CHAPTER – I

INTRODUCTION

1.1 Introduction

Banking is a process by which banks bridge the gap between the sources of funds
and their application. The term banking means “the accepting, for the purpose of
lending or investment, of deposits of money from public, repayable on demand or
otherwise and withdrawal by cheque, draft, or otherwise” (Banking Regulation Act,
1949). The concept of banking as we know it today originated in India long back in
the late decades of 18th century. As per central banking committee, 1931 (RBI,
2008), moneylenders started this concept of accepting deposits and issuing receipts
for the same in India. However, the banking activities were discovered long back in
the Vedic period i.e. 2000 to 1400 BC. Even the traces of professional banking have
been found in Kautilya Arthashastra in 400 BC, where the terms such as lenders,
creditors and lending rates were used.

In the pre-independence period, the banking functions were performed by the banks
established by Britishers in the form of joint stock companies (Manikyam, 2014).
The first bank that was introduced in India was General Bank of India in 1786.
Slowly and gradually many small and private banks came into existence but most of
them failed in a very short span of time. There were three main banks, which were
started by The East India Company namely, The Bank of Bengal in 1809 (later
known as the Bank of Calcutta), Bank of Bombay in 1840 and Bank of Madras in
1843. These three banks were setup in the form of joint stock banking companies and
were later converted under one category named as Presidency banks. The first bank,
which was solely ruled by Indians, was Allahabad Bank started in the year 1865.
After this the second bank to join the same category was Punjab National Bank,
which was established in 1894. Later on some other banks were established namely,
Central Bank of India, Canara Bank, Bank of India, Bank of Baroda, Indian Bank
and Bank of Mysore. Afterwards, a major change came in the structure of Presidency
Banks in the year 1921, when these banks were merged and named as Imperial Bank
of India, with a country wide setup of total 22 branches. In 1934, the Reserve Bank
of India Act was presented for securing monitory stability and to centralize the

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banking operations in India. With the establishment of this Act in March 1935, the
RBI became the central Bank of India. This led to the first phase of Indian Banking
growth, but the growth was at very slow pace and for strengthening the banking
control in the country, another act - Banking Companies Act, 1949 was passed by the
government of India which was later named as Banking Regulations Act, 1949.

When India got independence in 1947, the face of Indian Banking was very
complicated. At that time, small private sector banks covered the major share of
Indian Banking. There were only six big banks with aggregate public deposits of Rs
100 crore or more. These banks were, Imperial Bank, Central Bank of India, Punjab
National Bank, Bank of India, Bank of Baroda and United Commercial Bank.
However, only after independence in 1948 the RBI became the 100% public owned
unit. Apart from this, one big step taken in light of banking reforms in India was
nationalization of Imperial banks, under State Bank of India Act, 1955. The Imperial
bank was renamed as State Bank of India and started working as the principal agent
of RBI. It was the second phase in the growth of Indian Banking known as
nationalization phase. In this era many banks got nationalized viz., in 1959 seven
subsidiaries of SBI got nationalized. In 1969 - 14 banks were nationalized and in
1980 six more banks were added in this category. This was the phase when
approximately more than 75% of Indian Banking sector was under the hold of
government of India. In 1991, Narsimham Committee presented a report on banking
reforms and liberalization in Indian banking sector, on its suggestions the Banking
Regulations Act, 1949 was amended and here came the next phase of growth in
which the provisions for the new private sector banks were introduced.

The primary and traditional functions and objectives of banks are to accept money
from depositors and offer loans to the borrowers and also facilitate payments as a
part of the country’s payment and settlement systems. In their starting years in India,
Banks provided basic intermediary services of sourcing funds in the form of deposits
and diverting them towards productive sectors of the economy. But overtime, as the
economy developed and moved from a production led growth phase to consumption
led growth phase, the credit demand from the basic industrial and infrastructure
sectors got lessened and banks started to lend to masses to cater to their consumption
requirements. Easier access to loans meant that more consumers could buy more
products and services and benefited from ‘buy now’ and ‘pay later’ concept.

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 Figure 1.1: Phases of Indian Banking Industry

(2004
onwards)
(1990- 2004) Phase IV
Phase III Era of
(1955- 1990) Introduction of Liberalisation
Banking Introduction of
Phase II Reforms Technology in
Period of Gateway open to Indian Banking
(Prior to 1955) Nationalisation Private Sector Sector
Phase I Governement Banks
share increased
Pre-Nationalisationdrastically
Era
Joint Stock Banking
Companies &
Presidency Banks
covered the major
market share

Source: RBI (2008)

1.2 Banking Frauds in India

Over the years the banks have developed in a very big way, and with the growth of
banking business, banking frauds have taken birth. The history of banking frauds is
almost as old as the banking startup. The term fraud is defined as, “any behavior by
which one person intends to gain a dishonest advantage over another” (RBI, 2013).

Thus, Reserve bank of India defines fraud as an act of commission and / or abetment,
which is intended to cause illicit gain to one person(s), entity and wrongful loss to
the other, either by way of concealment of facts by deceit or by playing a confidence
trick.

Today, bank frauds have taken all possible forms and are prevalent in every facet of
banking. There is a spirited need for banks to always stay alive to threat of frauds,
build strong systems that can shield, pre-empt frauds, continuously monitor and
review the efficiency of such preventive systems. To succeed in controlling frauds,

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banks need to be proactive and pre-emptive. Frauds in banks take place, when either
the safeguards or procedural checks are inadequate or not adhered to, leaving the
system vulnerable to perpetrators, who can be an insider or an outsider. A fraudster
plans to strike the system at its most vulnerable point. An effective defense the bank
can have against fraud is to continuously strengthen its operational practices,
procedures, and control and review mechanism that fraud prone areas are sanitized
against internal and external breaches.

The advent of computerization in banks have added a new dimension to the concept
of frauds and the potential for fraud has brought about a need for a review and
adaptation of a comprehensive control system aimed at fraud prevention.

1.3 Factors which are responsible for Frauds in Banking Sector

The banks are exposed to risks. This is especially because banks are easing account
opening rules, thus overlooking the Know Your Customer (KYC) norms.
Duplication of bank accounts, in the quest to achieve high targets or to avail
insurance benefits, it is a big challenge. If duplicate accounts are opened but remain
dormant, it would be financial inclusiveness only in name.

Yet another facility of overdraft could end up swelling bad loans for banks as the
scheme does not spell out how the banks can collect debt waivers in the past, people
may end up treating the loans as freebies.

Over burdening or lack of incentives of bank officials resulting in the hampering of

normal operations, customer harassment etcetera also needs to be looked into. Most
of the schemes that aim to cover the entire population have had their share of errors
in on-boarding citizen’s information.

1.4 Nature and Types of Frauds in Banking Sector

Frauds in banking sector can be classified as systematic or human failures, or a

combination of both. Frauds arising out of both system and human failures in banks
are grouped in the following four categories:

i. Frauds committed by bank employees.

ii. Frauds committed by bank employees, in collaboration of third party.

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 iii. Frauds committed by outsiders with insider support/ involvement.
iv. Frauds committed by customers or any other third party.

Further, the broad categories under which the above kinds of associations are formed
to commit fraud takes place are as under:

a) Frauds related to advances

b) Cyber frauds or any other technology related frauds
c) Other frauds- KYC/ deposit frauds, cheque frauds, accounting frauds,
etcetera.

Although RBI had introduced the system of fraud reporting as early as in July 1970
itself (Refer: Annexure III for current RBI policy regarding fraud reporting), fraud
detection and fraud reporting in banks remained quite low in the last millennium.
Frauds reported during the last decade were largely limited to frauds committed by
staff in customer accounts and those committed by customers with simple modus
operandi, mostly on operations side like chemical alterations in cheques and
collection related frauds. The retail lending boom witnessed in the late 90’s in Public
Sector Banks saw the manifested emergence of mortgages frauds in the home loan
portfolio of the banks during the turn of the century. As a reactive response, banks
started strengthening their mechanism of due diligence on loan aspirants, as well as
properties offered as security. Banks strengthened and standardized their appraisal
and due diligence procedures, with the singular objective of preventing frauds. As a
result of the steps taken by banks, home loan frauds witnessed a considerable
decline. As at 31st March 2013, the cumulative total of home loan frauds, reported by
all banks to RBI, stood at just 5.11 percent of all reported frauds (RBI, 2013). The
banks used the lessons learnt from home loan frauds as the pathway in other
mortgage related advance accounts also.

The RBI report for ten year had witnessed a multi fold increase in bank frauds, both
in number and amount, as represented in the Table No. 1.1. The large number seen in
the bucket ‘less than 1 lac’ are due to technology related frauds, which are normally
more in number and less in amount. The increase in number can be attributed to
increasing use of technology frauds arising due to chinks in banking systems could
be well contained. However, frauds due to weakness at the customer end, like
compromising of passwords, continued to occur. The increase over the years in the

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bucket ‘More than 1 lac, less than 1 crore’ is gradual and moderate. This bucket
normally comprises of other frauds such as material alteration/ forgery, cheque
collection frauds, etc, besides frauds in small value advance accounts. Banks have
been fairly successful in identifying causative factors and building preventive
mechanism in this category of frauds.

