulent
practices is less significant and is not considered further in this study. Indian banking system
has remained plagued with growth in NPAs during recent years, which resulted in a vicious
cycle affecting its sustainability. Chakrabarty (2013) noted in his speech that, while most
numbers of frauds have been attributed to private and foreign banks, public sector banks have
made the highest contribution towards the amount involved. Key findings in RBI (2014b)
included the stress of asset quality and marginal capitalization faced by public sector banks,
and various recommendations to address these issues. Rajan (2014) stressed on good
governance and more autonomy to be conferred to public sector banks to increase their
competitiveness and to be able to raise money from markets easily. In response to the
common perception that increasingly strict regulations will make business opportunities take
a hit, Raju (2014) stated that, regulations do not seem to be a bar in functioning of banks after
the crisis. Subbarao (2009) was of the opinion that without broad-based trust and presumption
of honest behaviour, there wouldn’t be a financial sector of the current scale and size. He
called the emergence of a moral hazard problem in the banking system as privatization of
profit and socialization of costs. To maintain uniformity in fraud reporting, frauds have been
classified by RBI based on their types and provisions of the Indian penal code, and reporting
guidelines have been set for those according to RBI (2014a and 2015a). Towards monitoring
of frauds by the board of directors, a circular was issued as per RBI (2015b) to cooperative

66
banks to set up a committee to oversee internal inspection and auditing, and plan on
appropriate preventive actions, followed by review of efficacy of those actions. Impartial
policy guidelines and whistle-blower policy are vital to empower employees to handle frauds.
RBI also issued a circular and introduced the concept of red flagged account (RFA), based on
the presence of early warning signals (EWS), into the current framework, for early detection
and prevention of frauds. Gandhi (2014) discussed the prime causes of growing NPAs and
recognised the absence of robust credit appraisal system, inefficient supervision post credit
disbursal, and ineffective recovery mechanism as key barriers addressing those aspects.
Gandhi (2015) stressed on the basic principles that can go a long way in preventing fraud,
namely the principles of knowing the customer and employees as well as partners. He also
pointed out the significance of a robust appraisal mechanism and continuous monitoring.
Locale (2014) reveals that the share of retail loan segment in total NPAs continues to stay
high, of which credit card loans (2.2 percent) have the third-highest contribution after
personal and housing loans. Livshits, MacGee, Tertilt (2015) empirically suggest that the rise
in consumer bankruptcy can largely be accounted by the extensive margin and lower stigma
associated with it. It also suggests that financial innovations have led to higher aggregate
borrowings, which has resulted in higher defaults. A study by Assocham (2014) finds strong
correlation between sustainable credit growth, leading to healthy asset creation, and GDP
growth. It emphasizes robust credit assessment and use of early warning systems to monitor
asset quality of institutions.

Group wise summary of bank fraud cases

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Note: Data pertains to the period from March 31, 2010 to March 31, 2013. Source:
Chakraborty (2013).

Figure 2: Group wise summary of advance related fraud cases

Note: Data pertains to the period from March 31, 2010 to March 31, 2013. Source:
Chakrabarty (2013).

According to findings of Deloitte (2015), number and sophistication of frauds in banking

sector have increased over the last two years. Around 93 percent of respondents suggested an
increase in fraud incidents and more than half said that they had witnessed it in their own
organizations. Retail banking was identified as the major contributor to fraud incidents, with
many respondents saying that they had experienced close to 50 fraudulent incidents in the last
24 months and had lost, on an average of Rupees ten lakhs per fraud. In contrast, survey
respondents indicated that the non-retail segment saw an average of 10 fraud incidents with
an approximate loss of Rupees two crore per incident. Many respondents could not recover
more than 25 percent of the loss.

The risks undertaken by banks are still a cause of worry although it has moderated a bit. This
is indicated by the bank stability indicator. Similarly, banks were worried by poor asset
quality. System level credit risk is determined by gross NPA ratio which is expected to be
around 5.4 percent by September 2016 and 5.2 percent in March 2017 as per RBI (2015c).
Further, the ratio of stressed assets has increased significantly in the last few years. As of

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September 2015, stressed and written off assets (SWA)4 are at 14.1 percent. The trends
however are divergent, with public sector banks having an SWA of 17 percent and private
sector banks having an SWA of 6.7 percent according to Mundra (2016). As far as credit risk
is concerned, 16 out of 60 banks (26.5 percent market share) were not able to cover their
expected losses from their current framework. RBI states that NPAs from retail banking are
just 2 percent, whereas NPAs from corporate banking are 36 percent. Given the size of
transactions in corporate banking, it is important that banks implement a robust monitoring
mechanism post sanction and disbursement of facilities, and be vigilant to early signs of
stress in the borrower accounts.5 India has witnessed a massive surge in cybercrime incidents
in the last ten years - from just 23 in 2004 to 72,000 in 2014-15 (Figures 3 and 4). As per the
government's cyber security arm, computer emergency response team-India (CERT-In),
62,189 cyber security incidents were reported in just the first five months of 2015-16.

Figure :3 Cyber frauds

Source: PWC India and ASSOCHAM (2014).

Figure 4: Identity Theft Fraud

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Source: PWC India and ASSOCHAM (2014)

Interview Based

A semi-structured interview was conducted by the authors with various officials of the
banking industry and investigating agencies. Detailed projects can be made available on
request. Thus, from the study, the authors were able to come up with the following insights
and key findings: -

1. Fraud detection procedure in public sector banks: The authors analysed the process of
fraud detection and reporting in a public sector bank and who are the various players
involved in this process. Following is a step by step illustration of the same (Figure 5).

a) First, a fraud is internally reported to senior management of a bank. These may include
chief general managers, executive directors, chairman and managing director. They may also
be reported to vigilance department of the bank.

b) If reported to the vigilance department of the bank, it investigates the fraud and then
reports it to both senior management as well as the central vigilance commission (CVC) to
whom they are required to report monthly.

