India: Banking Frauds - Prevent Or Lament!

Last Updated: 11 July 2013
Article by Neeraj Dubey

Introduction

The primary responsibility for preventing frauds lies with individual banks; however, the Reserve Bank of India ("RBI") routinely advises banks1 about major fraud prone areas and the safeguards necessary for prevention of frauds. This is done so that banks can introduce necessary safeguards by way of appropriate procedures and internal checks. With growing usage and dependency on electronic forms of transaction, banks have employed more secured means and platform separate from the normal channels of communication. The authenticity and integrity of such a platform is ensured through usage of specific software, which ensures the validity of the bank's electronic documents. But has such processes ensured safe and secure banking? Or, are frauds still prevalent? Is online mode secure? In this bulletin, we will discuss these crucial aspects and find out the current state of e-banking transactions, reporting requirements to be followed by banks and how secure e-banking is for the consumers.

1. E-banking transaction: how are they secured?

An electronic banking transaction involves the transmission of an electronic message from the customer to the bank directing the bank to transfer money from his account to another account either in the same bank or to another branch or any other bank anywhere in the world. This may also be a bank's electronic communication regarding the credit or debit card statement to a customer, which essentially and mostly is a statement of account.

Though e-banking still does not account for a significant portion of total transactions in India as per RBI. The generation today is increasingly opting for net transactions to settle their utility bills and do all kinds of bank-related work. With increased online usage, online frauds have also increased. E-banking transactions are made safe, its integrity and authenticity preserved by encrypting the messages. These messages are further hashed and converted into a digital signature with a private key having a secret and individualistic signer. Digital signatures cannot be unwrapped or tampered. A key pair is generated by the subscriber using asymmetric crypto system and is registered with the controlling authorities. While the private key remains with the subscriber, the other key remains with the controlling authorities and is published and is available to persons who need them.

In order to secure the e-transactions, the Information Technology (Certifying Authorities) Rules, 2000 were issued and its annexure II provides for the security guidelines for the implementation and management of information technology security. These guidelines specifically provide that the implementation of an information security program should be completed in the following stages:

  1. Adoption of security policy;
  2. Security risk analysis;
  3. Development and implementation of a information classification system;
  4. Development and implementation of the security standards manual;
  5. Implementation of the management security self-assessment process;
  6. On-going security program maintenance and enforcement; and
  7. Training

Though there are rules in place and RBI, as a guardian bank, proactively keeps a vigil on the conduct, the onus largely lies upon the banks to keep a check on frauds and fraudulent behaviors, employ means to secure transactions and report to RBI if they experience any fraud in their branches. Reporting of frauds also helps the RBI and other banks to understand the ways in which frauds are committed and employ means to keep a check on such fraudulent ways. Based on the reporting received from various banks, RBI regularly provides certain do's and don'ts for banks, which needs to be diligently followed. The Financial Fraud (Investigation, Prosecution, Recovery and Restoration of property) Bill, 2001 has been proposed to prohibit, control, investigate financial frauds; recover and restore properties subject to bank frauds, prosecute for causing financial fraud and all related matters.

2. What constitute a fraud? Can it be classified?

Let us understand the crucial elements of a fraud. Fraud is defined in section 421 of the Indian Penal Code and section 17 of the Indian Contract Act and has the following essential elements:

  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; and
  4. It must induce another to act upon the assertion in question or to do or not to do certain act.

Internet frauds in India are recent phenomena but over the years, it has emerged like an organized crime. Hackers may be anywhere in the world and employ any technique to commit the fraud. Even mobile transactions are hit by the frauds. There are three crucial elements which are considered responsible for the commission of frauds in banks:

  1. Involvement of bank's employee or in connivance with outsiders;
  2. Failure of the bank staff to follow the instructions and guidelines; and
  3. External elements or collusion between various parties or by a hacker.