Table No. 1.1: Number of frauds reported by all Indian banks (Amount in
Rupees)
>1Lakh Upto > 1 cr. Upto 50 Total
< 1 Lakh > 50 cr.
1 cr. cr. (Amt. in Crores)
FY
No. Amt. No. Amt. No. Amt. No. Amt. No. Amt.

2004- 05 7553 12.50 2407 287.32 111 584.89 1 53.57 10072 938.29

2005- 06 11395 18.63 2334 290.20 192 1009.23 2 135.47 13923 1453.53

2006- 07 20415 31.22 3048 325.02 158 791.17 1 78.45 23622 1225.86

2007- 08 17691 30.25 3381 383.98 177 662.31 - - 21249 1076.54

2008- 09 19485 33.85 4239 442.94 214 1129.56 3 305.33 23941 1911.68

2009- 10 20072 30.36 4494 474.04 222 1129.28 3 404.13 24791 2037.81

2010- 11 15284 26.09 4250 494.64 277 1515.15 16 1796.20 19827 3832.08

2011- 12 10638 19.05 3751 509.17 327 2113.23 19 1850.08 14735 4491.54

2012- 13 9060 22.11 3816 491.13 372 2798.00 45 5334.75 13293 8646.00

2013- 14 Not available 3859 507.12 401 2845.41 45 6811.33 4305 10163.86

TOTAL 131593 224.06 35579 4205.56 2451 14578.23 135 16769.31 169758 35777.19

Source: Compiled from the various RBI publications (2004- 2014)

As clear from the Table 1.1, there had been a marked increase in the bucket ‘More
than 1 Crore, less than 50 crores’ and a very sharp upsurge in the bucket ‘More than
50 Crores’. The fraud amount reported during 2013-14 under these two segments
together is 1512.50 percent higher than the amount reported during 2004-05. Frauds
in large value advances are major contributors under this segment. The trends seen in
these segments are worrisome, since these frauds had caused huge losses to banks
and also dented the public perception about the executives of the banks.

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According to a survey on Indian Banking Fraud (Deloitte, 2015), 93% of the
respondents were of the view that the frauds in Indian banking industry have
increased in last two years drastically. And the most frequent reasons for the increase
in frauds were:

 Negligence by the employees (including managerial level) in following the

general processes.
 Pressure on the employees for meeting the targets.
 Lack of facilities for the identification of red flags.
 Illegal cooperation between employees and outsiders.

Figure 1.2: Major Contributors in Bank Frauds in India

Negligence of employees for

the processes
4% 4% 2%
Pressure of tragets
22%
10%

12%
Shortage of tools for
18%
identification of potential red
14% flags
14%
Illegal cooperation between
employees and outsiders

Technology related frauds

Source: Deloitte, 2015

The survey report highlighted the common frauds observed as:

(i) In Retail Banking sector: fraudulent documentation and overvaluation or

absence of collateral.
(ii) In Corporate banking sector: diversion of frauds and siphoning of funds.
(iii) In Private banking sector: identity theft and fraudulent documentation.

Also, it was found that these frauds were discovered through the various sources like,
complaints by the customers, internal whistle blower and auditor’s report and with
the help of data analysis or by software’s for transaction monitoring.

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In yet another survey conducted by Deloitte (2017), it was found that about 65% of
the respondents thought that the trend of fraud is likely to increase in upcoming
years. The main reasons responsible for occurrence of frauds were ineffective
control, technological advancements and the support of unethical practices among
employees. The top most frauds which were faced by the industry were bribery and
corruption, financial statement fraud and embezzlement of funds.

As per RBI Data (Assocham, 2017), the top most bank during the period of April
2016 to December 2016, from the perspective of number of cases was ICICI bank
which was involved in 455 fraud cases, this figure was followed by State bank of
India which was on the second number with 429 fraud cases, the next banks in the
list were standard Chartered Bank with 244 cases and HDFC bank with 237 Cases.
Other banks who were also found with large number of cases were Axis Bank with
189 cases, Bank of Baroda 176 Cases and Citibank with 150 cases. On the other
front, SBI topped from the perspective of amount involved in these frauds which was
reported to be Rs. 2,236.81 Cr, the other banks to follow the league were Punjab
National Bank with Rs. 2,150.34 Cr and Axis Bank with Rs. 1,998.49 Cr. It was
reported by RBI to the Finance Ministry that in all these fraud cases reported by
banks the major role was played by Bank staff. The total number of employees
involved in all the frauds cases occurred in Public as well as private sector banks
were 450, out of which 64 employees were of State Bank of India, 49 employees
were of HDFC Bank and 35 employees were involved in the Axis Bank frauds cases.
The total cases reported in this duration from all the banks were 3,870 and the total
amount involved in these frauds was 17,750.27 crores. This shows a huge amount
every quarter and even every year is lapsed by banks in the fraud cases which
ultimately hampers the goodwill of the banks, also the profitability of banks get
affected.

1.5 Detection and Prevention of Frauds

Today, banking sector is facing strict regulatory policies in many countries. They
have many advanced techniques to identify the suspected fraud, committed by staff,
client, and other outside parties. Various fraud detection techniques are being
introduced by the Reserve Bank of India and other government agencies time to
time, which help the banks to detect, analyze and prevent the potential fraud. Banks

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can also reshape the policies for detection of frauds as per the requirement. This not
only helps the banks to detect the frauds but also enhances an effective system in the
path of anti fraud culture.

Systems and procedures those are frequently used by various Indian banks as
prescribed by RBI facilitate timely detection of frauds. Some of the sources of
unearthing frauds could be:

 Complaints from customers/ alerts from investigating agencies

 Electronic/ print media/ other outside sources.
 Prompt reconciliation of inter-office accounts
 Controller’s visits.
 Various audits/ inspections both by inside and outside agencies.
 Periodical changes in incumbencies.
 Anonymous/ pseudonymous complaints with verifiable facts.

Investigation into a fraud should bring out the modus operandi, lapses and the
persons accountable for the loss to the bank. Procedural irregularities or any
shortcomings, which facilitated the frauds, pointed out by an investigating official
must be rectified and confirmation must be given to the higher authorities and to the
regulatory bodies.

Compliance of prescribed systems and procedures and control functions are critical
to the organization in prevention of frauds. A review thereof should be undertaken on
a regular basis to ensure that frauds of similar nature do not occur. An illustrative list
of areas demanding focused attention of controllers, at every level, to ensure
prevention of frauds, is given below:

 Stress on following of compliance related to KYC norms should be a regular

practice.
 It should be ensured that all the control reports are meaningfully checked on
day-to-day basis. In case of any violation in preparation of reports, branch
managers and controllers should be held responsible.
 Secrecy of passwords should be maintained.
 Paying branches should seek prior confirmation from issuing branches in case
of presentation of a manually prepared draft for payment.

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  Involvement of staff should be there through concepts likes, “Preventive
vigilance committees”, “whistle blower”, “Alertness Awards Scheme”, etc.
 Imparting training to employees to update their job knowledge in changes in
systems and procedures, etc., and equip them to cope up with the
technological advancement in bank.
 Following ethical practices and code of conduct adopted by the bank.
 Action should be taken against the third party vendors who are found to have
committed any fraud individually or with collaboration of bank employees.
 There must be a policy for Job rotation, transfers of employees.
 The bank should keep an eye over the lifestyles of members of staff and also
there should be proper Scrutiny of staff accounts.

1.6 Preventive Vigilance

The literal meaning of the root-word "vigil" is "being watchful and alert even during
the time given to rest or sleep."

In an organizational setup, therefore, "vigilance" connotes being watchful in the day-

to-day transactions in line with the laid down systems and procedures as well as
being judicious, transparent and disciplined in all official dealings. The main focus
of vigilance activity is generally to diagnose the symptoms of procedural/systemic
failures in a particular part, or organization as a whole. The role of vigilance is akin
to that of antibodies built up in the immunity system of the body to fight against any
internal/ external attack. Thus, vigilance works against any possible abuse/ misuse of
powers and exercise of discretion which is to the detriment of the organization.

The reason of such activities of vigilance is not to reduce but to enhance the level of
managerial efficiency and effectiveness in the organization, both at micro as well as
on macro level. Commercial risk taking forms part of business. The purpose of
vigilance at the public sector bank is not to stifle such ability or obstruct the
achievement of organizational goals and objectives. Vigilance itself is classified in
the functional aspects in the following categories:

a) Punitive vigilance

b) Detective / Surveillance vigilance

c) Preventive vigilance

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The above order is as per the traditional approach, in which the vigilance activity is
performed. The right approach would be the other way round, i.e., starting from
preventive, then detective and ultimately leading to punitive vigilance.

