Banking System Frauds and Legal Control

Banking System Frauds And Legal Control

Banking System

What is banking?

While walking on the streets of any town or city you

might have seen some signboard on buildings with names –

Canara bank, Punjab national bank, State bank of India,

Commercial bank, etc. what do these names stand for?

Did you ever try to know about them? If you ever enter such

building you will find some kind of a business office. You will

see some employees sitting behind counters dealing with

visitors standing in front of them you will find that some are

depositing money at one counter while some are receiving

money at other counter behind the counters of office you will

see tables and chairs occupied by officers. On one side of the

office you will also see a chamber (small partitioned room)

where the manager is sitting with papers on his tables this is

office of a ‘bank’.

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DEFINATION OF BANKING

‘Banking is defined in the Banking Regulation Act as “the activity of acceptance of deposits of money from the public repayable on demand or otherwise for the purpose of lending or for investment’.

TYPES OF BANKS

EVOLUTION OF BANKING SYSTEM IN INDIA

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Commercial banks1. Public sector banks2. Private sector banks3. Foreign banks

Development Bank

Co-operative banks 1. Primary credit societies 2. Central co-operative bank3. Sate co-operative banks

Specialised banks(EXIM Bank, SIDBI, NABARD)

Central bank(RBI, In India


Banking system occupies an important place in a nation's

economy. A banking institution is essential in a modern

society. It plays a pivotal role in economic development of a

country and forms the core of the money market in an

advanced country.

Banking industry in India has traversed a long way to

assume its present status. It has undergone a major

structural transformation after the nationalization of 14

major commercial banks in 1969 and 6 more on 15 April

1980. The Indian banking system is unique and perhaps has

no parallels in the banking history of any country in the

world.

Investment in India - Banking System

The central bank of the country is the Reserve Bank of India

(RBI). It was established in April 1935 with a share capital of

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Rs. 5 crores on the basis of the recommendations of the

Hilton Young Commission. The share capital was divided into

shares of Rs. 100 each fully paid which was entirely owned

by private shareholders in the begining. The Government

held shares of nominal value of Rs. 2, 20,000.

Reserve Bank of India was nationalized in the year 1949. The

general superintendence and direction of the Bank is

entrusted to Central Board of Directors of 20 members, the

Governor and four Deputy Governors, one Government

official from the Ministry of Finance, ten nominated Directors

by the Government to give representation to important

elements in the economic life of the country, and four

nominated Directors by the Central Government to represent

the four local Boards with the headquarters at Mumbai,

Kolkata, Chennai and New Delhi. Local Boards consist of five

members each Central Government appointed for a term of

four years to represent territorial and economic interests and

the interests of co-operative and indigenous banks

The Reserve Bank of India Act, 1934 was commenced on

April 1, 1935. The Act, 1934 (II of 1934) provides the

statutory basis of the functioning of the Bank.

The Bank was constituted for the need of following:

To regulate the issue of banknotes To maintain reserves with a view to securing monetary

stability and To operate the credit and currency system of the

country to its advantage.

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Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the

important functions of a central bank the Reserve Bank of

India.

Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank

has the sole right to issue bank notes of all denominations.

The distribution of one rupee notes and coins and small

coins all over the country is undertaken by the Reserve Bank

as agent of the Government. The Reserve Bank has a

separate Issue Department which is entrusted with the issue

of currency notes. The assets and liabilities of the Issue

Department are kept separate from those of the Banking

Department. Originally, the assets of the Issue Department

were to consist of not less than two-fifths of gold coin, gold

bullion or sterling securities provided the amount of gold was

not less than Rs. 40 crores in value. The remaining three-

fifths of the assets might be held in rupee coins, Government

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of India rupee securities, eligible bills of exchange and

promissory notes payable in India. Due to the

Exigencies of the Second World War and the post-was

period, these provisions were considerably modified. Since

1957, the Reserve Bank of India is required to maintain gold

and foreign exchange reserves of Rs. 200 crores, of which at

least Rs. 115 crores should be in gold. The system as it

exists today is known as the minimum reserve system.

Banker to Government

The second important function of the Reserve Bank of India

is to act as Government banker, agent and adviser. The

Reserve Bank is agent of Central Government and of all

State Governments in India excepting that of Jammu and

Kashmir. The Reserve Bank has the obligation to transact

Government business, via. To keep the cash balances as

deposits free of interest, to receive and to make payments

on behalf of the Government and to carry out their exchange

remittances and other banking operations. The Reserve Bank

of India helps the Government - both the Union and the

States to float new loans and to manage public debt. The

Bank makes ways and means advances to the Governments

for 90 days. It makes loans and advances to the States and

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local authorities. It acts as adviser to the Government on all

monetary and banking matters.

Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank.

According to the provisions of the Banking Companies Act of

1949, every scheduled bank was required to maintain with

the Reserve Bank a cash balance equivalent to 5% of its

demand liabilities and 2 per cent of its time liabilities in

India. By an amendment of 1962, the distinction between

demand and time liabilities was abolished and banks have

been asked to keep cash reserves equal to 3 per cent of

their aggregate deposit liabilities. The minimum cash

requirements can be changed by the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of

India on the basis of eligible securities or get financial

accommodation in times of need or stringency by

rediscounting bills of exchange. Since commercial banks can

always expect the Reserve Bank of India to come to their

help in times of banking crisis the Reserve Bank becomes

not only the banker's bank but also the lender of the last

resort.

Controller of Credit

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The Reserve Bank of India is the controller of credit i.e. it has

the power to influence the volume of credit created by banks

in India. It can do so through changing the Bank rate or

through open market operations. According to the Banking

Regulation Act of 1949, the Reserve Bank of India can ask

any particular bank or the whole banking system not to lend

to particular groups or persons on the basis of certain types

of securities. Since 1956, selective controls of credit are

increasingly being used by the Reserve Bank.

