Prevention of Frauds – Internal Checks and Controls
All institutions/organisations which as part of their normal activities, engage themselves in financial transactions, run the risk of being put to loss sometime or other through frauds perpetrated on them. The probability of being defrauded is more in the case of banks as the transactions which they handle involve monetary and financial dealings. Further, they are liable to be defrauded not only by their own employees and constituents but also by third parties. At times persons in two or even all the three of the aforesaid categories collude in perpetration of frauds. Hence the procedure and systems to prevent/expose frauds need adherence at all times and deserve attention and review on a priority and continuous basis.
2. WHAT IS FRAUD?
Frauds, as they are popularly understood, are acts of criminal deception resorted to by persons singly or in collusion with others with a view to deriving gains to which they are not legally entitled.
3. FRAUDS ON BANKS
In the case of banks, frauds are generally those wherein they are put to loss through –
4. AREAS OF FRAUD
There is no area of the banks working which does not provide scope for perpetration of frauds. There are, however, some areas which are more prone to frauds etc. which are discussed below :
Besides the frauds arising out of actual shortage of cash, there could be cases wherein the shortage is attempted to be concealed through a bogus instrument/voucher being kept alongwith the cash to indicate that the amount mentioned therein has been paid out of the cash late after the cash balance was struck. Such an instrument is likely to be a cheque, drawn by a party which may not have sufficient balance in his account, but it could as well be a forged/unauthorisedly issued fixed deposit receipt, demand draft or pay order. As regards a debit voucher, it is more likely to represent cash purported to have been debited to another branch but it may as well purport to represent some other payment which may not be a genuine one. To present frauds in this area, good internal control systems should be followed like joint custody and dual responsibility, prompt reporting of currency chest transactions to RBI, exercising due care while issuing / making payment of high value drafts, deposit of large amounts in to newly opened accounts, checking for benami accounts, following KYC norms while opening new accounts as well as monitoring the existing accounts, etc. The RBI has issued detailed guidelines on KYC norms which have to be followed scrupulously by the banks. Moreover the Prevention of Money Laundering Act, 2002 which has come into force casts upon banks the obligation to report cash transactions above a threshold limit as well as suspicious transactions to the Financial Intelligence Unit- India, New Delhi.
These advances are granted by way of either hypothecation or pledge of goods. If due precautions and adequate counter checks are not observed, banks are liable to be easily defrauded by the parties availing of such advances. However, since in the case of advances by way of hypothecation, the goods remain under the custody of the borrowers and the bank to a large extent relies on the declaration of the borrowers, the risk of fraud is more in such advances. Some of the more common devices adopted by the borrowers for defrauding the banks are –
Failure on the part of the top management to establish the sound lending policy and / or to effectively monitor the implementation of its policy / procedures has resulted in several frauds. Some of the reasons for frauds in this area are – unwarranted distribution of credit, behest lending (lending at the instance of top management / Directors of banks), unsound credit appraisal, complacency and lack of supervision, technical incompetence, poor selection of risks, etc.
The frauds under this category of advances arise out of over valuation of the security or the title of the borrower thereto being defective or the security having been already charged to another institution by way of equitable mortgage at times the borrowers deposit with the banks copies of title deeds instead of originals with malafied intention of defrauding the bank.
Facilities for purchase/discount of clean bills provide fertile ground for parties to defraud banks when they are in financial difficulties. They draw bills not backed by trade transactions which are eventually not honoured by the drawees. Very often, the drawees of such bills are allied/associate concerns of the drawers. At times, two or more parties avail of bank finance against such accommodation bills, drawn on each other. As long as all the bills continue to be honoured the banks are misled about the credit worthiness of the parties. Further, when one bill in a chain is dishonoured, the entire chain breaks down resulting in a loss to the bank/banks concerned. Some parties utilize the cheque purchase facility for raising finance in a similarly dubious manner by maintaining accounts with two or more banks for this purpose and taking advantage of the facility allowed by the banks of drawing against uncleared cheques. Such transactions are called kite flying in banking parlance.