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c) Although CVC can report fraud directly to investigating agencies like CBI, usually final
decision to either report fraud to an external agency or to deal with it internally is made by
senior management of the bank. Depending upon size of the bank, amount of money involved
in fraudulent activity and number of third parties involved, senior management may choose to
deal with the fraud internally or file an FIR and report it to either local police or CBI.

d) A committee of the RBI also independently monitors fraudulent behaviour in banks and
reports its observations on quarterly basis to central board of the RBI. The board may then
report the matter to either central vigilance commission or ministry of finance (MoF).

e) Auditors, during the course of their audit, may come across instances where transactions in
accounts or documents point to possibility of fraudulent transactions in accounts. In such a
situation, auditor may immediately bring it to the notice of top management and if necessary
to audit committee of board (ACB) for appropriate action.

f) Employees can also report fraudulent activity in an account, along with the reasons in
support of their views, to the appropriately constituted authority (Table 1), under the whistle
blower policy of the bank, who may institute a scrutiny through the fraud monitoring group
(FMG). The FMG may ‘hear’ the concerned employee in order to obtain necessary
clarifications. Protection should be available to such employees under the whistle blower
policy of the bank so that fear of victimization does not act as a deterrent.

Figure 5: Flow Chart depicting procedures post Fraud Detection and Reporting in PSBs

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 Chapter 4

Data Analysis:

Analysis Research

As per the RBI, bank frauds can be classified into three broad categories: deposit related
frauds, advances related frauds and services related frauds. Deposit related frauds, which
used to be significant in terms of numbers but not in size, have come down significantly in
recent years, owing to a new system of payment, and introduction of cheque truncation
system (CTS) by commercial banks, use of electronic transfer of fund, etc. Advances related
fraud continue to be a major challenge in terms of amount involved (nearly 67 percent of total
amount involved in frauds over last 4 years), posing a direct threat to the financial stability of
banks. With ever-increasing use of technology in the banking system, cyber frauds have
proliferated and are becoming even more sophisticated in terms of use of novel methods.
Also, documentary credit (letter of credit) related frauds have surfaced causing a grave
concern due to their implications on trade and related activities. The data reveals that more
than 95 percent of number of fraud cases and amount involved in fraud comes from
commercial banks. Among the commercial banks, public sector banks account for just about
18 percent of total number of fraud cases, whereas in terms of the amount involved, the
proportion goes as high as 83 percent. This is in stark contrast with private sector banks, with
around 55 percent of number of fraud cases, but just about 13 percent of the total amount
involved in such cases (Figure 1). The PSBs are more vulnerable in case of big-ticket
advance related frauds (1 crore or above) in terms of both number of fraud cases reported and
total amount involved (Figure 2). The correlation between rising level of NPAs of public
sector banks and frauds probably indicates lack of requisite standards of corporate
governance leading to more instances of high value bank loan default and possible collusion
between corporate entities and high echelon bank officials. Also, in case of private banks,
high number of fraud cases with relatively low cost of fraud indicates very nature of fraud -
online/cyber/technology related frauds with a high frequency of occurrence and relatively
low associated cost.

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4.2

Reason for higher advance related frauds in public sector banks and rising NPAs: Higher
advance related frauds of above rupees one crore loans (87 percent of total amount involved
in loan worth rupees one crore or above in value) (Figure 2) in public sector banks as
compared to private sector banks (11 percent of total amount involved) could be due to the
proportion of the loan advanced by both PSBs (~ 70 percent) and private sector banks (~ 30
percent) especially in large and long gestation projects like infrastructure, power or mining
sectors. Also, the higher number of fraud cases reported by PSBs (65 percent of total) as
compared to PVBs (19 percent of total) may be attributed to stringent oversight of CVC in
PSBs. It may also be due to a possible underreporting/evergreening of loans on the part of the
PVBs, evidenced by RBI’s measures to curb such practices in recent times. 7 The reason for
large NPA’s of PSBs could be attributed to greater amount of lending/exposure to mining,
infrastructure and power sector projects, whose performance and associated cash flows
closely follow the economic cycle of boom and recession. Also, in India, post - 2008 global
crisis, a number of governance and other external issues such as policy paralysis, inordinate
delay on account of stringent environmental laws/regulation, Supreme Court decision on coal
mines as well as weak demand crippled these sectors and resulted into weaker cash flows.
These developments severely affected the ability of such firms to service their loans leading
to higher NPAs. There is an ongoing debate on the nexus between rising NPAs in the banking
system and the increasing incidence of fraud. A former CBI director, in 2013, had raised the
point that, amount involved in bank frauds had increased almost 324 percent in last three
years while large ticket fraud cases involving amounts of Rs. 50 crore and above had
increased tenfold. He also pointed to reluctance on part of banks to declare bad accounts as
frauds despite there being clear-cut manifestation of malfeasance CBI (2014).