The Reserve Bank of India is armed with many more powers

to control the Indian money market. Every bank has to get a

license from the Reserve Bank of India to do banking

business within India, the license can be cancelled by the

Reserve Bank of certain stipulated conditions are not

fulfilled. Every bank will have to get the permission of the

Reserve Bank before it can open a new branch. Each

scheduled bank must send a weekly return to the Reserve

Bank showing, in detail, its assets and liabilities. This power

of the Bank to call for information is also intended to give it

effective control of the credit system. The Reserve Bank has

also the power to inspect the accounts of any commercial

bank.

As supreme banking authority in the country, the Reserve

Bank of India, therefore, has the following powers:

(a) It holds the cash reserves of all the scheduled banks.

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(b) It controls the credit operations of banks through

quantitative and qualitative controls.

(c) It controls the banking system through the system of

licensing, inspection and calling for information.

(d) It acts as the lender of the last resort by providing

rediscount facilities to scheduled banks.

Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain

the official rate of exchange. According to the Reserve Bank

of India Act of 1934, the Bank was required to buy and sell at

fixed rates any amount of sterling in lots of not less than Rs.

10,000. The rate of exchange fixed was Re. 1 = sh. 6d. Since

1935 the Bank was able to maintain the exchange rate fixed

at lsh.6d. Though there were periods of extreme pressure in

favor of or against

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The rupee. After India became a member of the International

Monetary Fund in 1946, the Reserve Bank has the

responsibility of maintaining fixed exchange rates with all

other member countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the

Reserve Bank has to act as the custodian of India's reserve

of international currencies. The vast sterling balances were

acquired and managed by the Bank. Further, the RBI has the

responsibility of administering the exchange controls of the

country.

RESERVE BANK OF INDIA

Supervisory functions

In addition to its traditional central banking functions, the

Reserve bank has certain non-monetary functions of the

nature of supervision of banks and promotion of sound

banking in India. The Reserve Bank Act, 1934, and the

Banking Regulation Act, 1949 have given the RBI wide

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powers of supervision and control over commercial and co-

operative banks, relating to licensing and establishments,

branch expansion, liquidity of their assets, management and

methods of working, amalgamation, reconstruction, and

liquidation. The RBI is authorised to carry out periodical

inspections of the banks and to call for returns and

necessary information from them. The nationalization of 14

major Indian scheduled banks in July 1969 has imposed new

responsibilities on the RBI for directing the growth of banking

and credit policies towards more rapid development of the

economy and realization of certain desired social objectives.

The supervisory functions of the RBI have helped a great

deal in improving the standard of banking in India to develop

on sound lines.

RESERVE BANK OF INDIA

Promotional functions

With economic growth assuming a new urgency since

Independence, the range of the Reserve Bank's functions

has steadily widened. The Bank now performs a variety of

developmental and promotional functions, which, at one

time, were regarded as outside the normal scope of central

banking. The Reserve Bank was asked to promote banking

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habit, extend banking facilities to rural and semi-urban

areas, and establish and promote new specialized financing

agencies. Accordingly, the Reserve Bank has helped in the

setting up of the IFCI and the SFC; it set up the Deposit

Insurance Corporation in 1962, the Unit Trust of India in

1964, the Industrial Development Bank of India also in 1964,

the Agricultural Refinance Corporation of India in 1963 and

the Industrial Reconstruction Corporation of India in 1972.

These institutions were set up directly or indirectly by the

Reserve Bank to promote saving habit and to mobilize

savings, and to provide industrial finance as well as

agricultural finance. As far back as 1935, the Reserve Bank

of India set up the Agricultural Credit Department to provide

agricultural credit. But only since 1951 the Bank's role in this

field has become extremely important. The Bank has

developed the co-operative credit movement to encourage

saving, to eliminate moneylenders from the villages and to

route its short term credit to agriculture. The RBI has set up

the Agricultural Refinance and Development Corporation to

provide long-term finance to farmers.

Classification of RBIs functions

The monetary functions also known as the central banking

functions of the RBI are related to control and regulation of

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money and credit, i.e., issue of currency, control of bank

credit, control of foreign exchange operations, banker to the

Government and to the money market. Monetary functions

of the RBI are significant as they control and regulate the

volume of money and credit in the country.

Equally important, however, are the non-monetary functions

of the RBI in the context of India's economic backwardness.

The supervisory function of the RBI may be regarded as a

non-monetary function (though many consider this a

monetary function). The promotion of sound banking in India

is an important goal of the RBI, the RBI has been given wide

and drastic powers, under the Banking Regulation Act of

1949 - these powers relate to licensing of banks, branch

expansion, liquidity of their assets, management and

methods of working, inspection, amalgamation,

reconstruction and liquidation. Under the RBI's supervision

and inspection, the working of banks has greatly improved.

Commercial banks have developed into financially and

operationally sound and viable units. The RBI's powers of

supervision have now been extended to non-banking

financial intermediaries. Since independence, particularly

after its nationalization 1949, the RBI has followed the

promotional functions vigorously and has been responsible

for strong financial support to industrial and agricultural

development in the country.

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India has a financial system that is regulated by independent

regulators in the sectors of banking, insurance, capital

markets, competition and various services sectors. In a

number of sectors

Government plays the role of regulator.

Ministry of Finance, Government of India looks after financial

sector in India. Finance Ministry every year presents annual

budget on February 28 in the Parliament. The annual budget

proposes changes in taxes, changes in government policy in

almost all the sectors and budgetary and other allocations

for all the Ministries of Government of India. The annual

budget is passed by the Parliament after debate and takes

the shape of law.

Reserve bank of India (RBI) established in 1935 is the Central

bank. RBI is regulator for financial and banking system,

formulates monetary policy and prescribes exchange control

norms. The Banking Regulation Act, 1949 and the Reserve

Bank of India Act, 1934 authorize the RBI to regulate the

banking sector in India.