Though there are various kinds of frauds, but purely from reporting standpoint, RBI has classified frauds on the basis of the provisions of the Indian Penal Code ("IPC"):

  1. Misappropriation (Section 403 IPC) and criminal breach of trust (Section 405 IPC);
  2. Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property (Sections 477A, 378 and 120 A);
  3. Unauthorized credit facilities extended for reward or for illegal gratification;
  4. Negligence and cash shortages;
  5. Cheating (Section 415 IPC) and forgery (Section 463 IPC);
  6. Irregularities in foreign exchange transactions; and
  7. Any other type of fraud not coming under the specific heads as above.

3. Reporting of banking frauds

To keep the above frauds at bay, RBI prescribes that bank should conduct annual review of frauds and apprise its board regarding the findings. While conducting the review, the most crucial aspect that must be taken into account by banks includes the following:

  1. Has the bank employed adequate system to detect frauds?
  2. How are frauds examined?
  3. What kind of action bank takes and within how much time if a person is found responsible for fraud?
  4. What are the reasons for the fraud - laxity in following the systems and procedures or loopholes in the system?
  5. What measures have been taken to ensure that the systems and procedures are scrupulously followed by the staff concerned or the loopholes are plugged?
  6. Whether frauds are reported to the local police for investigation?
  7. Whether bank maintains the data and records of these facts: (i) total number of frauds detected during the year; (ii) amount involved as compared to the previous two years; (iii) modus operandi of major frauds reported during the year along with their present position; (iv) estimated loss to the bank; (v) number of cases (with amounts) where staff are involved and the action taken against staff; (vi) time taken to detect frauds (number of cases detected within three months, six months, one year, more than one year of their taking place); (vii) status of the matters reported to the police and (viii) preventive/punitive steps taken by the bank.

In order for the RBI to continue doing this work, it is essential that banks should have proper reporting mechanism in place to report to the RBI all information about frauds and the follow-up action taken.

4. Fraud prevention measures

Inadequate measure to prevent banking fraud is the primary reason for widespread frauds. Delay in reporting by banks is another important reason. Banks should, therefore, ensure that the reporting system is suitably streamlined so that frauds are reported without any delay. Banks must fix staff accountability in respect of delays in reporting fraud cases to the RBI. Delay in reporting of frauds and the consequent delay in alerting other banks about the modus operandi and issue of caution advices against unscrupulous borrowers could result in similar frauds being perpetrated elsewhere. Banks may, therefore, strictly adhere to the timeframe fixed by RBI for reporting fraud cases failing which banks would be liable for penal action as prescribed under Section 47(A) of the Banking Regulation Act, 1949. Banks should specifically nominate an official of the rank of General Manager who will be responsible for submitting all the returns referred to in this circular. Fraud Monitoring Cell, Department of Banking Supervision, Central Office publishes a directory of officers of all banks/financial institutions responsible for reporting of frauds. All banks should furnish to the aforesaid department any changes in the names of officials that will be necessary for inclusion in the directory on priority basis as and when called for.

Banks must provide sufficient focus on the "Fraud Prevention and Management Function" to enable, among others, effective investigation of fraud cases. Banks should be able to provide promptly as well as accurate reporting of frauds to appropriate regulatory and law enforcement authorities including RBI. The fraud risk management, fraud monitoring and fraud investigation function must be owned by the bank's CEO, its Audit Committee of the Board and the Special Committee of the Board, at least in respect of large value frauds. Banks can also frame internal policy for fraud risk management and fraud investigation function, based on the governance standards relating to the ownership of the function and accountability for malfunctioning of the fraud risk management process in their banks.

So, what should banks do to safeguard the interests of its customers?

Banks can secure and preserve the safety, integrity and authenticity of the transactions by employing multipoint scrutiny – cryptographic check hurdles. Banks should rotate the services of the persons working on sensitive seats, keep strict vigil of the working, update the technologies employed periodically and engage more than one person in larger transactions. Banks can verify the credentials of the person approaching the bank, the documents they produce, the details provided in the forms they fill and utmost care in recruiting the staff. Banks should educate and make its customers aware about such frauds by sending e-mails and also providing tips on their websites. Banks can give confidence to its customers if they have prescribed and follow best practices and also the guidelines provided by RBI, have a fraud free culture and in-house grievance redressal mechanism.

Footnote

1 Please see http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5861 for details (last visited on July 03, 2013)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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