There are some limitations that emerged in the discussion. One limitation is that bankers take
the project at their face value during inspection. Even today due diligence across several
public sector banks is weak. The banks keep the outstanding amount as current assets and
hence the original costing basis of asset valuation shows no loss of money. Shareholders are
hence not aware for a long time. The classification of bad debts is also delayed considerably
for a long time across all banks in India. Also, due diligence involves whether the project has
got all necessary approvals, illustratively, a selling agreement as power-purchase agreement

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with the state government electricity board. Receivables from the government are taken for
granted by the bankers but when the project goes sick these cash-flows are not realizable. 3.
Third party agencies involved: Big loan advance frauds are not so easy to commit and it often
results because bank officials collude with borrowers and sometimes even with officials of
third parties such as advocates or chartered accountants (CAs). In such cases, the third parties
such as the CAs or the advocates often get away as it is nearly impossible for the banks to
prove criminal intent on the part of such persons due to various reasons such as lack of clear
understanding of legal matters to bankers, and lack of expertise and legal advice on this
subject, and unwillingness to reveal some sensitive data to courts/ public domain. Also, self-
regulatory bodies of advocates, auditors or accountants like bar council and the institute of
chartered accountants of India do not generally bar their errant members. Also, in this
context, cost of pursuing such individuals and delay caused by courts often deter the PSBs.
The role of auditors was further analysed in order to identify gaps and loopholes that exist in
the current system. Auditors can be classified into three main types: a) Bank auditors – There
are two main types of auditors that work for a bank to look into financial statements of its
borrowers. They work in different capacities in terms of their scope and knowledge. They can
be held responsible for any misreporting under common legal framework due to faith placed
on them by banks. The two types of auditors are: i. Statutory auditor – These look into
financial statements of all borrowers that borrow from a bank. These are external auditors.

ii. Concurrent auditor – These help supplement the functioning of bank in terms of internal
checks and check on financial statements of its borrowers. These may be external/internal
auditors b) Statutory auditors of the borrower – These auditors work for the borrower firm
and help in reporting their financial statements. c) Special auditors – These auditors work on
a case by case basis independently and are not associated with any firm or bank. They help
provide an external view on statements reported by the borrower to the bank. In our
discussions, one factor that emerged was that there is a lack of competent auditors in India.
The reasons were: a) Staffing of auditors in banks: The staffing of auditors is generally very
competitive and price driven. It is a relatively low paying job which means only so much
effort is put in by auditors to do their work. Also, the skill-set of many young auditors is low.
This coupled with low standards of training meted out to them leaves them at a disadvantage
in terms of the benefit of observation and experience. In addition, the auditors have
clerks/article ship students working with them, who can be easily manipulated. b) Training
given to auditors: The standards of training imparted to bank auditors are very low. Unlike as

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in the case of forensic auditing, they are not generally questioned regarding the veracity of
documents they produce and no one challenges the financial information that they generate.
In some cases, they are not equipped with the working knowledge of different instruments
used by banks and are technically handicapped. c) Attention to early warning signals: As a
consequence of low pay benefits and training standards, it has been observed that auditors do
not generally pay attention to the various early warning signs that can help an organization
recognize potential fraudulent malpractices in existence. d) Weaker enforcement of laws in
our country: Law enforcement agencies in India are burdened with excessive work pressure
and therefore have to choose between different assignments. This is due to insufficient
resources and manpower available at their disposal. In such situations, auditors happen to be
most dependent for law enforcement agencies.

Moreover, according to discussions, many officials in law enforcement agencies lack

necessary skill-sets and financial expertise to identify and deal with fast moving financial
frauds. 8 4. Poor appraisal system and monitoring mechanism in PSBs: The initial project
appraisal process in PSBs is as good as that of PVBs. But monitoring post sanction of loan is
weaker in PSBs compared to the PVBs on account of diverse loan portfolio, lack of expertise
and modern technological resources, and lack of manpower and motivated employees, who
are not appropriately incentivized to detect early frauds or prevent them. 5. Corporate
governance and other HR issues: The root cause of weak corporate governance at highest
level is directly linked to the very process of appointment of highest level of officials and
poor compensation structure of highest level functionaries. The weakness in selection process
for top level management as documented in RBI (2014b) results into weak governance at the
highest level. Also, there is a serious issue in terms of pay structure in higher echelons of
PSBs, which is markedly lower than their counterparts in PVBs. The only good factor in
PSBs is prestige of a post that a person holds. The inability to hire competent professionals
and expertise from market (lateral hiring) due to existing recruitment policy, flight of officials
to greener pastures and private or foreign banks, poor compensation structure, unionization
challenges as well as lack of adequate training in contemporary fraud prevention techniques
are key HR issues, which indirectly contribute to bank frauds. 6. Senior management and
board of directors: At times, senior management themselves may like to cover-up some cases
to meet their short term targets and goals, and create a good picture for the shareholders. In
fraud cases, within the banks, with suspected involvement of senior management, there is
significant resistance while prosecuting officers in level 4 or above. Most of the officers retire

75
before they can be booked for a fraud. Once retired, pension regulations apply to them
making them immune to any financial penalty.

If the case is finally taken up in the court of law, a public prosecutor represents the bank. The
public prosecutor is usually overburdened with pending cases. Additionally, from the bank’s
perspective, having already lost substantial amount in fraud, they allocate limited budget for
prosecutions, making it easier for the guilty to escape. 7. Bank employees: Incentive structure
for employees needs a re-evaluation and gives too much importance to short term targets.
This incentivizes the employees to give preference to short term targets only and not exercise
proper due diligence. Hence, they take more risk than is usually the norm or resort to
unethical means. There have been instances of frauds involving collusion of staff with third
party agents like auditors to indulge in fraudulent activities on customers. Detection of such
frauds takes a long time, and is only discovered when there are customer complaints of
fraudulent cases. The customers who are victim of fraudulent activities by the bank, due to
identity theft etc., could have avoided so, by following appropriate preventive measures and
customer awareness guidelines. Political reasons may also be responsible for indulgence in
loans proceed which has substantial risk of being defaulted or defrauded, especially when a
red flag is raised on the loan. As legal opinion is not the strength of a banker, advocate’s
directions in that matter assume importance. Frauds also result from lack of awareness of
staff towards appropriate procedures in place and red flags they should be aware of.
Technology related frauds are primarily due to nonadherence to standard procedures and
systems in place, by the employees. Even when any employee detects some fraudulent
activities in existence involving people in power, whistle blower protection policy does not
guarantee adequate safety. PSBs in India had prepared a five-point action plan to make them
more competitive, which included suggestions like introduction of performance management
systems and incentives in banks. Smaller banks should focus on the areas of their strength (to
optimize capital utilization) among other reform plans. The banks demanded creation of bank
board bureau and bank investment committee and empowerment of banks on certain decision
making capabilities, in line with RBI (2014b). Additionally, they demanded simplification of
credit insurance process and strengthening of legal framework for debt recovery, apart from
more usage of technology.