India has commercial banks, co-operative banks and regional

rural banks. The commercial banking sector comprises of

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public sector banks, private banks and foreign banks. The

public sector banks comprise the ‘State Bank of India’ and its

seven associate banks and nineteen other banks owned by

the government and account for almost three fourth of the

banking sector. The Government of India has majority shares

in these public sector banks.

India has a two-tier structure of financial institutions

with thirteen all India financial institutions and forty-six

institutions at the state level. All India financial institutions

comprise term-lending institutions, specialized institutions

and investment institutions, including in insurance. State

level institutions comprise of State Financial Institutions and

State Industrial Development Corporations providing project

finance, equipment leasing, corporate loans, short-term

loans and bill discounting facilities to corporate. Government

holds majority shares in these financial institutions.

Non-banking Financial Institutions provide loans and hire-

purchase finance, mostly for retail assets and are regulated

by RBI.

Insurance sector in India has been traditionally

dominated by state owned Life Insurance Corporation and

General Insurance Corporation and its four subsidiaries.

Government of India has now allowed FDI in insurance sector

up to 26%. Since then, a number of new joint venture private

companies have entered into life and general insurance

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sectors and their share in the insurance market in rising.

Insurance Development and Regulatory Authority (IRDA) is

the regulatory authority in the insurance sector under the

Insurance Development and Regulatory Authority Act, 1999.

RBI also regulates foreign exchange under the Foreign

Exchange Management Act (FERA). India has liberalized its

foreign exchange controls. Rupee is freely convertible on

current account. Rupee is also almost fully convertible on

capital account for non-residents. Profits earned, dividends

and proceeds out of the sale of investments are fully

repatriable for FDI. There are restrictions on capital account

for resident Indians for incomes earned in India.

Securities and Exchange Board of India (SEBI) established

under the Securities and Exchange aboard of India Act, 1992

is the regulatory authority for capital markets in India. India

has 23 recognized stock exchanges that operate under

government approved rules, bylaws and regulations. These

exchanges constitute an organized market for securities

issued by the central and state governments, public sector

companies and public limited companies. The Stock

Exchange, Mumbai and National Stock Exchange are the

premier stock exchanges. Under the process of de-

mutualization, these stock exchanges have been converted

into companies now, in which brokers only hold minority

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share holding. In addition to the SEBI Act, the Securities

Contracts (Regulation) Act, 1956 and the Companies Act,

1956 regulates the stock markets.

RESERVE BANK OF INDIA-ECONOMIC AND

SOCIAL OBJECTIVE

The Reserve Bank of India has an important role to

play in the maintenance of the exchange value of the

rupee in view of the close interdependence of

international trade and national economic growth

and well being. This aspect is of the wider

responsibly of the central bank for the maintenance

of economic and financial stability. For this the bank

is entrusted with the custody and the management

of country's international reserves; it acts also as the

agent of the government in respect of India's

membership of the international monetary fund. With

economic development the bank also performs a

variety of developmental and promotional functions

which in the past were registered being outside the

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normal purview of central banking. It also acts an

important regulator.

RECENT TRENDS OF BANKING SYSTEM IN INDIA

In the banking and financial sectors, the introduction of

electronic technology for transactions, settlement of

accounts, book-keeping and all other related functions is

now an imperative. Increasingly, whether we like it or not, all

banking transactions are going to be electronic. The thrust is

on commercially important centers, which account for 65

percent of banking business in terms of value. There are now

a large number of fully computerized branches across the

country.

A switchover from cash-based transactions to paper-based

transactions is being accelerated. Magnetic Ink character

recognition clearing of cheques is now operational in many

cities, beside the four metro cities. In India, the design,

management and regulation of electronically-based

payments system are becoming the focus of policy

deliberations. The imperatives of developing an effective,

efficient and speedy payment and settlement systems are

getting sharper with introduction of new instruments such as

credit cards, telebanking, ATMs, retail Electronic Funds

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Transfer (EFT) and Electronic Clearing Services (ECS). We are

moving towards smart cards, credit and financial Electronic

Data Interchange (EDI) for straight through processing.

Financial Fraud (Investigation, Prosecution, Recovery and

Restoration of property) Bill, 2001

Further the Financial Fraud (Investigation, Prosecution,

Recovery and Restoration of property) Bill, 2001 was

introduced in Parliament to curb the menace of Bank Fraud.

The Act was to prohibit, control, investigate financial frauds;

recover and restore properties subject to such fraud;

prosecute for causing financial fraud and matters connected

therewith or incidental thereto.

Under the said act the term Financial Fraud has been defined

as under: Section 512 - Financial Fraud Financial frauds

means and includes any of the following acts committed by a

person or with his connivance, or by his agent, in his

dealings with any bank or financial institution or any other

entity holding public funds;

1. The suggestion, as a fact, of that which is not true, by one

who does not believe it to be true;

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2. The active concealment of a fact by one having

knowledge or belief of the fact;

3. A promise made with out any intention of performing it;

4. Any other act fitted to deceive;

5. Any such act or omission as the law specially declares to

be fraudulent.

Provided that whoever acquires, possesses or transfers any

proceeds of financial fraud or enters into any transaction

which is related to proceeds of fraud either directly or

indirectly or conceals or aids in the concealment of the

proceeds of financial fraud, commits financial fraud.

513(a) - Punishment for Financial Fraud

Whoever commits financial fraud shall be:

(a) Punished with rigorous imprisonment for a term, which

may extend to seven years and shall also be liable to fine.

(b)Whoever commits serious financial fraud shall be

punished with rigorous imprisonment for a term which may

extend to ten years but shall not be less than five years and

shall also be liable for fine up to double the amount involved

in such fraud.