1.6.1. The definition of Vigilance angle by Central Vigilance Commission

The term "Vigilance angle" has been defined in the Special Chapters for Vigilance
Management in the public sector enterprises, Public sector banks and public sector
insurance companies. The matter with regard to bringing out greater quality and
precision to the definition has been under reconsideration of the Commission. The
Commission, now accordingly, has formulated a revised definition of vigilance angle
as under:

1. Vigilance angle is obvious in the following acts:

i. Demanding and/ or accepting gratification other than legal remuneration in

respect of an official act or for using his influence with any other official.

ii. Obtaining valuable thing, without consideration or with inadequate

consideration from a person with whom he has or likely to have official
dealings or his subordinates have official dealings or where he can exert
influence.

iii. Obtaining for himself or for any other person any valuable thing on pecuniary
advantage by corrupt or illegal means or by abusing his position as the public
servant.

iv. Possession of assets disproportionate to his known sources of income.

v. Cases of misappropriation, forgery on cheating or other similar criminal

offences.

2. There are, however, other irregularities where circumstances will have the
weighed carefully to take a view whether the officer's integrity is in doubt. Gross
or willful negligence, recklessness in decision-making, blatant violations of
systems and procedures, exercise of discretion in excess, where no ostensible or
public interest is evident, failure to keep the controlling authority/superiors
informed in time-these are some of the irregularities where the disciplinary

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 authority with the help of the Chief vigilance officer (CVO) should carefully
study the case and weigh the circumstances to come to a conclusion whether
there is reasonable ground to doubt the integrity of the officer concerned.

3. The reason of the vigilance activity is not to reduce but to enhance the level of
managerial efficiency and effectiveness in the organization. Therefore, every loss
caused to the organization, either in pecuniary or non pecuniary terms, need not
necessarily become the subject matter of the vigilance inquiry, thus, whether a
person of common prudence, working within the ambit of the prescribed rules,
regulations and instructions, would have taken the decision in the prevailing
circumstances in the operational interests of the organization is one possible
criterion for determining the bona fides of the case. A positive response to these
questions may indicate the existence of bona fides. A negative reply, on the other
hand, might indicate their absence.

4. Absence of vigilance angle in various acts of omission and commission does not
mean that the concerned official is not liable to face the consequences of his
actions. All such lapses not only attractive vigilance angle would, indeed, have to
be dealt with appropriately as per the disciplinary procedure under the service
rules.

Studies have shown that the preventive vigilance (as against surveillance/ detective/
punitive vigilance) culture is not only cost-effective but is also people-oriented and
works in the greater cohesive interest of the employer-employees. An organizational
culture which nurtures professionalism and proactive approach in the sphere of
vigilance presupposes presence of preventive measures.

The employees of any financial institution, like the employees of any organizations
come from diverse and myriad set of social, economic and religious backgrounds.
Their interactions in the various formal and informal forums in the organizational
set-up are bound to be guided by the values or beliefs ingrained over a period of
time. So that, the explicit and implicit values, organizational values and expectations
are stated beforehand and the people may not find the difference between their
conduct in a social context and that in the organizational context. Even though, in a
broad spectrum, people can be looked at as employees, with homogeneous
expectations, they essentially differ from each other in terms of their values, beliefs,

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knowledge, skills and attitudes. They are therefore required to be guided in their
organizational endeavors.

On the dimension of honesty and efficiency, broadly the people can be classified in
four distinct categories as follows:

a) Honest and efficient

b) Honest but inefficient

c) Dishonest but efficient

d) Dishonest and inefficient

While the bank can justifiably be proud of the officials under category (a), it will
have no problems in identifying and weeding out the last category of employees.
Cases of those falling under category (b) would generally be dealt with by initiating
the appropriate disciplinary proceedings process. However, it is the people whose
description matches with category (c), who are required to be guided in the
"preventive vigilance" area.

Various management theories have, on the basis of empirical studies, tried to unravel
the mystery of motives and the motivational drives of the employees. These
(motives) refuse to be cast in any broad behavioral paradigm, which could apply to
all set of people, all the times, under all circumstances. These behavioral scientists
have made assumptions about the employees as rational human beings, who are
guided by their own 'motives', in terms of their values, beliefs and incentive
structure. The fact is that the external environment factors play a very big role in
shaping of personal values or beliefs of the employees.

Douglas McGregor (1957), (of Theory X/ Theory Y fame), in his theory on the
"elements of discipline" (popularly known as "Hot Stove" theory) mentioned five
elements of discipline as a sine-qua-non for a conducive organized set-up
environment in an organization. These are:

1. Announcement

2. Advance warning

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 3. Immediacy

4. Impartiality

5. Impersonality

Prevent Vigilance refers to that branch of vigilance activity which involves taking
"proactive steps" (as against reactive) which makes the prognosis ( as against
diagnosis) of the organizational environment, by defining and delimiting the systems
and procedures and test their robustness in an efficacious manner; It checks how the
knowledge base of its human resources and HRM policies help in achieving its
corporate objectives; how the tools or mechanism employed help in ensuring "rotten
eggs" segregated and weaned away, and the people with right set of values
encouraged and propelled, with a view to bring about purity of administration.

The primary preventive measures required to be adopted by the banks are in the
following areas:

a) Right recruitment

b) Proper training

c) Stringent rules and external vigilance

a. Right recruitment

The lure of "lucre", to some, is so strong and opportunities of making quick buck are
so many in banking transactions, that only a stable mind can resist the temptations.
With the alarmingly falling moral values, the fence-sitters are joining the team of
inherently dishonest persons. The psychological screening (what is commonly
known as "psychometric tests") has therefore come to assume a bigger role.
Although, the banks are already using these psychometric tests on their prospective
employees, the testing techniques are required to be refined further.

b. Training

Training, retraining and refresher courses are the watchwords of all organizations
that achieve their targets and reach coveted goals. Obsolescence of the technology in
banking is so fast that if training, retraining to the upgraded technology is not

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managed, the organization is likely to be left behind, besides exposing itself to many
dangers from the lurking "bunko". Training for this purpose should focus on,
improving the knowledge base, improving the interpersonal relationship,
management of men, materials and situations; bringing in motivation, job
satisfaction, and philosophy of correct attitude in trying situations and improving the
operational skills, applications, appraisals and innovation.

Training is too serious a matter to be left at the hands of the middle level managers.
Top management is required to involve itself fully in the training related processes,
in the interests of organization’s requirements. The following statements would
capture the training function at most of the places:

1. Trainers are generally short-listed from out of those who are not wanted
elsewhere, often dubbed as a frustrated lot. They even do not motivate the
trainees who also are the frustrated and de-motivated bunch.

2. The attitude of the top management towards training is as "imposed

unnecessary evil" and a "wasteful activity".

3. Inadequate training aids.

4. Lack of the academic environment.

5. No formal system of obtaining feedback, more often not taking lessons there-
from.

Training of the bankers is expected to make them fighting-fit to meet the menace of
frauds squarely. The programmes on fraud prevention and detection are required to
be organized on regular basis so that the operational level people understand the
following areas:

1. Why frauds occur?

2. Fraud prone potential areas

3. Committal mode- Local loops

4. Preventive mode- Environment and on site/ off site controls

5. Detection mode

6. Minimization of losses
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Training is also required to lay stress on human behaviour, thus leading to
inculcating values like,

a) Honesty

b) Devotion to duty

c) Excellence

d) Critical appraisal of performance

e) Contentment

f) Motivation for hard, honest and efficient work

g) Cooperation

c. Stringent rules and effective vigilance environment

Banking transactions are the result of the work of the whole team, thereby naturally
resulting into placing of some trusts in the other member for team. If an employee
becomes untrustworthy, the first specialty will be the trust and the resulting mistrust
would be to the detriment of the bank. The rules should be such that the possibility of
prolonging flash delaying the proceedings and punishment should not be possible.
Thus, the rules must be explicitly stated and should not leave any scope for loose-
ends.

1.7 Fraud Prevention

The focus of the preventive vigilance activity is to create a right environment which
would ensure the employees willingly complying with the systems and procedures,
thus disallowing the damage to the interest of the organization, posed by the internal
and external sources. Even though, the scope of preventive vigilance goes much
beyond dealing with only fraud cases, the reality is that the frauds occupy a lot of
time and efforts, and money of the organization, in terms of prevention, detection
and appropriate follow-up measures.

Fraud prevention as stated earlier, is the most cost-effective way to minimize the
fraud incidents. There have been many studies conducted in the manufacturing
sectors (which apply to service sector, in equal measure) which indicate that the cost

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of preventive maintenance vis-a-vis the corrective maintenance and the failure cost
follow a ratio of 1:10:100. It indicates that the preventive measures do have a definite
cost, but it is only 1/l0th of the cost associated with correction related measures and
only 1/100th of the cost if the actual failure takes place.

