Assignment 2 Dealing with frauds in banking industry

Fraud is any dishonest act and behaviour by which one person gains or intends to gain
advantage over another person. Fraud causes loss to the victim directly or indirectly. Fraud has
not been described or discussed clearly in The Indian Penal Code but sections dealing with
cheating. concealment, forgery counterfeiting and breach of trust has been discusses which
leads to the act of fraud.

In Contractual term as described in the Indian Contract Act, Sec 17 suggests that a fraud means
and includes any of the acts by a party to a contract or with his connivance or by his agents with
the intention to deceive another party or his agent or to induce him to enter in to a contract.

Banking Frauds constitute a considerable percentage of white-collar offences being probed by

the police. Unlike ordinary thefts and robberies, 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.

Classification

In order to have uniformity in reporting, frauds have been classified as under, based mainly on the
provisions of the Indian Penal Code:

a. Misappropriation and criminal breach of trust.

b. Fraudulent encashment through forged instruments, manipulation of books of account or through
fictitious accounts and conversion of property.
c. Unauthorised credit facilities extended for reward or for illegal gratification.
d. Negligence and cash shortages.
e. Cheating and forgery.
f. Irregularities in foreign exchange transactions.
g. Any other type of fraud not coming under the specific heads as above.

Bank frauds and rise in last decade:

1. 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.
 2. 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.
3. 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.
4. 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.
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.
Need of governance reforms and other 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 zerofraud
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 loopholes, 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 to time.
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.
https://www.legalserviceindia.com/article/l261-Bank-Frauds.html

https://pib.gov.in/newsite/PrintRelease.aspx?relid=186411

https://m.rbi.org.in/commonperson/English/Scripts/Notification.aspx?Id=578

https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10477

https://blog.forumias.com/answered-what-are-various-reasons-for-the-rise-in-cases-of-bank-frauds-in-
last-decade-in-india-also-discuss-the-need-of-bringing-reforms-in-banking-governance-and-impact-of-
such-frauds/

https://rbidocs.rbi.org.in/rdocs/Notification/PDFs/100MNF4F1E72176524C698EE963510D79FBAE.PDF

PNB is India's second-biggest state-run lender. The scam stunned the financial sector of
the country after a fraud worth Rs 11, 400 crore was unearthed at a single branch in
Mumbai.
The bank discovered that at least 2 of its employees - deputy manager Gokulnath Shetty
and clerk Manoj Kharat - from its Brady House branch in Mumbai repeatedly issued
Letters of Undertaking (LoU) to Nirav Modi's companies without following the
processes. According to the bank, the employees issued the LoUs without securing
cash reserve or collateral and without recording the transactions in the bank's core
banking software.
An LoU is a guarantee by the issuing bank to the receiving bank and the companies that
it would undertake to pay a certain amount of money on a specific date.
Nirav and his companies allegedly leveraged those LoUs in Hong Kong to secure buyers'
credit from the local branches of Allahabad Bank, Union Bank, Axis Bank, Bank of India,
State Bank of India. These suspect bank officials issued the LoUs and informed these
branches via the international cash transfer service called SWIFT (Society for Worldwide
Interbank Financial Telecommunication). The service connects all international banks
worldwide.
The suspect bank officials knew that PNB had not integrated its SWIFT network with the
bank's core banking network. They chose not to record these transactions in the bank's
own system.
The fraud was unravelled when the officials from three diamond firms approached the
PNB officials for a bank credit to import rough stones from overseas. When the three
firms approached PNB in January 2018 for bank credit via a Letter of Undertaking, the
official concerned in the bank sought a 100 percent cash margin since there was no pre-
sanctioned limit for these firms.
The diamond firms contested the bank's demand and claimed that they have been
availing this facility in the past also. However, the branch records did not reveal details
of any such facility having been granted to the said firms. This raised an alarm, forcing
the bank to launch an internal investigation in the previous bank credits.
The internal probe revealed that two officials of the bank had in the past fraudulently
issued LoU to the said firms without following due process. These fraudulent LoUs were
then transmitted across the SWIFT messaging system, based on which credit was
offered to the said firms.