Provided that in both (a) and (b) all funds, bank accounts

and properties acquired using such funds subjected to the

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financial fraud as may reasonably be attributed by the

investigating agency shall be recovered and restored to the

rightful owner according to the procedure established by

law.

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Banking Fraud - Prevention and

Control

Banking Fraud is posing threat to Indian Economy. Its vibrant

effect can be understood be the fact that in the year 2004

number of Cyber Crime were 347 in India which rose to 481

in 2005 showing an increase of 38.5% while I.P.C. category

crime stood at 302 in 2005 including 186 cases of cyber

fraud and 68 cases cyber forgery. Thus it becomes very

important that occurrence of such frauds should be

minimized. More upsetting is the fact that such frauds are

entering in Banking Sector as well.

In the present day, Global Scenario Banking System has

acquired new dimensions. Banking did spread in India.

Today, the banking system has entered into competitive

markets in areas covering resource mobilization, human

resource development, customer services and credit

management as well.

Indian's banking system has several outstanding

achievements to its credit, the most striking of which is its

reach. In fact, Indian banks are now spread out into the

remotest areas of our country. Indian banking, which was

operating in a highly comfortable and protected environment

till the beginning of 1990s, has been pushed into the choppy

waters of intense competition.

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A sound banking system should possess three basic

characteristics to protect depositor's interest and public

faith. Theses are (i) a fraud free culture,

(ii) A time tested Best Practice Code, and

(iii) An in house immediate grievance remedial system.

All these conditions are their missing or extremely weak in

India. Section 5(b) of the Banking Regulation Act, 1949

defines banking... "Banking is the accepting for the purpose

of lending or investment, deposits of money for the purpose

of lending or investment, deposits of money from the public,

repayable on demand or otherwise and withdraw able by

cheque, draft, order or otherwise." But if his money has

fraudulently been drawn from the bank the latter is under

strict obligation to pay the depositor. The bank therefore has

to ensure at all times that the money of the depositors is not

drawn fraudulently. Time has come when the security

aspects of the banks have to be dealt with on priority basis.

The banking system in our country has been taking care of

all segments of our socio-economic set up. The Article

contains a discussion on the rise of banking frauds and

various methods that can be used to avoid such frauds.

A bank fraud is a deliberate act of omission or commission

by any person carried out in the course of banking

transactions or in the books of accounts, resulting in

wrongful gain to any person for a temporary period or

otherwise, with or without any monetary loss to the bank.

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The relevant provisions of Indian Penal Code, Criminal

Procedure Code, Indian Contract Act, and Negotiable

Instruments Act relating to banking frauds have been cited

in the present Article.

BANK FRAUDS: CONCEPT AND DIMENSIONS

Banks are the engines that drive the operations in the

financial sector, which is vital for the economy. With the

nationalization of banks in 1969, they also have emerged as

engines for social change. After Independence, the banks

have passed through three stages. They have moved from

the character based lending to ideology based lending to

today competitiveness based lending in the context of

India's economic liberalization policies and the process of

linking with the global economy.

While the operations of the bank have become increasingly

significant banking frauds in banks are also increasing and

fraudsters are becoming more and more sophisticated and

ingenious. In a bid to keep pace with the changing times, the

banking sector has diversified it business manifold. And the

old philosophy of class banking has been replaced by mass

banking. The challenge in management of social

responsibility with economic viability has increased.

DEFINITION OF FRAUD

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Fraud is defined as "any behavior by which one person

intends to gain a dishonest advantage over another". In

other words , fraud is an act or omission which is intended to

cause wrongful gain to one person and wrongful loss to the

other, either by way of concealment of facts or otherwise.

Fraud is defined u/s 421 of the Indian Penal Code and u/s 17

of the Indian Contract Act. Thus essential elements of frauds

are:

1. There must be a representation and assertion

2. It must relate to a fact

3. It must be with the knowledge that it is false or without

belief in its truth

4. It must induce another to act upon the assertion in

question or to do or not to do certain act.

BANK FRAUDS

Losses sustained by banks as a result of frauds exceed the

losses due to robbery, dacoit, burglary and theft-all put

together. Unauthorized credit facilities are extended for

illegal gratification such as case credit allowed against

pledge of goods, hypothecation of goods against bills or

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against book debts. Common modus operandi are, pledging

of spurious goods, inletting the value of goods,

hypothecating goods to more than one bank, fraudulent

removal of goods with the knowledge and connivance of in

negligence of bank staff, pledging of goods belonging to a

third party. Goods hypothecated to a bank are found to

contain obsolete stocks packed in between goods stocks and

case of shortage in weight is not uncommon.

An analysis made of cases brings out broadly the under

mentioned four major elements responsible for the

commission of frauds in banks.

1. Active involvement of the staff-both supervisor and

clerical either independent of external elements or in

connivance with outsiders.

2. Failure on the part of the bank staff to follow exactly

laid down instructions and guidelines.

3. External elements cause to continue indefinitely frauds

on banks by forgeries or manipulations of cheques, drafts

and other instruments.

4. There has been a growing collusion between business,

top banks executives, civil servants and politicians in

power to defraud the banks, by getting the rules bent,

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regulations flouted and banking norms thrown to the

winds.

FRAUDS-PREVENTION AND DETECTION

A close study of any fraud in bank reveals many common

basic features. There may have been negligence or

dishonesty at some stage, on part of one or more of the

bank employees. One of them may have colluded with the

borrower. The bank official may have been putting up with

the borrower's sharp practices for a personal gain. The

proper care which was expected of the staff, as custodians of

banks interest may not have been taken. The bank's rules

and procedures laid down in the Manual instructions and the

circulars may not have been observed or may have been

deliberately ignored.

Bank frauds are the failure of the banker. It does not mean

that the external frauds do not defraud banks. But if the

banker is upright and knows his job, the task of defrauder

will become extremely difficult, if not possible.

