1.

INTRODUCTION

Banking and financial systems have been the essence of growth and development of all of
mankind since hundreds of years. The robustness of the banking and financial system of a
country helps determine the production and consumption of goods and services within a
country. It is directly indicative of well being and living standards of a country’s citizens.
Therefore, if banking system is plagiarized with high levels of non- performing assets on
balance sheets of banks, financial distress of borrower clients and inefficiencies in
transmission mechanisms then it is a cause of worry for the economy. Indian economy
suffers o a great extent from these problems and this served as a motivation for us to carry
out this detailed study of the Indian banking system from a 360 degree view. The report
talks about various regulations in place, issues faced by the Indian banking sector with
special emphasis on public sector banks (as most NPAs lie on the balance sheets of these
banks) and possible recommendations that can help mitigate these problems.

The banking and financial service, government and public administration and
manufacturing industries were the most represented sectors in the fraud cases that were
examined by Association of Certified Fraud Examiner while preparing the global Fraud
Study 2016. The frequency, complexity type and the money involved in banking frauds
have increased manifold resulting in a very serious case of concern for regulators, such as
RBI.

​In the last three years, public sector banks (PSBs) in India have lost a total of Rs. 22,743 crore,
on account of various banking frauds. 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.

This study takes into consideration, different aspects of Indian banking sector. Specifically for this
study, primary semi-structured interviews were conducted with bankers and industry.
1.2. Meaning

Fraud is delibrate and mala fide mistake. It means intentional misrepresentation of

financial information by management or employees or third parties. It is a delibrate mistake
committed in the accounts to deceive others and get personal gains.

1.3. What is fraud?

The Institute of Internal Auditor (2009) defines fraud as: " Any illegal act characterized by deceit,
concealment, or violation of trust. Frauds are perpetrated by parties and organization to obtain
money, property or services to avoid payment or loss of services personal or business advantage."

Fraud impacts organization in several areas including financial, operational, and psychological.​Most
of the time, it is difficult to detect frauds well-in-time, and even more difficult to book the offenderury terms.
In those cases, the frauds are referred to the CBI. Cases above Rs. one crore must be referred to a different
wing of the CBI depending on the category it falls into. In the case of private-sector banks, frauds of Rs. one
lakh and above committed by an outsider, in connivance with a bank official should be referred to the local
police. ​DNA (2012)​ found that “in many of the cases the banks do not follow the RBI guidelines.” The
central bank has taken several steps to sensitize banks and curb frauds in the banking industry. So, after RBI
learns of the fraud, they examine the case and advise the concerned bank to report the case to the CBI/police,
or Serious Fraud Investigation Office. Also, it takes measures to recover the amount involved in the fraud.
The RBI has also issued several notifications sensitizing banks about common fraud prone areas and issued
caution notices against repeat offenders.
CHAPTER 2: Research methodology and Objectives

2.1. Objectives

The objective of this study was three fold.

● To study Indian banking and financial system along with current processes and
regulations in place.
● To identify issues in the current system and reasons for these issues.
● To suggest recommendations that can help the system tackle these issues.
2.2. Research Methodology

​The methodology adopted by us was a survey – based and interview – based

approach. We started with a comprehensive study of financial regulations in place across
the world and then in India. We then identified issues that concern Indian banking and
financial system. A 360 degree analysis was conducted by interviewing prominent figures
belonging to each of the major players involved in detection and reporting of fraudulent
activities in a bank. To understand the role of senior management, board of directors and
employees of a bank we interviewed a retired Chairman and Managing Director of a major
public sector bank. In order to study the role of third parties and judiciary, we spoke with a
senior official of a top auditing firm in India and a highly experienced lawyer of an esteemed
banking regulatory authority in India. Chief Vigilance Officer of another major public sector
bank helped us understand challenges faced by the vigilance department inside the bank as
well as the Central Vigilance Commission of India. Chairman and Director of a top
multinational engineering and electronics company helped us assess the issue from the
viewpoint of a borrower corporate client. Officials from a top investigating agency helped us
understand the perspective of investigating agencies involved in inspection of cases
involving financial frauds. All these interactions with top personalities from both
government and private entities in India helped us come up with recommendations that we
believe can address existing issues to resolve frauds in banking to a great extent.

2.3. Statistics reltaed to banking frauds

As many as 861 bank advance related fraud cases of Rs 1 lakh and more, involving Rs 4,920 crore, were
reported in the first half of 2015-16. During 2014-15, 1,651 such cases were reported that involved an
amount of Rs 11,083.11 crore.