8. Borrowers and clients of banks: Frauds may also arise solely from the borrower’s side.
Companies have been found to take part in ‘high sea sales’ with investment from Indian
banks but the funds are either routed for other purpose or are not repaid after the sale has

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been made and instead, routed to other channels, resulting in a NPA. Such breach of contract
is another instance of fraud since the funds are not utilized for the purpose they were initially
set out and based on the project evaluated by the banker. 9. Legal aspects of frauds and role
of investigative agencies: Investigating and supervisory bodies like central vigilance
commission (CVC) or central bureau of investigation (CBI) are already overburdened with
many pending investigations and have limited resources at their disposal. The biggest hurdle
in pursuing fraudsters is proving criminal intent on their part in the court of law. Most of the
bank frauds are detected very late and by that time, fraudsters get enough time to wipe out
trails and it becomes very difficult to establish criminal intent due to loss of relevant
documents and non-availability of witnesses. Also, while pursuing fraudsters, banks and
investigation agencies face many operational issues. Bankers are not experts in legal
paperwork, and formal complaints against fraudsters drafted by them often lack incisiveness.
Also, in absence of a dedicated department handling fraud matters, investigating officers
(CBI/police) have to deal with multiple departments and people within the bank, which often
results into poor coordination and delay in investigation. This results in very low conviction
rate for fraudsters (less than 1 percent of total cases). Even after conviction in fraud cases,
there is no legal recourse to recover the amount lost in the bank frauds and the country’s legal
system is perceived to be very soft on defaulters. Also, lack of strong whistle-blower
protection law inhibits early detection in case of involvement of internal employees.

10. Judicial system: The long and elaborate judicial process is another major deterrent
towards timely redressal of fraud cases. The delay in judiciary to prosecute those guilty of
fraudulent practices, could lead to dilution of evidence as well as significant cost building on
part of the victim bank. Also, wilful default is still not considered as a criminal offence in
India. Fraudsters, both big and small, take undue advantage of these means of evasion and
commit maligned activities without risk of conviction. 11. Technological and coordination
perspective: RBI has an elaborate set of early warning signals (EWS) for banks to curtail
frauds. However as of now, there are inadequate tools and technologies in place to detect
early warning signals and red flags pertaining to different frauds. The authors’ interaction
with a former chairman of a big public sector bank shockingly revealed that there is only one
provider of vigilance and monitoring software for banks and price discovery is poor. Even the
biggest of public sector banks cannot afford to buy that software. Also, lack of coordination
among different banks on fraud related information sharing is another major roadblock.

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4.3

Different types of frauds caused Rs. 6,600 crores of loss to the Indian economy in 2011-12,
and banks were the most common victims in swindling cases; insider enabled fraud
accounted for 61% of fraud cases. However, Soni and Soni25 concluded that “cyber fraud in
the banking industry has emerged as a big problem and a cause of worry for this sector.”
Similarly, another survey conducted by Deloitte26 shows that “banks have witnessed a rise in
the number of fraud incidents in the last one year, and the trend is likely to continue in the
near future.” The Deloitte India Banking Fraud Survey Report Edition II added, “the number
of frauds in banking sector have increased by more than 10% over the last two years. Banks
witnessed rise in level of sophistication with which frauds were executed.”8 It is universally
accepted that continued prevalence of frauds will have long-term bad consequences for
banks, customers, investors, government and the economy in general. The year-wise details,
beginning from 2000-01 to 2013-14, regarding the number and amount of frauds reported by
the Indian banking sector to the RBI, are shown in Table 2. The following broad
generalizations can be made. During the last six years, from 2000-01 to 2005-06, the number
of fraud cases has shown a constantly rising trend. For example, in 2000-01 there were 1858
cases of frauds, which substantially jumped to 2658 fraud cases in 2005-06. However, in
2006-07 and 2007-08, the number of fraud cases declined sharply from 2568 to 1385,
respectively. In fact, the amount involved in fraud cases has also increased very sharply from
the lowest level of Rs. 374.97 crore during 2002-03 tothe highest level of Rs. 1134.39 crore
during 2005-06. The year 2007-08 was an exceptional year in which the amount of loss
caused due to fraud declined to Rs. 396.86 crore. In sharp contrast to this, year 2005-06 was
also a very significant year for the banking industry, since this year witnessed the highest
ever fraud loss of Rs. 1134.39 crore. Keeping in view the loss of Rs. 451.04 crore in 2004-05,
the loss of Rs. 1134.39 crore in 2005-06, works out to about 2.5 times the loss of previous
year. Moreover, the scenario of number of frauds and amount involved has significantly
changed from 2008-09 to 2013-14. For example, 24,791 cases of frauds were reported in
2009-10, which showed a constant trend of decline till 2012-13. Number of fraud cases
reported were 19,827 in 2010-11, which declined to 14,735 cases in 2011-12, and 13,293
cases in 2012-13 (a decline of 46.37%), respectively. As against this, the trend has reversed
when we have a look at the amount of loss suffered by banks during the same period. For
instance, the amount of loss suffered has increased very sharply from Rs. 2037.81 crore in
2009-10 to Rs. 8646 crores in 2012-13, an increase of 324.27%. As Pai and Venkatesh27

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(2014) reported, “As on March 31, 2014 banks reported total loss of Rs. 169,190 crores from
29,910 cases. In 2012-13, Rs. 13,293 crore of fraud was detected from 8646 cases.” During
Apr.-Dec. 2014, PSBs suffered losses of Rs. 11,022 crores from 2100 fraud cases involving
Rs. one lakh or more. During same period, 46% more amount was lost due to frauds
compared to last full-year. With the advent of mobile and internet banking, the number of
banking frauds in the country is on the rise as banks are losing money to the tune of
approximately Rs. 2,500 crore every year. While the figure for 2010-11 was Rs. 3,500 crores,
for the current financial year (till September) it is about Rs. 1,800 crores.