Prevent vigilance follows almost similar pattern vis-a-vis the other types of
vigilance. Therefore, it pays to have prevented vigilance culture in an organization
then to "rue at one's leisure".

A fraudster is actuated by personal gain motive for which, consciously or otherwise,

he would do a mental risk-return trade-off. Once he reassures himself that the payoff
for committing a fraud is higher than the associated risk-costs, he would try to take
his chance. In this process, he sometimes twists the risk-return tradeoff, taking
advantage of the environmental factors. This poses a real danger and sometimes it
may not be possible for the fraud-buster to forecast or visualize the pattern of grand
designs of the fraudster. However, more and more one shows willingness to know
and learn about the possible loopholes in the system, the probability of success of the
fraudsters can be mitigated.

Once a fraud has been committed, there are no winners. Victims lose because of the
stolen money, legal fees, lost time, public exposure, and other consequences.
Perpetrators also lose because once caught, they suffer humiliation and
embarrassment and also punishment. The investigation of fraud can be very
expensive. Organizations and individuals that are associated with taking proactive
fraud prevention measures usually find that these measures pay big dividends.

These measures could be divided into two parts; first dealing with values of honesty,
openness and assistance, while the other set deals with taking away the opportunities
from the fraudsters to commit frauds.

Anybody could become dishonest

It would be nice to believe that most individuals and most employees are honest and
would never commit fraud. On the contrary, most people are capable of committing
frauds and many people adapt to the environment of low integrity, poor control, poor
accountability, and high-pressure; people become increasingly dishonest than they
are, where the management resorts to questionable dishonest practices. The fraud

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incidences increase when crimes are perceived as mere deviations or when equivocal
signals are given by the management, indicating permissive culture.

The culture of honesty, openness and assistance

Five major factors in fraud prevention in relation to creating a culture of honesty,

openness, and assistance are as follows:

1. Hiring honest people and the provision of fraud awareness training.

2. Creating a positive work environment which means having an open door policy,
not operating on a crisis basis and having a low fraud atmosphere.

3. Having a well understood and respected code of ethics.

4. Providing an employee assistance programme that helps employees to deal with

personal pressures.

5. Creating an expectation that dishonesty will be punished.

High fraud environment is characterized by following factors

1. Managers not caring about or paying attention to honesty.

2. Inadequate pay.

3. Lack of recognition for job performance.

4. Unreasonable budget expectations.

5. Employees’ expectations of a high lifestyle.

6. Perceived inequalities in the organization.

7. Inadequate expense accounts.

8. Autocratic management.

9. Low company loyalty.

10. Short-term focus.

11. Management by crisis.

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12. Rigid rules.

13. Negative feedback and reinforcements.

14. Repression of differences.

15. Poor promotion opportunities.

16. Hostile environment.

17. High turnover and absenteeism.

18. Cash flow problems/others finish in problems.

19. Reactive management.

20. Managers who model to be ready that, impulsive, insensitive, emotional, or

dominant personalities.

21. Rivalry / adversarial relationship.

22. Lack of clear organizational responsibilities.

23. Communication practices.

1.7.1. Fraud Prevention Measures

Eliminating opportunities for fraud

The six methods of checking fraud opportunities are:-

1. Having a good system of internal controls.

2. Discouraging collusion between employees, customer and vendors.

3. Clearly informing vendors and others outside contacts of the company's policies
against fraud.

4. Monitoring employees.

5. Providing a hotline for anonymous tips.

6. Conducting proactive auditing.

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A good System of internal controls

1. Deterrence of frauds.

2. Internal auditing responsibilities:

a) Organization environment fostering control consciousness

b) Realistic organizational goals and objectives are set

c) Written corporate policies prohibiting activities or actions which are non

tolerable

d) Appropriate authorization policies established and maintained

e) Policies, practices, procedures, reports and other mechanisms are developed

to monitor and safeguard assets, particularly in high-risk areas

f) Communication channels provide management with adequate and reliable

information

g) Recommendations need to be made for establishment or enhancement of

cost-effective controls of frauds

3. Monitoring employees.

4. Providing a hotline for anonymous tips.

5. Conducting proactive auditing.

1.8 Financial Fraud

The legal position in respect of frauds has three dimensions, viz., contractual,
tortuous and criminal.

Fraud is defined in Section 17 of the Indian Contract Act, 1872 for the purpose of the
contract. In such an event, the contract becomes voidable (as against void/ illegal) at
the option of the party suffering from the fraud. He may, if he likes, decide to
continue with the contract. Law provides absolute option to the concerned party as a
special additional right to neutralize the advantage or gain by the party committing
fraud. The court may also compensate him if he suffered from any damage before

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terminating the contract. But he has a burden of proof to show to the court that he
was defrauded by the other party intentionally according to the definition conditions
laid down by the act, that

a) A party having the knowledge of fact essential to a contract did not disclose the
fact which would have altered the decision of the other party, or

b) A material misstatement was made knowing that the statement was false, and

c) That the party intended to obtain a favorable decision from the other party by
committing such an act.

Tortuous dimension of fraud: As a civil wrong (private wrong) within the

parameter of right in rem, fraud covers any action or abstinence, statutory or
otherwise, which may cause damage to other. So if any fraud is caused on any person
in any of the situation other than the contractual situation whether it does or does not
fall under any specified crime, the person can bring the matter to the notice of the
district court for obtaining remedies. Thus, in any market situation, fraud is regarded
as a foul play in the market game and as such, the market regulator may neutralize
the impact of the act by (a) penalizing the players by giving him warning for minor
foul so that he does not dare it repeat; (b) suspend him from the game; (c). de-bar
him from playing the game permanently; and (d) impose penal compensation to
identify the person suffering from fraud.

Criminal dimension of fraud: Fraud as such is not a criminal offence in India. If

any fraud is committed in a bilateral contractual situation or otherwise whether
involving personal fund or public fund, also an act of cheating or if such an act
involves impersonation, criminal breach of trust or criminal conspiracy, or forgery,
or falsification or destruction of documents for wrongful gain or embezzlement of
funds, then and only then, such fraud can be an offence.

The expert committees on Legal Aspects of Bank Frauds (Dr. N.L. Mitra Committee)
(Mitra, 2001) have suggested that the following aspects can be covered in prevention
of frauds:

a. In -house operations to legal compliance and certification process

b. Development of best practice code for observance of prescribed and

professional code

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 c. In-house watchdog

d. Information networking between the member banks

e. Codification of standard audit practices on fraud and adults

f. Fraud defense networking

g. Special programmes for developing auditor's consciousness on fraud.

The timely intervention in fraud cases is of paramount importance. Role of internal

staff of a bank in financial fraud was also examined by the N.L. Mitra Committee.
The role of the staff can be divided into the three specific heads:

a) Action taken with due diligence and in good faith

b) Action taken negligently without regard to due diligence, and

c) Transactions conducted in collusion

The Committee observed that financial and banking fraud could not be accomplished
without the participation of internal staff. Frauds are committed usually in anyone of
the following ways:

a. Preparation of letter of credit (LC) foreign excess of dissension remit.

b. Establishing of LC in favour of associate concerns.

c. Sale of goods under LC, in transit and diversion of sale proceeds.

d. Drawing from some cash trade account beyond sanctioned limits.

e. Diversion of funds.

f. Removal of stocks and securities.

g. Falsification of receivables.

Some examples of financial frauds

a) A person took project finance from a bank creating a security interest by happen
to getting its plant and machinery. The company afterwards transfers the plant
without the permission of the bank. This is a financial fraud by suppression of
fact.

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b) A person having taken credit from the bank on the security interest of charge
being created on inventories, described as sealed tins containing mustard oil, and
replaced the tins with "Ganga" water. This is a financial fraud by cheating.

c) A person opens a letter of credit for goods on transit by ship and transfers the
goods on the way and takes the consideration without the information being
communicated to the bank. This is a financial fraud by suppression of fact.

d) The person opens a Foreign Currency Non-Repartriable (FCNR) account with the
power of attorney from a Non-Resident Indian (NRI) and uses the same as the
security interest on his overdraft borrowing. Money is drawn and transferred
from the overdraft account to another banker. This is a financial fraud by way of
suppression of fact and misstatement.

e) The person in debt intentionally doing an act for making the creditor unable to
realize his credit is a financial fraud by fraudulent act.

f) A banker violating the guidelines of the bank or of the RBI without acting
prudently and sanctioning the loan with intention of making a wrongful gain or
providing an opportunity for gaining wrongfully by the debtor or causing a
wrongful loss to the bank commits a financial fraud by fraudulent action.

g) A debtor creating security interest on stocks and shares at the market value and
thereafter playing with the intention of reducing the value of those shares in the
share market commits a financial fraud by fraudulent action.

h) An act, which in the event of insolvency or bankruptcy may be considered as

fraudulent preferences, is a financial fraud.

i) A person transferring any fund from one account to another account by means of
electronically operated system without proper authority commits a financial fraud
by fraudulent means.