Detection of Frauds

Despite all care and vigilance there may still be some frauds,

though their number, periodicity and intensity may be

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considerably reduced. The following procedure would be

very helpful if taken into consideration:

1. All relevant data-papers, documents etc. Should be

promptly collected. Original vouchers or other papers

forming the basis of the investigation should be kept

under lock and key.

2. All persons in the bank who may be knowing something

about the time, place a modus operandi of the fraud

should be examined and their statements should be

recorded.

3. The probable order of events should thereafter be

reconstructed by the officer, in his own mind.

4. It is advisable to keep the central office informed about

the fraud and further developments in regard thereto.

Classification of Frauds and Action Required by Banks

The Reserve Bank of India had set-up a high level

committee in 1992 which was headed by Mr. A.Ghosh, the

then Dy. Governor Reserve Bank of India to inquire into

various aspects relating to frauds malpractice in banks.

The committee had noticed/observed three major causes

for perpetration of fraud as given hereunder:

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1. Lenient in observance of the laid down system and

procedures by operational and supervising staff.

2. over confidence reposed in the clients who indulged in

breach of trust.

3. Unscrupulous (dishonest) clients by taking advantages

of the lenient in observance of established, time tested

safeguards also committed frauds.

In order to have uniformity in reporting cases of frauds, RBI

considered the question of classification of bank frauds on

the basis of the provisions of the IPC.

Given below are the Provisions and their Remedial

measures that can be taken.

1. Cheating (Section 415, IPC)

Remedial Measures.

The preventive measures in respect of the cheating can be

concentrated on cross-checking regarding identity,

genuineness, verification of particulars, etc. in respect of

various instruments as well as persons involved in

encashment or dealing with the property of the bank.

2. Criminal misappropriation of property

(Section 403 IPC).

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Remedial Measure

Criminal misappropriation of property, presuppose the

custody or control of funds or property, so subjected, with

that of the person committing such frauds. Preventive

measures, for this class of fraud should be taken at the level

the custody or control of the funds or property of the bank

generally vests. Such a measure should be sufficient, it is

extended to these persons who are actually handling or

having actual custody or control of the fund or movable

properties of the bank.

3. Criminal breach of trust (Section 405, IPC)

Remedial Measure

Care should be taken from the initial step when a person

comes to the bank. Care needs to be taken at the time of

recruitment in bank as well.

4. Forgery (Section 463, IPC)

Remedial Measure

Both the prevention and detection of frauds through forgery

are important for a bank. Forgery of signatures is the most

frequent fraud in banking business. The bank should take

special care when the instrument has been presented either

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bearer or order; in case a bank pays forged instrument he

would be liable for the loss to the genuine costumer.

5. Falsification of accounts (Section 477A)

Remedial Measure

Proper diligence is required while filling of forms and

accounts. The accounts should be rechecked on daily basis.

6. Theft (Section 378, IPC)

Remedial Measures

Encashment of stolen' cheque can be prevented if the bank

clearly specify the age, sex and two visible identify action

marks on the body of the person traveler's cheques on the

back of the cheque leaf. This will help the paying bank to

easily identify the cheque holder. Theft from lockers and

safe deposit vaults are not easy to commit because the

master-key remains with the banker and the individual key

of the locker is handed over to the costumer with due

acknowledgement.

7. Criminal conspiracy (Section 120 A, IPC)

In the case of State of Andhra Pradesh v. IBS Prasad Rao and

Other, the accused, who were clerks in a cooperative Central

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Bank were all convicted of the offences of cheating under

Section 420 read along with Section 120 A. all the four

accused had conspired together to defraud the bank by

making false demand drafts and receipt vouchers.

8. Offences relating to currency notes and

banks notes

(Section 489 A-489E, IPC)

These sections provide for the protection of currency-notes

and bank notes from forgery. The offences under section

are:

(a) Counterfeiting currency notes or banks.

(b) Selling, buying or using as genuine, forged or counterfeit

currency

Notes or bank notes. Knowing the same to be forged or

Counterfeit.

(c) Possession of forged or counterfeit currency notes or

bank-notes, knowing or counterfeit and intending to use the

same as genuine.

(d) Making or passing instruments or materials for forging or

counterfeiting currency notes or banks.

(e) Making or using documents resembling currency-notes or

bank notes.

Most of the above provisions are recognizable Offences

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

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FRAUD PRONE AREAS IN DIFFERENT ACCOUNTS

The following are the potential fraud prone areas in Banking

Sector. In addition to those areas and also have kinds of

fraud that are common in these areas.

Savings Bank Accounts

The following are some of the examples being played in

respect of savings bank accounts:

(a) Cheques bearing the forged signatures of depositors may

be presented and paid.

(b) Specimen signatures of the depositors may be changed,

particularly after the death of depositors,

(c) Dormant (inactive) accounts may be operated by

dishonest persons with or without collusion of bank

employees, and

(d) Unauthorized withdrawals from customer's accounts by

employee of the bank maintaining the savings ledger and

later destruction of the recent vouchers by them.

Current Account Fraud

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The following types are likely to be committed in case of

current accounts. (a) Opening of frauds in the names of

limited companies or firms by unauthorized persons;

(b) Presentation and payment of cheques bearing forged

signatures;

(c) Breach of trust by the employees of the companies or

firms possessing cheque leaves duly signed by the

authorized signatures;

(d) Fraudulent alteration of the amount of the cheques and

getting it paid either at the counter or though another bank.

Frauds In Case Of Advances

Following types may be committed in respect of advances:

(a) Spurious gold ornaments may be pledged.

(b) Sub-standard goods may be pledged with the bank or

their value may be shown at inflated figures.

(c) Same goods may be hypothecated in favour of different

banks.