i) Deposit Accounts
Frauds are more common in current and saving bank accounts. Frauds take place in both payment and collection of cheques and other instruments. The inoperative accounts also provide opportunity for perpetration of frauds. The modus operandi generally followed are discussed below:
C) Other Areas of Fraud:
C.1 Frauds in a computerized environment
The need for a computerized environment can hardly be questioned in the modern day world. With increasing competition, banks need to invest in information technology to survive and grow. At the same time they have to take necessary safeguards to avoid the over increasing incidence of frauds in this area. The following areas need special focus:
C.2 Frauds in Foreign Exchange Transactions (FOREX)
Most UCBs are not doing FOREX business as a part of their banking operations. However, recently the RBI has permitted UCBs to do FOREX business by obtaining AD category I / II licences based on eligibility criteria laid down. The frauds in the dealing room operations are due to the following reasons:
5. GENERAL SAFEGUARDS/PRECAUTIONS
Frauds can not be prevented merely by laying down well conceived and well defined procedural instructions. What is more important is the strict adherence to the implementation of such instructions at the various levels. The need for the banks to be on their guard all the time and to make available suitable machinery for ensuring proper checks and counter checks at various stages need hardly be emphasized. Some general precautions which may help early detection of frauds are listed below:
6. Reporting of frauds by the UCBs to RBI
6.1 Frauds less than Rs.1 lakh – They need not be reported individually to RBI. However, the data regarding them should be submitted in the quarterly report on frauds outstanding to the RO of UBD of the RBI under whose jurisdiction the Head Office of the banks falls.
6.2 Frauds of Rs.1 lakh and more but less than Rs.25 lakh – The cases of individual frauds should be reported to the concerned RO of UBD of RBI within three weeks from the date of detection
6.3 Frauds involving Rs.25 lakhs and above – Individual cases should be reported to the Fraud Monitoring Cell, DBS, CO, RBI, Mumbai within three weeks from the date of detection. Additionally, banks may report the fraud by means of a DO letter addressed to the CGM-in-Charge, DBS, CO, RBI within a week of the fraud coming to notice of the banks head office, with a copy endorsed to RO, UBD, RBI. The letter should contain particular such as amount involved, nature of fraud, modus operandi, names of parties / officials involved, complaint lodged with the police etc.
6.4 Quarterly progress reports on frauds of Rs.1 lakh and above are required to be submitted to the RO, UBD, RBI.
6.5 Reports to Board of Directors (BoD) – Bank should report all frauds of Rs.1 lakh and above to the BoD promptly on their detection, quarterly review of frauds (March, June and September) and annual review of frauds for the year ended December which may be reported by the end of March of the following year. The review should cover whether frauds have occurred due to laxity in following the systems.
7. Case Exercises
Please indicate the shortcomings in the system of internal checks and procedures that had facilitated the commission of frauds in the following cases:
1. Demand Draft
Two demand drafts for Rs.25/- each were issued by a bank which were presented for payment by changing the names / date / amounts to Rs.14,500/- and Rs.13,500- respectively. The drafts were presented and paid.
List out deficiencies.
A cheque for Rs.2,500/- was deposited in the S.B. Account of the customer and the drawal for full amount was allowed. A fictitious S.B. Account was opened in the name of the same customer and the paid cheque was removed from the voucher and deposited again to the newly opened bogus account and drawal was allowed. In another case a cheque for Rs.2,600/- was deposited and the drawal for full amount was allowed. Subsequently, the paid cheque was removed from the voucher and by changing the date of the cheque it was again deposited in the same account and drawal was allowed second time also on the same cheque.
List out deficiencies.
CAB H No.1165 Prepared by Shri S L Gaur and updated by Smt. Uma Sankar
Prevention of Frauds , By: Uma Sankar