The essential elements in all these examples are not very different. These are,

a) Misstatement, nondisclosures, suppression of facts, using asymmetry of

information as a method of wrongful gain,

b) A fraudulent intention of wrongful gain inflicting wrongful loss,

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c) Siphoning of public money like government funds, investors funds or public
deposits.

1.8.1 Prevention of Bank fraud

Financial frauds have become concern for the financial sector of many countries. The
Reserve Bank of India, in exercise of its supervisory powers west with it, has been
focusing on the bank fraud perpetrated by staff and outsiders. The highlighted fraud
prone areas are as follows:

a) Deposit accounts

b) Issue/payment of the demand drafts and other transfer instruments

c) Discounting / purchase of telegraphic transfers

d) Letters of credit/ guarantees and co-acceptances

e) Investments

f) Credit portfolio

g) Other common frauds

Most of the frauds had been perpetrated through:

a.Opening of accounts in fictitious names and then withdrawing there from the
proceeds of cheques, drafts, etcetera deposited therein. Moreover, some people open
fixed deposit accounts in several fictitious names or in names of persons not liable to
pay income tax and arrange loans of overdraft against security of such deposits.

b.Fraudulent withdrawals from properly opened accounts.

c.Manipulation of accounts.

1.8.2 Other Preventive Measures for Tackling Frauds

Administrative Measures for prevention of frauds:

a. Recruitment of employees should be carefully verified.

b. All employees handling various duties should be made aware of the essential

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 safeguards, which should be observed in the discharge of those duties.

c. The duties and responsibilities of the employees should be clearly laid down.

d. The principles of dual custody and not showing any vouchers, register,
ledgers to remain unchecked by a higher authority should be observed at all
times.

e. Banks should take steps to transfer their officials at reasonable intervals and
insist on their going on leave periodically.

f. Checking on the lifestyle of employees.

g. Disciplinary action should be taken timely and speedily.

h. Maintenance of security items and records.

i. Educating the public and the bank customers.

Additional measures of internal control for safeguarding bank focus on the

following cases:

1. Balancing of transactions relating to clearing of cheques, drafts etcetera.

2. Books of instructions.

3. Material alteration in cheques, if the bank is convinced that fraud has been
committed by its staff towards any constituent, it should at once acknowledge
its liability and pay the just claim instead of unnecessary litigation.

4. Prompt communication of contents of RBI to branches and other offices.

5. Furnishing of opinion reports on borrowers.

6. Safe custody of specimen signatures of officers.

7. Regulation of the issue of bank cheques by banks.

8. Grant of advances against third parry deposits.

9. Fraudulent encashment of foreign currency.

10. Periodical balancing of books.

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 11. Setting up of audit committees of board of directors.

12. Fraud in FCNR/ NRI accounts.

13. Frauds by parties promising to arrange for large deposits.

14. Credit monitoring system.

15. Grant of advances to a group of concerns by several banks.

Possible circumstances which facilitates perpetration of fraud

1. Wrong persons introduced both in deposit and borrowed accounts without

detailed inquiry or scrutiny and thus were given access to banking services.

2. Certain persons acting as middlemen/brokers without proper identification

were entertained as agents of so-called depositors/borrowers.

3. Large credits, debit and cash transactions in newly opened accounts did not
arouse the suspicion of the staff and no attempt was made to verify the
genuineness of the transactions with reference to the business of the account
holders.

4. Reconciliation of inter-branch accounts, clearing adjustment accounts,

follow-up of large outstanding entries in Office heads of accounts remaining
pending for long time.

5. The role of controlling office particularly in regard to receipt and scrutiny of

control returns and housekeeping was far from being effective.

6. There were huge arrears of balancing of books.

7. The bank's critical stationery; its stock-in-hand, indent, custody, issue,

movement, loss etcetera was not properly monitored.

8. Appraisal and review of borrowed accounts were carried out as a matter of

routine and early warning signals were ignored.

9. Inordinate delay in completion of investigation of detected frauds by

investigating agencies and also delaying completion of departmental action
not only failed to send a clear and strong message to the errant staff but also

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 demoralized honest staff who because of the case being treated as composite
one, came within the purview of investigation.

10. Unlimited computer access was provided to the third party suppliers and the
bank employees not related to the book keeping and supervision.

11. The process of concurrent audit as operative in the banks fail to achieve its
objectives in as much as the early signals of gross irregularity were not timely
reported and acted upon.

1.8.3 Profile of a fraud perpetrator

By physical attributes, it is very difficult to distinguish between a potential-fraudster

and any other person. No scientific formula has been formulated so far to capture the
essential personality profile of a potential fraudster. The work done in this area in the
western world has however led to identification of some traits which are more likely
to make somebody as a hot contender to fit in the description of a fraudster. The
fraudsters are, generally speaking, interfluent "know all", affable, sophisticated,
genial and good demeanor persons. But a word of caution here will be appropriate.
We should not paint all persons with the similar trait-profile as fraudsters. Every
intelligent person is not a fraudster. We must understand this basic premise;
otherwise it will lead to error of inductive logic.

W. Steve Albrecht, et al., in their book "Fraud-Bringing. Light to the Dark Side of
Business" had (Albrecht et al., 1995) compared the white collar criminals with

(1) Prisoners incarcerated for other property offences and

(2) A non-criminal sample of college student.

The personal backgrounds and psychological profiles of three groups were

computed. The results indicated that incarcerated white-collar criminals were
generally not similar to other incarcerated prisoners. When compared to other
criminals; white-collar criminals were less likely to be caught, turned in, arrested,
convicted, and incarcerated; they were also less likely to serve long sentences. In
addition, white collar criminals were considerably older, which might be expected
since it usually takes longer to get into managerial positions or other positions of
confidence. White-collar criminals tended to have much more stable family

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situations, they were more likely to be married and less likely to be divorced, they
had more children, and they were more likely to be active religious members.

Compared to other property offenders, a white-collar criminals were better educated,

more religious, less likely to have criminal records or otherwise be criminally
inclined, less likely to abuse alcohol and considerably less likely to use drugs. White-
collar criminals were also in better psychological health. They enjoyed more
optimism, self-esteem, self-sufficiency, achievement, motivation, and family
harmony than did other property offenders, which showed more depression, self-
degradation, dependence, lack of motivation, and family disharmony. White-collar
criminals seem to express more social conformity, self-control, kindness and
empathy, as compared to other property offenders who had greater social deviancy,
impulsiveness, hostility, and insensitivity to other people.

The above study showed that it is important to understand the characteristics of

white-collar criminals, because they appear to be a close match to people who have
the traits that organizations look for in hiring employees, seeking out customers, and
selecting them for this. This understanding leads to following statements:

a) That any employee, customer, vendor, or business associate fits the profile of
a white collar criminal and is probably capable of committing frauds, and

b) That it is impossible to predict in advance the employees and others who will
cross the line and become dishonest.

In his book "Bank Frauds- Prevention & Detection", B. R. Sharma (Sharma, 2008)
gives a profile of the "bunko", an insider causing damage to the organization from
within. The main characteristics of the personality of a "Bunko" are:

1. He is efficient.

2. He is obliging.

3. He is a "know all".

4. He is "indispensable".

The KPMG (2002) fraud survey, report in the Business World showed the profile of
a typical fraudster as that of a male, 26 to 40 years of age and who has been with the

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company for less than two years. Needless to say that he is intelligent, which is the
most common trait, as found in most of the studies, in India and abroad.

By no stretch of imagination, we should fall into the trap of generalization, and

should start reading something but is not there. But nevertheless, it will be safe to
deal with the people in a transparent manner and also should be watchful of the
environment, without becoming too intrusive into the affairs of the other employees.

1.8.4 Fraud perpetrators and their motivations as per Fraud Triangle Concept

There are thousands of ways in which the fraudsters have perpetrated frauds (Cressy,
1973). The three reasons among all of them that make a distraught wrangle and allow
the fraudster to perpetrate are:

1. Strong financial pressure,

2. A perceived opportunity to commit and conceal the fraud, and

3. A way to rationalize or justify the fraud as being ok.

Figure 1.3: The Fraud Triangle

Rationalization

Individual

Opportunity Pressure

Source: Adapted from Cressey, 1973

Pressure: Every fraud perpetrator faces some kind of pressure- actual or perceived.
Most such pressures involve financial needs. However, non-financial pressures such
as need to report results better than the last performance, frustration with work and

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even challenge to be the system can motivate fraud.

Opportunity: How so ever greater maybe the degree of pressures, the fraud would not
take place unless the perpetrator visualizes an opportunity and environment through
which he would give effect to his design. It did not matter much if the arbitrators
would actually get away with his crime; what mattered was that he could conceal the
fraud for which he had a perceived opportunity.