Types of Fraud

Electronic Fraud

Identity Fraud

Spy ware and Ad ware

Debit/Credit Card Fraud

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ELE CTRONIC FRAUD

Refers to email scams from fraudsters to obtain your

banking and personal information and here is how it works:

You will receive an email appearing to be from

NBK or another legitimate company in or out of

Kuwait

The email may claim a number of different things

such as:

There is a problem with your account

Ask you to enter a contest to win a prize

Ask you to subscribe to a service that will

provide you with prizes and etc

You are then asked to provide your personal and

financial information by completing an online

form.

The form requests a variety of information such

as:

Your credit card numbers

Your account number

Your passport or Civil ID numbers and so

forth

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Once you provide this information the fraudsters

will have the necessary information on you to

conduct a fraud.

Here is an example of an email fraud:

IDENTITY FRAUD

Identity fraud is where a dishonest person will gather your

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personal details in order to conduct a fraud which will

financially hurt you. These fraudsters can obtain your

personal information in a number of ways, via telephone

scams or on the internet.

The following can be used to assume your identity:

• Your date of birth

• Your address

• Your Civil ID number or other identification numbers

• Your mobile phone number

• Your banking information

To protect your identity we recommend the following:

Immediately report any loss or theft of your

important documents such as your Civil ID,

passport, driver’s license, credit card etc.

Keep your financial and personal documents in a

safe and secure place.

Do not keep your ATM Pin number in your wallet.

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Never provide personal information on the phone

or emails to anyone who calls or emails you.

SPYWARE AND ADWARE Spyware is a type of software that secretly collects your

personal and user information while on the Internet.

Adware is a type of spyware used to track visitors' habits

and interests on the Internet. Adware can monitor the types

of sites you visit, the articles read or the types banners you

click on and so forth. Many times this information is sold to a

third party for the purpose of marketing.

You can minimize your chances of downloading spyware

onto your computer by:

Never click on banners no matter how enticing they

may appear.

Read the terms and conditions when you install free

programs or subscribe to services from the Internet.

Use up to date anti spyware programs on a regular

basis to scan you computer.

DEBIT/CREDIT CARD FRAUD

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Credit card and debit card fraud is a crime where your credit

or debit cards are reproduced by criminals. This type of

crime is known as 'skimming'.

Credit or debit card fraud can also occur when your card is

lost or stolen and used by fraudster to purchase goods or

remove cash from ATMs or other locations.

Here are some guidelines to protect your debit and credit

card information:

Always sign your credit card in ink as soon as you

receive it.

Memorize your ATM and/or credit card Pin numbers and

never write them down.

Do not let your credit card out of you sight. Even when

paying with it at a store or restaurant go with the card.

Tear up all credit card and debit card receipts into small

pieces before throwing them away.

If you use your credit card online make sure you are on

a secure site:

o Always look for the lock pad symbol at the bottom

right of your browser's window

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Never give your ATM card or credit card numbers to

strangers or telemarketers who call you on the phone

or send you an email.

Contact NBK immediately on 801801 if you feel there is

something fraudulent or strange about your credit card

activity or on your account statement.

LEGAL REGIME TO CONTROL BANK FRAUDS

Frauds constitute white-collar crime, committed by

unscrupulous persons deftly advantage of loopholes existing

in systems/procedures. The ideal situation is one there is no

fraud, but taking ground realities of the nation's environment

and human nature's fragility, an institution should always

like to keep the overreach of frauds at the minimum

occurrence level.

Following are the relevant sections relating to Bank Frauds

Indian Penal Code (45 of 1860)

(a) Section 23 "Wrongful gain".-

"Wrongful gain" is gain by unlawful means of property to

which the person gaining is not legally entitled.

(b) "Wrongful loss"

"Wrongful loss" is the loss by unlawful means of property

to which the person losing it is legally entitled.

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(c) Gaining wrongfully.

Losing wrongfully-A person is said to gain wrongfully when

such person retains wrongfully, as well as when such

person acquires wrongfully. A person is said to lose

wrongfully when such person is wrongfully kept out of any

property, as well as when such person is wrongfully

deprived of property.

(d) Section 24. "Dishonestly"

Whoever does anything with the intention of causing

wrongful gain to one person or wrongful loss to another

person, is said to do that thing "dishonestly".

(e) Section 28. "Counterfeit"

A person is said to "counterfeit" who causes one thing to

resemble another thing, intending by means of that

resemblance to practice deception, or knowing it to be

likely that deception will thereby be practiced.

BREACH OF TRUST

1. Section 408- Criminal breach of trust by clerk or

servant.

2. Section 409- Criminal breach of trust by public servant,

or by banker, merchant or agent.

3. Section 416- Cheating by personating

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4. Section 419- Punishment for cheating by personating.

OFFENCES RELATING TO DOCUMENTS

1) Section 463-Forgery

2) Section 464 -Making a false document

3) Section 465- Punishment for forgery.

4) Section 467- Forgery of valuable security, will, etc

5) Section 468- Forgery for purpose of cheating

6) Section 469- Forgery for purpose of harming reputation

7) Section 470- Forged document.

8) Section 471- Using as genuine a forged document

9) Section 477- Fraudulent cancellation, destruction, etc.,

of will, authority to adopt, or valuable security.

10) Section 477A- Falsification of accounts.

THE RESERVE BANK OF INDIA ACT, 1934

Issue of demand bills and notes Section 31

Provides that only Bank and except provided by Central

Government shall be authorized to draw, accept, make or

issue any bill of exchange, hundi, promissory note or

engagement for the payment of money payable to bearer on

demand, or borrow, owe or take up any sum or sums of

money on the bills, hundis or notes payable to bearer on

demand of any such person

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THE NEGOTIABLE INSTRUMENTS ACT , 1881

Holder's right to duplicate of lost bill Section 45A.

1. The finder of lost bill or note acquires no title to it. The

title remains with the true owner. He is entitled to recover

from the true owner.