Fig I: ​Number of bank fraud cases involving Rs. 1 Lac and above

While one sees in isolation, the above statistics does not mean anything. However when one sees the figure
below, one observes that the decreasing trend (in number) is primarily attributed to the decrement in the low
value cases (less than 1 Lac.). There has been substantial improvement in the large ticket cases (involving
Crores.). Needless to say, this is an alarming trend
 Fig. II: ​Year wise fraud cases reported by commercial banks

What is more alarming is the below mentioned cases which shows the number of cases closed by RBI. If the
increment of number of such cases were not enough, Fig III goes on to show that the said cases are not
closed.
  The authors are not aware of the reasons of the same but this for sure is not a good sign.

Fig. III: ​Year wise details of fraud cases closed

As per Fig IV, the number of cases and the value involved with SBI, its associates and the Public sector
banks are less than that of private sector banks. The amount involved is however the reverse. The private
banks have more number of small cases.
 Fig. IV: ​Bank Group wise fraud cases reported as of 31-Mar 2013

While the number of frauds and the amount involved, when seen in isolation, may seem large, it is
important to view the incidence of frauds in the banking sector in the context of the massive increase in the
number of deposit and credit accounts in banks and the huge volumes (number as well as value) of
transactions that are processed by the banks every day. To put figures in the right perspective, the number of
deposit accounts in the banks over ten years (between end 2002 and end 2012) has gone up from 43.99 crore
to 90.32 crore while the number of loan accounts in the same period has also more than doubled from 5.64
crore to 13.08 crore. A quick estimate puts the average number of all transactions that happen every day in
the banking system at approximately 10 crore, which is enormous. The number of frauds per million banking
transactions was about 0.4, which is not a very high figure.

The alternate Channels usage has also been improving over the years. Table I shares the data for March
months of 2012 and 2016. Number of POS transactions has grown 3 times in the period. The number of debit
cards outstanding as of the last date of that month has also doubled. A study on e-commerce in India by
Accel Partners estimated that shopping through mobile phones grew 800 per cent in 2013.

It is expected to show a compounded annual growth rate (CAGR) of 150 per cent by 2016.
Chapter 3: Literature Review

​Jeffords ​et al. (1992) ​examined ​910 cases submitted to the “Internal Auditor” during the ​nine-year
period from ​1981-1989 to assess the specific risk factors cited in the Treadway Commission Report.
Approximately 63% of the 910 cases are classified under the internal control risks. Similarly, ​Calderon and
Green (1994) made an analysis of 114 actual cases of corporate fraud published in the “Internal Auditor”
from 1986 to 1990. The study found that professional and managerial employees were involved in 45% of the
cases.

Willson (2006) ​examined ​the causes that led to the breakdown of „Barring‟ Bank, in his case study. The
collapse ​resulted due to the failures in management, financial and operational controls of Baring Banks.
However, ​Bhasin ​(2007) ​examined ​the reasons for check frauds, the magnitude of frauds in Indian banks, and
the manner in which the ​expertise of internal auditors can be integrated in order to detect and prevent frauds
in banks. In addition to considering the common types of fraud signals, auditors can take several „proactive‟
steps to combat frauds. One important challenge for banks, therefore, is the examination of new technology
applications for control and security issues.

As per the survey conducted by ​Ganesh and Raghurama (2008) about 80 executive from Corporation Bank
and Karnataka Bank Ltd of India, were requested to rate their subordinates in terms of development of their
skills before and after they underwent certain commonly delivered training programs. Responses revealed
that for the 17 skills identified, there was improvement in the skills statistically. The paired t-test was applied
individually for the seventeen skills, and all these skills have shown statistical significance. Moreover, a
study to investigate the reasons for bank frauds and implementation of preventive security controls in Indian
banking industry was performed by Khanna and Arora in 2009. The study seeks to evaluate the various
causes that are responsible for bank frauds. The result indicate that “”lack of training, overburdened staff,
competition, low compliance level are the main reasons for bank frauds.”

Chiezey and Onu (2013) ​evaluated ​the impact of fraud and fraudulent practices on the performance of 24
banks ​in Nigeria during 2001-2011. The relationship between fraud cases and other variables were estimated
using Pearson product moment correlation and multiple regression analysis was used. The paper
recommended that banks in Nigeria need to strengthen their internal control systems and the regulatory
bodies should improve their supervisory role.

The foregoing discussion suggests that the literature on the bank frauds in Indian-context is very limited and
inconclusive. Thus, our study builds on the previous literature of bank frauds in the Indian banking sector.
The scope of the study has been confined to 21 banks in the National Capital Region (NCR) of India during
2012-13.