Further, state-wise list of information on banking frauds shows Maharashtra (Mumbai)

reporting the highest number of cases to the RBI. In the last financial year, banks in the
Maharashtra reported 1,179 cases with Rs. 1,141 crores being lost to such frauds.
Maharashtra is followed by Uttar Pradesh with 385 cases during the same period.

4.4 surveys:
According to an economic crime survey performed by PwC in 2018, fraud is a billion-dollar
business and it is increasing every year: half (49 percent) of the 7,200 companies they
surveyed had experienced fraud of some kind.
Most of the frauds involves cell phones, tax return claims, insurance claims, credit cards,
supply chains, retail networks, purchase dependencies and turn out a big problem both for
governments and businesses.
Investing in fraud detection can take the following benefits:
• Promptly react to fraudulent activities
• Reduce exposure to fraudulent activities
• Reduce economic damages caused by frauds
• Recognise the vulnerable accounts more exposed to frauds
• Increase trust and confidence of the shareholders of the organisation
A good fraudster can work around the basic fraud detection techniques, for this reason
developing new detecting strategies it is very important for any organisation and fraud
detection must be considered a complex and always-evolving process.
Phases and Techniques

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Fraud detection process starts with a high-level data overview with the goal of discovering
some anomalies and suspicious behaviours inside the dataset, e.g. we could be interested in
looking for weird credit card purchasing. Once we have found the anomalies we have to
recognise their origin, because each of them could be due to frauds, but also to errors in the
dataset or just missing data.
This fundamental step is called data validation, and it consists in errors detection, followed
by incorrect data correction and missing data filling up.
Once data was cleaned up the real phase of data analysis can start; after the analysis is
completed all the results must be validated, reported and graphically presented.
To recap, the main steps in the detection process are the following:
• Data collection
• Data preparation
• Data analysis
• Report and presentation of results
• Arcade Analytics fits very well for the last steps, as it is a tool conceived to
create captivating and effective reports that allows to share in a very easy way the
results of a specific analysis by composing different widgets in complex dashboards.
• The main widget is the Graph Widget, it allows users to visually see relationships and
connections within their datasets and find meaningful connections and relationships.
Moreover, all the widgets present in the same dashboard can be connected in order to
make them interact with each other. In this way we will be able to see in the
outcoming dashboard bidirectional interactions between the graphs, data tables and
the traditional charts widgets.
• The chart distributions will be computed according to the partial datasets of the
correspondent primary widgets, making the final report dynamic and interactive.
But that is not at all, Arcade can be useful for several techniques in the data analysis
steps. Let’s see how then!
Data analysis often relies on automated processes exploiting statistical
methods and artificial intelligence techniques, that are commonly classified respectively
in supervised and unsupervised techniques.
Among the statistical methods we can found:
• Data processing
• Statistical parameters calculation, relevant for the specific domain
• Models and probability distributions

80
• Time series analysis
• Clustering and classification of entities, in order to find associations and patterns among
data.
Arcade offers several tools to perform single and multi series analyses exploiting an
efficient full text search engine and inverted indices, that assure good performances in
computing statistical parameters and distributions on the whole data source.

Global Transactions/Orders type distribution

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These methods are good to identify statistical classification and infer rules: these rules can be
then used to define rule-based classifiers, supervised learning algorithms that use rules
of If (fulfils certain conditions) and Then (appropriate category).
Moreover, Arcade offers good support to time series analysis: by using the timeline feature
you can see your data in the form of graph and how it changes over the time.

In this way we can analyse when the relationships between specific items or entities appeared
by exploiting a time filtering window, to narrow your temporal analysis to a specific and
customisable range.

Then you can interact with this analysis by zooming in and out: by changing the grain you
can perform a simple temporal top down analysis starting from a wider view, useful to see

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at a first glance how the events are distributed over the time, till reaching each single event if
needed.
Obviously in each perspective you can move back and forth through time.

Beside the statistical methods, it could be helpful put beside automated processes like:
• Data mining
• Patterns recognition
• Machine learning and prediction to implement proactive rules
In fact, these unsupervised methods do not require samples of fraudulent transactions, so
they turn out useful in all that scenarios where there is no a prior knowledge of classes of
transactions or when we want to extend these categories in order to recognise previously
undiscovered frauds, not yet present in historical databases.
Importance of human interaction
Often in this scenarios we can encounter the Fraud Analytics concept, that is commonly
conceived as a combination of automated analytics technologies and analytics techniques
with human interaction. In fact, we cannot get rid of domain experts users’ interaction
mainly for two reason:
• Problem of high number of false positives: not all the transactions detected as
fraudulent are actually frauds. Generally, detection systems based on the best algorithms
result in too many false positives, even though they are able to identify a high percentage
of the actual fraudulent transaction (till 99 %). Thus, all the results must be validated in
order to exclude the false positives from the first result.
• High computing time complexity of the algorithms, above all in prediction scenarios:
when algorithm time complexity is exponential, monolithic execution is not a good

