Bank Frauds in Bharat- Issues and Challenges

According to statistics given in the RTI query filed by economist Prasenjit Bose, total value of bank frauds where the amount involved was more than Rs. 1 Lakh in each case, has increased from Rs 1,542.8 crore in 2008-09 to Rs 22,469.6 crore in 2017-18. In seven out of these ten years, nationalised banks have accounted for more than two-third of the total amount involved in these frauds. While around 65% of the number of fraud cases were technology related frauds, major portion of the amount of frauds (64%) were advances related frauds.

The average amount involved in advances (loan) related fraud, in those cases where amount involved was more than Rs 1 lakh, which was at Rs 75 lakh in 2008-09 increased to Rs. 9 Crores in 2017-18.  During the period FY 2014-FY 2018, the number of fraud cases has been consistent at an average of 12 a day but the cumulative amount of frauds has gone up to  Rs 1,00,718 Crore. During this period the number of fraud cases grew up at an average of 4.6 percent whereas the amount of fraud has increased by 16.4 percent. The amount of fraud has sharply increased in FY 2017 and FY 2018 at 18 percent and 19 percent respectively.

In terms of the relative share of frauds, public sector banks have a disproportionate share of over 85 per cent, significantly exceeding their relative business share of about 65 to 75 per cent,” said the RBI in its Financial Stability Report of June 2018.

Coordination issues in implementing the ‘three lines of defence architecture’, which consists of frontline line management, an independent risk management, and an independent review leading to increase in the number and size of frauds in PSBs. RBI identifies weakness in internal controls and audits, risk management framework, and governance mechanism in PSBs as important grey areas for this phenomenon of increasing frauds and NPAs.

Lack of uniformity in internal control and risk management systems of banks is also a matter of concern and each bank follows its own policy since RBI has only laid down the broad guidelines but left it to the discretion of the banks to evolve their own internal policy guidelines with regard to these two important areas.

Frauds happen due to two reasons- (i) opportunity and (ii) intention.

Technology and systems can prevent the opportunity to commit frauds. However, they cannot eliminate the intention of the culprits to commit frauds. Big data and predictive analysis can be important tools in giving signals to alert the banks with regard to potential frauds. Analytics can predict the behavioral patterns of Vijay Mallyas (King Fisher) but it may not predict Rajat Guptas (Mckinsey) and Ramalinga Rajus (Satyam Computers). Technology and big data can bridge the information asymmetry but cannot detect information that is not visible or hidden from the public domain. Behavioral Finance is gaining importance in banking of late.

When it comes to financial matters people can be broadly classified into the following categories –

(A) Be honest, come what may,

(B) Pretend to be honest but if an opportunity comes take advantage,

(C) Basically honest but circumstances drive them to violate the rules or laws and commit frauds/ crimes, and

(D) Do mischief, come what may

For the people falling in the category of A and D, systems and controls do not matter since they continue to be honest or attempt mischief respectively unmindful of the systems and controls that are in place or not.

Category B people always look for gaps or lacunae in systems in order to take advantage out of it and commit frauds. Therefore, effective systems and controls can avert the threats from this Category B people.

Policy makers need to address the social challenges that go behind the circumstances which drive Category C people to violate the rules or laws and commit frauds/ crimes in order to find a long term solution to this problem, though they deserve to be punished as per the rule of the law for such violations.

Category D people are determined to commit fraud and for them even effective systems and control do not matter. Given the sad state of affairs in Bharat’s judicial system where disposal of the cases takes several decades Category D people thrive on this weak link. Therefore, timely punitive action without inordinate delay is the only option available to address this menace.

Trends in the bank frauds in the recent past reveal there is a scope for a nexus between few borrowers with political connections and some bank staff who are in vulnerable positions and succumb to influence (particularly in PSBs) apart from questionable inaction that tantamount to tacit support from some of the regulating and investigating agencies.

The Benami Transactions (Prohibition) Amendment Act, 2016 which is an amendment of the older Benami Transactions (Prohibition) Act 1988 and amendment to the Prevention of Money Laundering Act and Foreign Exchange Management Act in 2015, that now include a major clause whereby the government can seize and confiscate equivalent asset in Bharat where the asset located abroad cannot be forfeited are two major steps that will partly address the issue of diversion of funds through bank frauds. There is a need to have a mechanism in place to automatically ban the willful defaulters from travelling abroad, contesting the elections or disqualify them if they are elected representatives in addition to speedy disposal of such cases to initiate swift punitive action.

Yet another area that is also a matter of concern is the role of independent professional agencies who prepare DPRs (Detailed Project Reports) for large corporate loans. Banks rely excessively on the reports of these agencies while doing credit/ project appraisal but these agencies do not have any accountability where the project is found to be of dubious nature ab initio and culminates into fraud. There is a need to evolve a regulatory mechanism to rein these professional agencies to bring accountability and responsibility in order to maintain credibility of these agencies.

CIBIL (Credit Information Bureau of India Limited) data base only gives historical view of the credit profile of the bank clients but does not give any tools to predict the future financial behavior patterns of the people where there is either inadequate historical data or total lack of the same. In this regard social credibility rating tools can be more useful to give better insights. Social profiling of customers and employees can be done with the help of agencies who track the people’s social profiles. This is an emerging area and there is a need to strengthen this segment through legislative measures since it also involves the right of privacy of the people.

There is also a need to have a centralised agency (like- CIBIL) that captures the total banking/financial transactions of the customers across the banks and FIs to do predictive analysis and also fore warn the banks/lenders when potential financial threats are noticed.

Block chain technology can be an important tool in plugging the loopholes in operational risk and improve the internal control systems in the banks. Block chain is a chain of records, called blocks, which are linked and secured using cryptography. Each block typically contains a cryptographic hash pointer as a link to a previous block, a time stamp and transaction data. By design, block chains are inherently resistant to modification of the data. A block chain is typically managed by a peer to peer network collectively adhering to a protocol for validating new blocks. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks, which requires collusion of the network majority.

Last but not the least, proper due diligence on the bank employees at the time of recruitment is also of paramount importance. Banks need to evolve internal guidelines to address this challenge.

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About the Author

B.N.V. Parthasarathi
Ex Senior Banker, Management and Financial Consultant, Visiting faculty at premier B Schools and Universities. E mail- [email protected]