Rationalization: The third regiment in the floor to analysts the rationalization for
committing fraud so as to make the alienation consistent with the perpetrators
personal code of conduct. Rationalization consists of (a) the perpetrator did not
believe that what he was doing was illegal, although he might recognize it to be
unethical, and (b) he believed he would get an inheritance and be able to pay back
the money.

Thus, it would be seen that the three elements, perceived pressures, perceived the
opportunity and ability to rationalize are common to every fraud. Neither the
pressure nor the opportunity has to be real. If one perceives the pressure and an
opportunity and can rationalize his/ her behaviour, he/ she is likely to commit fraud.

The fraud fighters are generally focused only on one element of fraud triangle;
opportunity. They generally believed that the opportunities can be limited by having
good internal controls and focus on the prevention efforts on implementing controls
for ensuring that the frauds are prevented to occur. Rarely do they focus on the
pressures motivating frauds or on the rationalization of perpetrators. Actually these
three elements are interactive. In fraud, the greater the extent of perceived
opportunity or more intense the pressure, greater is the extent of perceived
opportunity to motivate someone to commit fraud. Likewise, the more dishonest the
perpetrator, the less opportunity and/or pressure it takes to motivate fraud. The
findings of various studies conducted recently shows that level of honesty are
decreasing, thereby making this interactive nature of the elements of raw tangle all
the more scary as less honesty makes it easier to rationalize, thus requiring less
opportunity and pressure for fraud to occur.

Pressures to commit frauds: Pressures that motivate individuals to perpetuate fraud

on their own behalf can be divided into four types:

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1. Financial pressures

2. Vices

3. Work related pressures, and

4. Other pressures

Financial pressures can occur due to:

a) Greed

b) Living beyond one's means

c) High personal debt

d) Highly medical bills

e) Poor credit excess borrowings

f) Personal financial loss

g) Unexpected financial needs

Vice pressures: Vices are the worst kind of fraud motivators. There are employees
who embezzle because they enjoyed drink and socialize in drinking clubs, horse
races, gambling, State government lotteries and now the online lottery culture.

Work related pressures: While financial pressures and vices motivate most frauds,
some people commit frauds to get even with their employers or someone else.
Factors such as getting little recognition for job performance, having a feeling of job
dissatisfaction, fearing losing one's job, being overlooked for promotion, and feeling
underpaid have motivated many frauds.

Other pressures: Sometimes, frauds are also motivated by some other

ungrouped/unrelated pressures, such as a spouse who insists, either directly or
indirectly, on improved lifestyle, or a challenge to beat the system. In the new
technology areas, there are those highly skilled professionals who only wanted to
show others that they can hack on crack the computer systems, even though they
were not interested in taking advantage of those skills for some material purposes.

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Most of us face pressures in our lives. We have legitimate financial needs, we make
foolish or speculative investments, we are also possessed by addictive vices, we feel
overworked and/or underpaid, or we are greedy and want more. We sometimes have
difficult time in making distinction between 'wants' and 'needs'. Indeed, the objective
of most people in the materialistic society is to obtain wealth, irrespective of the
means employed to ends achieved. The measure of success is how much money or
wealth a person has accumulated.

For some people, being successful is more important than being honest. If they are
asked to pick the personal characteristics they really like most in themselves, being
successful would rank higher than having integrity. Psychologists tell that
"everybody has his price", which acts as the threshold at which one may turn
dishonest. Individuals with high integrity and low opportunity need high pressure to
turn dishonest. That is the real danger.

In sum and substance, eliminating pressures in the fraud triangle has an effect similar
to the removal of heat from the fire. Without some kind of pressure, frauds rarely
occur.

Opportunity

Most frauds are perpetrated in environments in which controls are supposed to be in

place but are not being followed. This happens due to overriding and ignoring of
existing controls and not due to lack of controls, which allows most fraught with
perpetrated. A perceived to opportunity to commit fraud, to conceal it from being
detected, and to avoid being caught for the fraud is second element of the fraud
triangle. Albrecht et al (1995), categorizes such opportunities into six heads, under
internal control sectors and non-control sectors, as follows:

a) Lack or circumvention of controls that prevent and/or detect fraudulent

behavior

 Controlled environment

 The accounting system

 Control Procedures

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 b) Inability to judge quality of work.

c) Lack/ perception of disciplinary action.

d) Asymmetrical information.

e) Ignorance and apathy.

f) Lack of an audit trail.

Control structure related

1. Controlled environment: It is the work atmosphere that an organization

establishes for its employees. First, the most important element in establishing an
appropriate environment is managements own role and examples it sets for others.
Proper modeling (being a role model) and property labeling (training) are the two
most important elements in teaching honesty. Is the management models
unacceptable behaviour, the control environment is contaminated. Likewise, if the
management models a behaviour that is inconsistent with good control procedures,
the integrity of the control system erodes. Inappropriate behaviour by management
allows others to justify overriding or ignoring control procedures

Second, critical element is the management's communication. Proper labeling or

communicating what is and what is not appropriate is critical. Thus, parents who are
trying to teach their children awareness must say things like, "taking a chocolate bar
of a store shelves without paying for it is being dishonest" and "not returning the
extra change when someone portrays use dishonest". Similarly, the organizations that
what employees to behave honestly and advised that are consistent with could
control procedures must clearly label what is the accepted norms of behaviour. Code
of conduct, orientation meetings, training, supervisor/employee discussions, and
other types of indication that distinguish between acceptable and unacceptable
behaviour are very critical from employees’ point of view.

To be an effective deterrent to frauds, communication must be consistent. Messages

that change depending on circumstances in situations serve only to confuse
employees and to encourage rationalizations. The reason so many slots authoring
cash departments in the banks are that typical control procedures which are not
followed and inconsistent messages relating to procedures and controls are conveyed.

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Third, critical element in creating the proper control structure is the appropriate
hiring decisions. When dishonest individuals get hired, even the best controls will
not prevent frauds.

Fourth element of the control environment is a clear organizational structure. The

self day responsibilities are neatly defined, the fraud is less likely to be perpetrated.
In such an eventuality, it's easier to track missing assets and harder to embezzle
without being caught. State accountable defined job performance and for asset is
critical for a good control environment. The case in point is the testimony of the
fraudster, which shows the failure to assign strict responsibility:

"I was one of the eight tellers in a medium-sized bank. Because we all had access to
money orders and bank checks, I stole 16 money orders. I did not use them for 2
weeks to see if anyone would notice the missing. Then, I used one for $300. After
nothing being said during the next two weeks, I used seven more".

Fifth and last element of the control environment is having an effective internal audit
control, combined with security or loss prevention programmes. While most studies
have found the internal auditors detect only about 20 percent of all employ frauds
(others detected through tips, by alert employees and accidentally), the mere
presence of internal auditors provides is significant deterrent effect. Internal auditors
provide independent checks and cause perpetrators to question whether they can act
and not be caught. A visible and effective security function, in connection with an
appropriate loss prevention programme, can help ensure that fraud is properly
investigated and that control weaknesses and violations are appropriately established.

2. Accounting system: Second element of the control structure that reduces fraud
opportunities is a good accounting system. Every fraud is composed of three
elements:

a.The theft act, where receptors taken away.

b.Concealment, which is an attempt to hide the fraud from others.

c.Conversion, in which repetitive spends the money or converts the stolen asset.

3. Control procedures or activities: These procedures covered basically the

following five areas:

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 a) Segregation of duties, or dual custody

b) System of authorizations

c) Independent checks and balances

d) Physical safeguards

e) Documents and records

4. Inability to judge quality of work: The failures of controls are because of the
highly specialized area in which the supervisor either does not possess the
supervising skills or the workers have exceptional skills which the supervisor is not
able to monitor/ control. This description does not cover those cases where the
supervisors failed to exercise the controls which are available in the environment but
they themselves are not aware of, either because of lack of competence or because of
lack of excise of control. The latter category of cases is covered under "Under
control factors".

5. Lack/ perception of disciplinary action: An individual who commit fraud and its
either not punished or not punished adequately suffers no significant penalty and
offer resumes the full behaviour, because it appears to be rewarding. On the other
hand, the fraud perpetrators who was prosecuted, convicted or otherwise severely
punished commit no additional fraud/ offences, because he is disabled due to
documentation of his fraud. Fraud perpetrators are usually individuals who command
respect in their jobs, communities and social circles. They usually suffered
significant embarrassment from having family, friends, and business rates know
about their offences. Therefore they would like to have their act under the wraps and
not known to outsiders. However if organizations failed to realise that their failure to
discipline-and employee is like you to give messages and signals to others that fraud
perpetrators will not suffer significant consequences, the others would see perceived
opportunity that, when combined with pressure and rationalization, will result in
additional frauds in organization.

6. Asymmetrical information (lack of access to information): Many frauds are

perpetrated because the victims do not have access to precise information used by the
perpetrators, who have either by virtue of position or by knowledge, superior’s

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knowledge and therefore chance to perpetrate the fraud.