2. If the finder obtains payment on a lost bill or note in due

course, the payee may be able to get a valid discharge for it.

But the true owner can recover the money due on the

instrument as damages from the finder.

Section 58

When an Instrument is obtained by unlawful means or for

unlawful consideration no possessor or indorse who claims

through the person who found or so obtained the instrument

is entitled to receive the amount due thereon from such

maker, acceptor or holder, or from any party prior to such

holder, unless such possessor or indorse is, or some person

through whom he claims was, a holder thereof in due course.

Section 85:

Cheque payable to order.

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1. By this section, bankers are placed in privileged position.

It provides that if an order cheque is indorsed by or on behalf

of the payee, and the banker on whom it is drawn pays it in

due course, the banker is discharged. He can debit his

customer with the amount so paid, though the endorsement

of the payee might turn out to be a forgery.

2. The claim protection under this section the banker has to

prove that the payment was a payment in due course, in

good faith and without negligence.

Section 87. Effect of material alteration

Under this section any alteration made without the consent

of party would be void. Alteration would be valid only if is

made with common intention of the party.

Section 138. Dishonor of cheque for insufficiency, etc., of

funds in the account.

Where any cheque drawn by a person on an account

maintained by him with a banker for payment of any amount

of money to another person from out of that account for the

discharge, in whole or in part, of any debt or other liability, is

returned by the bank unpaid. Either because of the amount

of money standing to the credit of that account is insufficient

to honor the cheque or that it exceeds the amount arranged

to be paid from that account by an agreement made with

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that bank, such person shall be deemed to have committed

an offence and shall, without prejudice.

Section 141(1) Offence by companies.

If the person committing an offence under Section 138 is a

company, every person who, at the time the offence was

committed, was in charge of, and was responsible to, the

company for the conduct of the business of the company, as

well as the company, shall be deemed to be guilty of the

offence and shall be liable to be proceeded against and

punished accordingly.

Banking legislation

Banking supervision is exerted on the basis of laws which are

applicable throughout the Union. As a matter of fact, the

solidarity existing between the member States of the Union

is materialized, as far as the banking system is concerned,

by the adoption of a common law which is inserted into the

legal system of each State. This law which is commonly

referred to as Banking Law entered into force on 1st October

1990.

The Banking Law provides for an exact definition of banks

and financial institutions, and of the credit and investment

activities conducted by the latter. It specifies the conditions

of entry and of exercise of the banking profession, and

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determines the obligations which must be met by banks and

financial institutions in the execution of their operations. The

Banking Law defines the scope of the control exerted by the

Central Bank and the Banking Commission, and spells out

the rules governing the Monetary Union and the sanctions

applicable in case these rules are not respected.

Banks and financial institutions must be authorized and

registered on the list of banks and financial institutions to be

able to operate. This authorization is granted by the Minister

of Finance after BCEAO has examined the application and

the WAMU Banking Commission has certified its conformity

with applicable laws.

The conditions of approval are mainly based on :

The name;

the legal status of the establishment ;

the minimum capital which stands at 1 billion for banks

throughout the States, whereas that of financial

institutions is 300 million in Côte d'Ivoire and Senegal,

and 100 million in the other States ;

the adequacy between the resources and objectives of

the establishment to be created ;

the quality of shareholders ;

The worthiness and experience of managers.

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SECURITY REGIME IN BANKING SYSTEM

Security implies sense of safety and of freedom from danger

or anxiety. When a banker takes a collateral security, say in

the form of gold or a title deed, against the money lent by

him, he has a sense of safety and of freedom from anxiety

about the possible non-payment of the loan by the borrower.

These should be communicated to all strata of the

organization through appropriate means. Before staff

managers should analyze current practices. Security

procedure should be stated explicitly and agreed upon by

each user in the specific environment. Such practices ensure

information security and enhance availability. Bank security

is essentially a defense against unforced attacks by thieves,

dacoits and burglars.

PHYSICAL SECURITY MEASURES-CONCEPT

A large part of banks security depends on social security

measures. Physical security measures can be defined as

those specific and special protective or defensive measures

adopted to deter, detect, delay, defend and defeat or to

perform any one or more of these functions against culpable

acts, both covert and covert and acclamations natural

events. The protective or defensive, measures adopted

involve construction, installation and deployment of

structures, equipment and persons respectively.

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The following are few guidelines to check malpractices:

1. To rotate the cash work within the staff.

2. One person should not continue on the same seat for

more than two months.

3. Daybook should not be written by the Cashier where

another person is available to the job

4. No cash withdrawal should be allowed within passbook

in case of withdrawal by pay order.

5. The branch manager should ensure that all staff

members have recorder their presence in the attendance

registrar, before starting work.

Execution of Documents

1. A bank officer must adopt a strict professional approach

in the execution of documents. The ink and the pen

used for the execution must be maintained uniformly.

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2. Bank documents should not be typed on a typewriter

for execution. These should be invariably handwritten

for execution.

3. The execution should always be done in the presence of

the officer responsible for obtain them,

4. The borrowers should be asked to sign in full signatures

in same style throughout the documents.

5. Unless there is a specific requirement in the document,

it should not be got attested or witnessed as such

attestation may change the character of the instruments

and the documents may subject to ad volrem stamp duty.

6. The paper on which the bank documents are made

should be pilfering proof. It should be unique and available

to the banks only.

7. The printing of the bank documents should have highly

artistic intricate and complex graphics.

8. The documents executed between Banker and

Borrowers must be kept in safe custody.

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CHANGES IN LEGISLATIONS AFTER

ELECTRONIC TRANSACTIONS

1. Section 91 of IPC shall be amended to include

electronic documents also.

2. Section 92 of Indian Evidence Act, 1872

Shall be amended to include commuter based

communications

3. Section 93 of Bankers Book Evidence Act, 1891 has

been amended to give legal sanctity for books of account

maintained in the electronic form by the banks.