83
 approach, because it could require a lot of time for big inputs. Thus a progressive
approach is adopted, consisting in decreasing computational requested time
by combining specific resolution models and automated calculation with human
interaction, said designer.
Intermediate results are proposed to the designer during the computation, thus he decides
which way the analysis has to take in a progressive manner. In this way whole
execution branches can be omitted, achieving a good gain in terms of the performance.
For both these two aims a visual tool is needed, Arcade Analytics turns out very
appropriate for these tasks thanks to the features already shown and the expressive power
of the graph model.
How Graph perspective can help
Graph perspective can be very useful in fraud detection use case, because as already
said most of the computation relies on patterns recognition. Then we can use these
patterns to find out and retrieve all the unusual behaviours we are looking for, without
needing to write complex join queries.
Specifically Arcade offers support to different graph querying languages based on:
• the pattern matching approach: Cypher query language proposed by Neo4j and
the MATCH statement of the Orient DB SQL query language are fully supported in
Arcade nowadays. This is the winning approach when we can rely on several patterns to
detect frauds.
• the graph traversal approach, that makes very simple walk the graph to explore
information of actual interest. Gremlin is a good example of these kind of languages.
Moreover, one of the most attractive features of Arcade Analytics is that it allows users to
query data from a relational database to easily visualise the data therein as a
graph and explore the connections inside it without any migration and through few simple
steps.

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 Now let’s have a look to a very common pattern recognised as potential fraudulent activity
that is often missed by traditional fraud detection systems, and in what way Arcade Analytics
can help us in the analysis of all the instances matching this specific schema

The following can be a simple example:

John Smith opens a new credit card account, maxes out his credit line, defaults and then
disappears without leave any trace.
In this scenario Mr. Smith used his own credentials, with minor variations in his contact
data, to deliberately defraud the credit card company.
But we can also encounter group of two or more people organised into a fraud ring, where
there is a subset of legitimate contact information, like telephone numbers and addresses.
This data is combined to create several synthetic identities that will be used by the ring
members to open fraudulent accounts. Thus this new accounts have access to credit lines,
credit cards, overdraft protection, personal loans, etc.
The accounts are used normally, with regular purchases and timely payments, and for this
reason banks increase the revolving credit lines over time, due to the observed responsible
credit behaviour.
One day the accounts coordinate their activity, maxing out all of their credit
lines and disappearing.

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Then this ring schema can be detected as suspicious behaviour and if recognised and
validated in time can avoid big losses.
Here is a sample graph instance in Arcade matching this ring pattern:

This pattern can be looked for in the data through a specific query, loaded in Arcade
Analytics and deeply investigated by human experts in order to prevent this kind of fraud.

Chapter: 5

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Conclusion and Recommendations:

It is observed that PSBs fare better than PVBs in terms of total number of bank frauds.
However, the total amount involved is much higher in PSBs as compared to the private
sector. This can be attributed to large size of loans which PSBs offer to customers. Credit
related frauds have the maximum impact in all the banking frauds in India because of the
high amount involved and the cumbersome process of fraud detection followed by CVC. The
frauds may be primarily due to lack of adequate supervision of top management, faulty
incentive mechanism in place for employees; collusion between the staff, corporate
borrowers and third party agencies; weak regulatory system; lack of appropriate tools and
technologies in place to detect early warning signals of a fraud; lack of awareness of bank
employees and customers; and lack of coordination among different banks across India and
abroad. The delays in legal procedures for reporting, and various loopholes in system have
been considered some of the major reasons of frauds and NPAs.

This article investigated the occurrence of corporate fraud in Brazilian banking institutions in
the period between January 2001 and December 2012 using detection variables extracted
from agency theory and the economics of crime, grouped according to the dimensions of the
Cressey fraud triangle: pressure, opportunity, and rationalization. From agency theory,
variables were identified that enabled the measurement of the pressure and opportunity
dimensions pertaining to the instruments for monitoring manager actions, such as
remuneration incentives and corporate governance. From the economics of crime, technical
and empirical studies were used that enabled the identification of variables for measuring the
pressure and rationalization dimensions, such as indicators of pressure for company
performance and manager demographic characteristics, with age, educational level, training
in the area of business, and gender standing out.

The study confirmed the general hypothesis of the Cressey fraud triangle, in which breaking
financial trust is conditioned by the simultaneous existence of the three dimensions of the
fraud triangle: pressure, opportunity, and rationalization.

This article is relevant in that it fills a gap in the literature in the area by carrying out a
differentiated analysis of frauds, contemplating all those that occur in the context of an
institution and not being limited to only those of an accounting nature. Likewise, this study
enabled the measurement of the probability of occurrence of corporate fraud by dissociating

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fraudulent banking institutions from those that only showed indications of corporate fraud,
this situation not being found in neither the Brazilian or international empirical studies used.

Besides the theoretical relevance presented in the previous paragraph, it is worth highlighting
that the variables used in constituting the factors, with statistical significance, can be treated
as indicators of possible occurrences of corporate frauds. Moreover, identifying these
variables will enable both regulatory bodies and investors to analyse the possibilities of fraud
occurring, whether for the regulatory bodies to curb it or for investor decisions with regards
to maintaining or carrying out new investments.

This research also contributes with an investigation of new debates and studies in the
Brazilian academic field on corporate frauds in the country, since besides being few in
number these have different scopes to those of this study.

There were limitations for carrying out the study, especially during the data gathering
process, due to the existence of few institutions that presented the totality of their data series
for the period analysed, mainly impacting on the obtainment of information on manager
demographic characteristics. Another limitation was the temporal range of the data, covering
January 2001 to December 2012, due to the fact that via Circular Letter n. 3,630 of 2013 ( CB,
2013
) the CB relieved banking institutions of presenting QFI from January 2013 onwards. The
decision made obtaining the quarterly data from 2013 onwards unviable. This is added to the
limitations of the research from using punitive administrative proceedings as proxies for the
occurrence of corporate fraud; in future studies, judicial proceedings could be used for this
purpose.