Many investment scams and management frauds are dependent on the ability to
withhold information from victims. Individuals can attempt to protect themselves in
such scams by insisting on full disclosures including wanted financial statements, a
business history, and other information that could reveal the fraudulent nature of
such organizations. Certain employee frauds are also allowed to be perpetrated as
only the employee had access to necessary information.

7. Ignorance and apathy: Older people, individuals with language difficulty and
other one river citizens are often flawed victims because perpetrators know that such
individuals may not have the capacity or the knowledge to detect their illegal acts.
Fraud involves deception by scanning and that enable such people to be deceived
easily.

8. Lack of an audit trail: Organizations go to great lengths to create documents and

sister procedures that will provide an audit trail so transaction can be reconstructed
and understood. Many flaws, however, involves cash payments or a meditation of
records that cannot be followed. The smart employee fraud perpetrators understand
the failure of their fraud being concealed. They know that such concealment involve
depletion of financial statements etcetera.

The above analysis would tell that opportunities are provided by a weak internal
control environment (lack of internal control procedures, failure to enforce internal
controls), or other factors such as inability to judge the quality of performance, lack
of adequate punishment, lack of access to information, ignorance, incapacity or
apathy, or lack of audit trail. The lesson is that the opportunities should be minimized
so that they deter the perpetrator in making easy virtue out of the system deficiencies.

Rationalization: The third important element which completes the circuit for
fraudulent design is rationalization by the perpetrator. Nearly every fraud involves
the element of rationalization. Most fraud perpetrators are first-time offenders who
would not-commit other crimes. The common rationalizations used by the fraud
perpetrators are:

1. The organization owes it to me.

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2. I am only borrowing the money and will pay back.

3. Nobody will get hurt (as individual, at least).

4. I deserve more.

5. It's for a good purpose.

6. Something has to be sacrificed- my integrity is my reputation.

People rationalize for anything, good or bad. It may also sometime involve
dishonesty of lying. This type of rationalization often allows the perpetration of
frauds. Sometime it's lying to oneself. Sometimes, it's lying to others. We judge
ourselves by our intentions and other people by actions. For most of us, our
intentions are far better than our actions. When people judge themselves by their
intentions, it's easier for them to visualize frauds they have perpetrated. With
pressures, they perceive an opportunity, and they intend to (or rationalize that they
will) pay the money. That is a hot- recipe for commission of a fraud.

Perpetrators don't commit fraud unless they can rationalize it as being consistent with
their own personal code of ethics. Some frauds are visualized by revenge toward
specific organizations or individuals. Sometimes people see a difference between the
harm they would cause to individuals and doing harm to organizations. Someone
could justify taking on or cheating companies, but not people. He would see
company as an inanimate and bloodless entity and therefore, a perfectly fair target.
That is his own logic, fortified by his values/ rationalization.

1.8.5 Preventive Vigilance in Computerized Accounting Environment

Fraud Risks

1. The manual systems that govern Banking operations worldwide have evolved
over a couple of centuries. The checks and balances laid down from time to time
have taken account of the various risks to which the system is susceptible, and
the ingenuity of the perpetrator of frauds. As new methods or cheating the system
have come to light, the procedures have been modified where necessary. In a
computerized environment, the stakes have dramatically changed. The ledger
sheets have been replaced by computer files and printed books of accounts by

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 unwieldy continuous stationery. The look and feel of the operating environment
has now been taken over by a monitor display screen. The risk of fraud has
increased substantially, not because the-data programs are inherently unsafe, but
because of an all-abiding faith in the veracity of machine generated outputs. It is
often presumed at the outset that whatever report or calculation the computer
generates is 100 percent accurate. This attitude can lead to complacency and can
dilute the need to apply the rigorous checking discipline that was the hallmark of
the manual system. To complicate matters, it has been observed that most
computer frauds are highly ingenious and difficult to detect. It is, therefore, even
more important to create a set-up where the risk of fraud is clearly perceived and
preventive procedures are put in place at every stage of the operating cycle. The
access controls guidelines listed below will serve to illustrate some of the ways to
tackle these problems.

Physical Access

2. The repositories of sensitive data and programs in an on-line LAN environment

are usually a Minicomputer or File Server. Such systems should always be kept
away from the main operating area/banking hall, and in an enclosed cabin or
separate room that can be securely located. The system room should be
accessible to authorized personnel only. In a branch environment, such
accessibility options should be universally defined, such as the System
Administrator and Branch Manager only and should not be within the local
purview. In case any other official or service engineer has to enter in sensitive
area, it should be done only in the presence of the authorized officials, and it
should be logged in a register designated for the purpose.

3. At infrequent intervals, the branch may be visited by the officials from

controlling offices for the purpose of installing new software, or some such
reason. It should not be automatically assumed that the physical controls should
be dispensed without such visits. The credentials of the official should be
established before access is given and the bona fides of the visit itself should be
independently confirmed. The access should also be logged in the normal course.
Any software loading operation carried out by such an official should be done
with the full knowledge, and in the presence of the branch system administrator.

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 System access rights should be set up with only such facilities as to complete the
task at hand.

4. The system administrators that have full access to the system should be well
vetted before appointment. A position that requires the utmost integrity should
not be trifled with and the candidates selected should be judged on such merit.
Frustrated officials should never be considered for these posts.

5. Systems officials who have submitted letters of resignation should be

immediately relieved of administrative duties and moved to innocuous areas for
the period of notice. The same would also apply to, officials who have been
subjected to disciplinary proceedings.

System Access

6. All authorized users on a computer system should be provided access through a

unique ID, and a password.

7. A periodic log of all users with their access rights listed should be printed and
retained in the records of the branch.

8. Passwords should be defined to be force-changed at regular intervals: Users

should be educated about the need to maintain utmost secrecy about their
passwords.

9. User access rights should be assigned very carefully, with the job description
being the overriding factor. Users should be given only 'Read' rights to program
file areas. Even Data areas can be segregated by function, and the files impacted
upon by a particular job and none other, can be assigned only to that particular
operator.

10. User access should be ultimately set up so as to launch an application directly.

The underlying operating system and database should be transparent to the user.
There should not be any scope for a user to 'see' the files at the root level. The
application should be set up in such a manner that a user who exits the
application should then be logged out of the system altogether.

11. Operating system access should be limited, even in the case of the, official

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 designated as System Administrator (SA) in a branch. The SA can be given
sufficient rights as needed to complete the end-of-day processes and the main
Supervisor password can be retained in a sealed cover and kept in the custody of
the Branch Manager or at an offsite location to be used only when required. Such
usages should have firm authorization and should be separately logged. Needless
to add, the initial supervisory rights assignments will have to be done by external
officials from the controlling office. After each usage, the password should be
changed (preferably by the Branch Manager, or an external Project official) and a
fresh sealed cover prepared.

12. Most network operating systems have time-restricted access definitions. Users
should be set-up to permit access only within the normal office hours, with a
reasonable spill over for delayed transactions. Likewise for system administrative
functions. Users should never be permitted to have 24-hour access, or access on
the day designated as the weekly holiday.

13. The actual installation of new programs and patches should be done by
controlling office staff. Adequate rights should be made available at the site for
the duration of the install process and deleted thereafter.

14. It is preferable to install new programs/patches as part of a new release rather

than an ad-hoc update. This will ensure that the Release Control security
procedures will be followed as a routine measure.

15. All new systems and programs should be periodically reviewed to monitor
operational validity. It should be ensured that the introduction of new programs
and associated data files does not compromise or invalidate any other process.

16. Every program in a financial application should have been thoroughly vetted
before implementation. The operational controls of on-screen checking,
exception checking, referrals, etc., should be incorporated into the regular routine
to safeguard against fraudulent data input. Control reports such as day-books
should be checked in every instance. Audit trails should be built into the system
to confirm the validity of the final file updates. The internal discipline that has
guided the manual checking procedures should not be diluted in a computerized
set-up.

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17. Back up procedures should take care of maintaining the state of data files at
periodic intervals, both as a disaster recovery measure and as a control
mechanism. A previous state can be used as a comparison to a current state in
case of fraudulently introduced programmes and data.

18. The daily reports should always include exceptional conditions such as large
withdrawals, transactions on inoperative accounts, excess drawings etcetera.
Where such conditions are capable of being intercepted in the form of referrals
by on-screen checking, then these controls should be built into the application.

19. Inspection and audit procedures should ensure that the discipline laid down for
user access control and program access control are rigorously followed.

1.9 Fraud Investigation

When symptoms of some "fishy" dealings are smelt, a decision has to be made
whether or not the matter is required to be further investigated. The objective of
investigation is to find the truth- to determine whether the symptoms actually
represent fraud or whether they represent unintentional error or other factors. Fraud
investigation is a complex and sensitive matter. Thus, if conducted perfunctorily, can
cause injury to innocent individual, guilty parties can go spot-free undetected to
repeat the questionable act/s, and the offended entity left with incomplete
information as to the basis for prevention of similar incidents or recovery of
damages.