4. Section 94 of the Reserve Bank of India Act, 1939

shall be amended to facilitate electronic fund transfers

between the financial institutions and the banks. A new

clause (pp) has been inserted in Section 58(2).

CONCLUSION

The Indian Banking Industry has undergone tremendous

growth since nationalization of 14 banks in the year 1969.

There has an almost eight times increase in the bank

branches from about 8000 during 1969 to mote than 60,000

belonging to 289 commercial banks, of which 66 banks are

in private sector.

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It was the result of two successive Committees on

Computerization (Rangarajan Committee) that set the tone

for computerization in India. While the first committee drew

the blue print in 1983-84 for the mechanization and

computerization in banking industry, the second committee

set up in 1989 paved the way for integrated use of

telecommunications and computers for applying technogical

breakthroughs in banking sector.

However, with the spread of banking and banks, frauds have

been on a constant increase. It could be a natural corollary

to increase in the number of customers who are using banks

these days. In the year 2000 alone we have lost Rs 673

crores in as many as 3,072 number of fraud cases. These are

only reported figures. Though, this is 0.075% of Rs 8,96,696

crores of total deposits and 0.15% of Rs 4,44,125 crores of

loans & advances, there are any numbers of cases that are

not reported. There were nearly 65,800 bank branches of a

total of 295 commercial banks in India as on June 30, 2001

reporting a total of nearly 3,072 bank fraud cases. This

makes nearly 10.4 frauds per bank and roughly 0.47 frauds

per branch.

An Expert Committee on Bank Frauds (Chairman:

Dr.N.L.Mitra) submitted its Report to RBI in September 2001.

The Committee examined and suggested both the

preventive and curative aspects of bank frauds.

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The important recommendations of the Committee include:

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

• Amendments to the IPC by including a new chapter on

financial fraud;

• Amendments to the Evidence Act to shift the burden of

proof on the accused person;

• Special provision in the Cr. PC for properties involved in the

Financial Fraud.

• Confiscating unlawful gains; and preventive measures

including the development of Best Code Procedures by

banks and financial institutions.

Thus it can be concluded that following measures should

necessarily be adopted by the Ministry of Finance in order to

reduce cases of Fraud.

• There must be a Special Court to try financial fraud cases

of serious nature.

• The law should provide separate structural and recovery

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procedure. Every bank must have a domestic enquiry officer

to enquire about the civil dimension of fraud.

• A fraud involving an amount of ten crore of rupees and

above may be considered serious and be tried in the Special

Court.

The Twenty-ninth Report of the Law Commission had dealt

some categories of crimes one of which is "offences

calculated to prevent and obstruct the economic

development of the country and endanger its economic

health." Offences relating to Banking Fraud will fall under

this category. The most important feature of such offences is

that ordinarily they do not involve an individual direct victim.

They are punishable because they harm the whole society. It

is clear that money involved in Bank belongs to public. They

deposit there whole life' security in Banks and in case of

Dacoity or Robbery in banks the public will be al lost. Thus it

is important that sufficient efforts should be taken in this

regard.

There exists a new kind of threat in cyber world. Writers are

referring it as "Salami Attack" under this a special software is

used for transferring the amount from the account of the

individual. Hence the culprits of such crimes should be found

quickly and should be given strict punishment. Moreover

there is requirement of more number of IT professionals who

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will help in finding a solution against all these security

threats.

PRESS RELEASE

Seminar on Strategies for Prevention of Frauds in Banks and

Money Laundering

“Banks in India should take proactive steps to implement

strategies for preventing frauds in Banks and money

laundering” said Shri M S Sundara Rajan, Chairman and

Managing

Director, Indian Bank. Inaugurating a one day seminar on

“Strategies for Prevention of

Frauds in Banks and Money Laundering” at IMAGE, Chennai

today, Shri Sundara Rajan

Said that the quantum of frauds in India was nearly to the

tune of Rs.400 crores in 2002

And had mounted to around Rs.1400 crores in 2006 and

there was an urgent need for the

Banking Industry in coordination with the law enforcement

authorities to completely

Eliminate banking fraud. Indian Bank had organized the

seminar with an objective to

Benefit all the banks and the banking community through

the direct interaction and

Sharing of knowledge between the bankers and the law

enforcement authorities in finding

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Ways and means to prevent frauds in banks, he added.

Shri G.Nanchil Kumaran, IPS, Commissioner of Police,

Chennai City Police in his key

Note address lauded Indian Bank for its initiative in

organizing the seminar. The

Interaction between bank officials and police officers would

not only help detect frauds

But also prevent frauds, he said. He also stressed the need

to revamp the law in tune with

The changing times and enable speedy disposal of cases. in

courts.

Shri P.K.Das, Special Director, Enforcement Directorate in his

special address

Emphasized the need for banks and law enforcement

authorities to make optimum use of

The latest technologies to prevent frauds in banks and

money laundering.

The technical sessions included paper presentations on the

following

“Robbery and Theft” by Shri J.K.Tripathy, IPS, Inspector

General of Police, CB CID

“Frauds in Credit Cards, ATMs and Debit Cards” by Shri

S.Murugan, Dy. Commissioner

of Police, Madhavaram, Chennai City Police

“Money Laundering” by Shri Sanjeev Singh, Addl Director,

FIU-IND, Delhi

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“FEMA & Customs” by Shri Mohan Das, Dy Director,

Enforcement Directorate

“Strategies to be adopted to prevent cyber crimes in Banks”

by Shri Rajendran, Chief

Manager, Technology Dept, IOB and

“Fake currency” by Shri D Sethi, DGM, Issue Department,

RBI, Chennai

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Banking System Frauds and Legal Control

Documents

Transcript of Banking System Frauds and Legal Control