It bears mentioning that the models that use accounting variables can cause the problem of
variable endogeneity, which requires specific treatment. In linear panel data models, the
endogeneity of the regressors can be controlled using the generalized moments method
(GMM) technique. However, controlling the endogeneity of the regressors in non-linear
panel data models, especially in multinomial logit and probity cases, is something that is still
being developed and is not yet available in the literature. For this reason, this problem was
not considered in this article, representing a technical-scientific limitation to be addressed at
some point the future.

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For future studies, we propose an in-depth analysis of other measures of manager
remuneration incentives, such as share bonuses, and their effect on the probability of
corporate fraud occurring. We also suggest replicating this study for other activity sectors,
such as non-financial publicly-traded companies.

The frauds might be principally because of absence of sufficient supervision of best

administration, broken motivating force component set up for workers, intrigue between the
staff, corporate borrowers and outsider offices, frail administrative framework, absence of
suitable instruments and advances set up to identify early cautioning signs of a fake, absence
of attention to bank representatives and clients; and absence of coordination among various
banks crosswise over India and abroad. The brains of officers can't be perused amid the
season of enlistment. Mentality of some private and some open division bank representatives
should be to deliberately cheat the association. What the associations can do is to build up
and recheck frameworks which should raise the auspicious alarm on deviations. Web based
managing an account is the new pattern and it is digging in for the long haul. Banks must
understand that the clients who utilize web based keeping money administrations is a capable
gathering fit for propelling searing assaults utilizing the web-based social networking, which
can hopelessly discolour the notoriety of banks. Banks would need to continually screen the
typology of the fake exercises in such exchanges and routinely survey and refresh the current
security highlights to avoid simple control by programmers, skimmers, phishes, and so forth.
Banks have generally made arrangements for versatility against physical assaults and
catastrophic events; digital flexibility can be dealt with similarly. Banks ought to consider
their general digital flexibility capacities over a few measurements.

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 Recommendation:

5 Tips to Reduce Banking Fraud

• Multi-Factor Authentication. The best approach is to start with a multi-factor

authentication/multi-layered security structure. ...
• Banks: Monitor Transactions. ...
• Businesses: Reconcile Corporate Accounts Daily. ...
• Employ Dual, Triple Controls. ...
• Raise Fraud Awareness.

1. Multi-Factor Authentication
The best approach is to start with a multi-factor authentication/multi-layered security
structure. This is what Romeo is seeing from the institutions that are successfully thwarting
fraud. "Remember, there is no one silver bullet that will solve this problem, so if you put all
your hope in a single solution, you'll get compromised, and the intruder will have
everything."

This multi-layered approach from a software perspective, combined with old-fashioned out-
of-band phone calls to the customer to confirm a questionable transaction, can cut the
institution's headaches and the business' fraud losses.

In the old days, Romeo says, calendars were put in place for all set transactions for all
accounts, whether they were large corporates or small businesses. "If they had a weekly
payroll, that only went out once a week, and then all of a sudden we saw something going out
every day -- that would be a red flag; we would question it," he says.

2. Banks: Monitor Transactions

In his days in bank operations, Romeo says, the bank used to set up daily limits on each user.
"We used to set these limits on our mainframe processor in the bank, along with file limits
and batch limits, so if there were something added, or out of the ordinary, we would spot it."
Another thing to watch for is a whole lot of activity right under $9,000. "Because the
fraudsters know they won't draw suspicion of a bank if they fly under $10,000 mark."

3. Businesses: Reconcile Corporate Accounts Daily

For businesses, Romeo recommends reconcilement of banking accounts and transactions on a
daily basis -- either at end of day or at least at the beginning. "This will help catch any
transactions you didn't make, and the sooner you bring it to your bank's attention, the better
chance to retrieve the money, with the bank doing a recall or reversal of the transaction. The
longer you wait, the less likely it is that you'll see that money recovered."

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4. Employ Dual, Triple Controls
Dual controls at the corporate side are, at the very least, tables take. Romeo suggests even
triple controls, where one person creates the transaction, a second person approves it, and
then a third person actually sends the transaction.

"If you don't have the people, then set up the ACH transactions with the institution, an out of
band confirmation, whether it is a phone call to confirm that you've sent it, and confirmation
of the correct information was received," he notes. This can be done live or through an
automated voice response system. Usually, only one person would have the password and ID
to call the bank, which would be totally separate from the person's computer.

5. Raise Fraud Awareness

Finally, Romeo says, continuous education of business customers is important. At the
national level, this problem of corporate account takeover has gotten real attention. But real
solutions won't come until financial institutions and their corporate accounts alike realize the
real risks they face - and simple solutions they can implement to help mitigate those risks.

With over 11 million identity fraud victims in the United States annually, anyone with a bank
account must take the proper precautions. Fortunately, guarding yourself from fraudsters
requires a minimal time investment and a little common sense. Here are 20 easy ways to
secure your bank accounts and avoid identity theft.

Check your account activity regularly. This may be the single most effective strategy you
can employ to secure your finances. Balancing a check book is advised, though the technique
is becoming outdated with the advent of online banking. At the very least, you should log in
and view your account activity multiple times every week to make sure there are no
unexpected transactions. Report any discrepancies to your financial institution immediately.

Keep your PIN and passwords secret. These are the keys to your money. Guard them with
vigilance. Do not give them out to anyone, and never write them down on paper, in an email
or in a text message. These can all be easily intercepted.

Use a strong password for online banking. Do not use your birthday, your spouse’s name,
your kid’s name, your social security number, your address or anything so painfully obvious.
Always use a capital letter or two along with a few numbers. An example of a bad password
would be “Sarah”. An example of a good password would be “12MarinersRevenge56.” And
please, never set the word “password” as your password.

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Change passwords periodically. Get a new password every few months or so. That way, if
you’ve had to give someone else your password or for some reason made a physical record of
it, you will reset your chances of being hacked.

Do not give out account info over the phone. Your bank will not call requesting your
account numbers, PINs or passwords. They already have this information. You should be
automatically suspicious of unexpected calls. If you have any doubts about the caller, hang up
and call your bank directly.

Do not give out account info through email. Again, your bank will not email you
requesting your account numbers, PINs or passwords. Never send this information through
email.

Don’t click links embedded in emails. It is easy for scammers to rig convincing emails. If
you get an email from your bank, don’t click on the links. They could lead you anywhere.
Instead, type in the bank’s web address in your browser and navigate from there.

Use anti-virus protection software, firewalls and spyware blockers. By acquiring these
basic computer protection tools, you significantly reduce your vulnerability to cyber-attacks
and fraud attempts. Make sure to also keep your computer updated with the most recent
security patches.

Don’t use public computers for online banking. This is never a good idea. Even if you’re
careful to make sure no one sees your screen and you remember to log out completely, an
expert scam artist can find ways to record your activity. You should also avoid conducting
transactions using public Wi-Fi.

Check for secure connections. When visiting your bank’s website or conducting an online
transaction, check your browser to verify a secure connection. If the web address starts with
“https,” you should have a secure connection.

Report lost cards immediately. Act fast and prevent fraud before it can happen. Don’t
procrastinate. As soon as you realize your card is missing, call the bank and have them send
you a new one.

Be aware of your surroundings at ATMs. Keep an eye on the people around you. Make
sure no one is standing too close. Use the curved mirror to watch activity behind. It is

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absolutely imperative you keep your PIN secret and close your transaction completely before
walking away from the machine. If there is anything at all suspicious, quit your transaction
and walk away immediately.

Watch out for skimmers. Skimmers are interesting little devices that can be placed over
ATM card slots in order to steal your account information. They can be installed and
uninstalled in a matter of seconds. If the card slot looks peculiar, don’t use it.

Take your receipt. At the ATM, wait for your receipt to print and take it with you. Do not
toss it in a trashcan. The information could be used to access your accounts.

Shred documents and old checks. Anything with account information should be destroyed
beyond recognition. You don’t want sensitive documents to end up in the wrong dumpster.

Minimize check writing. Checks display a lot of personal information, including your phone
number, address, bank, account number and signature. Whenever possible, use a card or pay
in cash.

Write checks in permanent blue ink. This makes it more difficult for fraudsters to alter the
written information.

Do not leave blank space on your check. You don’t want to give anyone the opportunity to
tack another zero on the end.

Make sure checks can’t be seen through envelopes. This is an invitation for fraud. Use
security envelopes or place your check between sheets of heavy paper.

Use secure mailboxes only. When mailing checks, the mailbox at the end of your driveway
can hardly be considered safe. Anyone can come along and snatch your outgoing mail in a
matter of seconds. If you’re sending money through the Postal Service, use a secure box or
take it to the office directly.

Case study: Using anomaly detection for check kiting

Check kiting is where a scammer takes advantage of the float to withdraw non-existent funds
in a bank account. There are a number of possible indicators for kiting including a large
number of check deposits, accounts with large proportion of uncleared cash by the paying
bank and deposits through multiple bank branches.

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It is a multi-million-dollar problem that can be difficult to detect especially with accounts
with normal check writing and depositing activities. However, financial institutions of any
size can use their data and anomaly-detection models to find transactions that may be
indicative of check kiting.

The first step is to create the “ground truth”. This is where we create a baseline, or the model
that establishes what is expected, or normal behaviour for an institution’s client base.

To create the ground truth, the system takes in all the supporting transactions and starts
grouping them by characteristics. Any anomalies are isolated for review – are they “normal”,
are these cases of “Not Sufficient Funds (NSF)” or are they “suspicious or provide
indications of fraud”?

The process does take several iterations but once you have identified the valid and NSF
transactions, the system can quickly help fraud departments identify the transactions that are
potential cases of check kiting.

Strategies
Technology is only part of the solution for reducing bank fraud. Evolving policies and
procedures have to be in place to reduce the risk. Here are some strategies to address some of
the various types of fraud.

Preventing bust out fraud

• Implement a five business day clearing period
• Identify check payments versus electronic payments and frequency of deposits by
customers
Preventing account takeover fraud
• Alert when there is an account level change (authorized user, address, phone number,
card request)
• Alert when there are changes in spending pattern
Preventing identity fraud
• Verify identification
• Screen new customers against sanctions lists
• Review consumer alerts
• Review discrepancies between information from bureau and application

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 • Validate KYC (know your customer) information
• Call to verify employer
Preventing lost/stolen fraud
• Detect spending pattern changes (low to high volume)
• Look at small monetary value transactions that could be indication of credit card
testing
• Look for aggressive transactions at unattended merchants (gas stations, or Pay Pass)
Preventing internal fraud
• Prohibit emails from being sent outside the bank with card or customer information
• Review activities of top performers to look for irregular practices
• Follow-up with inconsistencies in employee resumes
Preventing bank fraud is deliberate activity that requires continuous update of technology,
policies and procedures. On the technology side, AI-based models are no longer something
just for tier 1 institutions and allow smaller organizations to enhance their existing rules-
based internal controls and identify previously undetected and evolving fraud schemes.

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