Investigation of fraud symptoms with an observational master of management's

approval and can be quite expensive. Investigation should be pursued only when
there is reason to believe that fraud has occurred or when "predication" (affirmation)
is present. The overall objective of investigation is to find the truth. More
specifically, the objective proof is required to answer the following questions:

1. Who? The possible perpetrators and their level of complicity in the fraud.

2. Why? The motives for the dishonest acts, though it may not be very material
in some cases where dishonesty is not an essential ingredients of the offence.

3. How? The way in which the fraud was perpetrated. This is required primarily
to see that such channels are cut down in future and the frauds are not
repeated.

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Albrecht et al. (1983) has discussed two approaches of investigation in his book. The
first is to separate the investigative techniques into four categories based on the type
of evidence they produced. Using this approach, popularly known as Evidence
Square which consists of four elements:

1. Testimonial evidence: It is gathered from individuals. Specific investigative

techniques used together this sort of evidence are, interviewing and honesty
testing, such as graphology or polygraph examination and brain finger print
etcetera.

2. Documentary evidence: This evidence is gathered on paper, why a computer, and

from other it not printed sources. Specific investigative technique for telling
documentary evidence include, document irrigation, public record his searches,
audits, computer searches, net worth deflation, and financial statement analysis
etcetera.

3. Physical evidence: This evidence include fingerprints, marks left behind,

weapons, stolen property, identification numbers on stolen objects, and other
tangible evidence that can be associated with the dishonest act. The gathering of
physical evidence often involves forensic analysis by experts.

4. Personal observation: This involves evidence that is sensed (seen, heard, felt
etcetera) by the investigators themselves. Personal observation investigation
techniques involve (a.) investigation and (b.) surveillance and covert operations.

1.10 Theories of Fraud

During last few decades, many authors contributed different theories of frauds which
helped the researcher to understand concept of fraud from different perspectives.
Cressy (1973) elaborated fraud triangle theory in his study, which was among one of
the earliest theories of fraud, and it was recognized globally. Another theory given by
Wolfe and Hermanson (2004) discussed Fraud diamond theory which was an
upgradation on Cressy’s theory. Many other authors have given their contribution to
this segment which shows different reasons and concepts of fraud occurrence. The
section hereafter helped to find out the existing fraud framework models given by
different researchers.

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1. Fraud Triangle Theory

Cressy (1973) had given the most widely accepted theory of fraud, which was done
by interacting 200 fraudsters who actually violates the trustworthiness. The research
was mainly conducted in the Midwest US, where the prisoners were interviewed. He
had given a concept of triangle which shows three important pillars of fraud.

Figure 1.4: The Fraud Triangle Theory Concept

Rationalization

Individual

Opportunity Pressure

Source: Adapted from Cressey, 1973

The foremost pillar discussed in his theory is pressure, which forces the employees to
do the fraudulent activities. The frauds can take place due to any financial problems
which may be non- shareable in nature. As per him, there are six factors of non-
shareable reasons, which are violation of obligations, personal failures, business
reversal, isolations, gaining of status and employer- employee relations. These non-
shareable reasons varies from person to person and it may be non-shareable in one
case but may be shareable in some other cases. As per Cressy (1973) all these six
factors are responsible for happening of fraud in one or other case.

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 Figure 1.5: Non-shareable Fraud Factors

Employer-
Violation of Personal Bussiness Status
Isolation Employee
Obligations Failure Reversal Gaining
Relations

Bad High Lack of

Drinking Family
Judgement Interest trust

Living
beyond
means

Investment
Gambling Recession Associates Betrayal
Failure

Source: Cressey (1973)

The second pillar of fraud triangle theory as per Cressy (1973) is Opportunity. The
same factor is also explained in one other research study conducted by (Wells 2005).
Both the researchers emphasized on the fact that there is always be an opportunity
available for the fraudster to commit the fraud as it is not possible only with the non-
shareable problems which can enforce the fraud. The most important issue of
opportunity of fraud is trust, as where there is trust there is an opportunity present for
fraud occurrence. Moreover, it is the trust which provides the space for opportunity
to do fraud, it is the situation where the employees take benefit of their position for
which they are answerable and for which they hold the authority. The studies
presented an interrelated model that gives the picture that in every illegal activity
there is some activity of trust violation which is due to the reason that the employees
have gone beyond the powers of their designation. So, in both the studies, it is clear
that one strong reason that leads to opportunity for fraud is the weakness of internal
control systems (Cressy (1973); Wells (2005)).

The third and last parameter of the triangle theory of fraud is rationalization. The
rationalization situation defends the fraudsters as in this situation, the fraudsters tries
to justify the crime they did. However the same concept was used by Sutherland
(1949) in his study, where he gave the concept that every person involved in fraud

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always makes the justification of fraud as the other person involved in fraud have
some relation with previous fraud cases where he had have misused his position and
the second time again the threat of being caught is not there in the employees. In this
position of rationalization the person is able to justify his crime.

2. Theory of Differential Association

The Theory of Differential Association was propounded by Edwin Sutherland in

1930. Sutherland is famous in the field and is generally known as the “father of white
collar crime” as he had given one of the earliest studies on white collar crime (Well,
2005). For the very first time he introduced the concept of “white collar crime” in
1939, where he discussed about the fraud committed by the top level management.

According to the theory of differential association, Dame Joan Sutherland

(1949) instructed that offence is learned just like any other subject matter. He
believed that criminal initiation happens with every second person in a
unique method of communication, so criminality couldn't occur while not the
assistance of people. Gaylord and Galliher (1988) observed that Dame Joan
Sutherland in departure from economic account, biological and pathological visual
aspect attributes criminal offense to the common context of the person.
Sutherland (1949) viewed criminal conduct as arising once an individual is
exposed additional to definition of favourable to irreverence of jurisprudence and
further to definitions of unfavourable to violation of law; hence criminal
behavior could be a result of conflicting values. He theorized that the
acquisition method consisted of two areas: the techniques to commit the criminal
offense and the attitudes, crusade, rationalization and want of the criminal
mind. Therefore, he found that constitution that have dishonest workers can
eventually ‘infect’ a little of honest ones and usually that honest workers can
eventually have associate in nursing influence on a number of areas and
become dishonest (Sutherland, 1949; Well , 2005). This theory of differential
association is one of the widely accepted theories of white-collar offense.

However, authors criticized the theory on many grounds. Akers (1996) argued
against Sutherland’s Differential association theory on the basis of the inaccurate
assumption that Sutherland had suggested in his theory that by simply interacting
with outlaw an individual would tend to criminal deportment; but this was not

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exactly what Sutherland proposed. On the other side, the people who supported
Sutherlan’s theory like Donald R. Cressey (Sutherland & Cressey, 1978) argued that
some of this literary criticism is misinterpretation on the piece of the critics (Akers,
1996). Other criticisms emanate from the apparent inability of the theory to explain
human activity of deviance that is not necessarily learnt. Other authors argued that
the theory cannot be considered to be empirical (Matsueda, 1988; Akers, 1996) due
to the inability or difficultness in measuring and defining Sutherland's conception of
"definitions" favourable and unfavourable to criminal behaviour. Sutherland did not
clearly defined which crimes were white collar crimes as not all individuals in a lieu
of trust responsible for a white-collar job, for example a vehicle mechanic.

Laub (2006) argued that Sutherland’s concept “was flawed because he embraced a
sociological model of crime and in doing so adopted a form of sociological
positivism.” He further argued that Sutherland ignored key facts about crime that
were reverse to his theoretical partialities. Another adverse judgment was that this
theory represents a "cultural deviance" theory as it made incorrect presumptions
about individual attitude and the importance of culture in adverse situations
(Matsueda, 1988). However, Akers (1996) again argued that this criticism was yet
another misinterpretation of Sutherland's theory. Sutherland (1974) summarized his
own lean of some of the unfavorable judgment stratum against his differential
association theory, such as the theory: is defective as it omits consideration of free
will; ignores the role of the victim; fails to explain the origin of offence; does not
define price such as "systematic" and "excess" clearly; ignore biological parameters;
can apply to common public and assumes all persons are equally exposed to criminal
and anti-criminal behaviour convention. In spite of criticisms brought forward
against it, the Differential Association theory’s part is strong and several
contemporary theorists in criminology and sociology have extended and expanded on
Sutherlands’ theory to explain criminal behaviour (Akers, 2004; Burgess and Akers,
1966; Bandura, 1997; Glaser, 1956).

3. Job Dissatisfaction Theory

A study quoted by Hollinger and Clarke (1983) based on demotivated and

dissatisfied employees behavior which generally leads to fraud. The study took a
sample of 12000 related employees for the purpose of research. According to the

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researcher, fraud takes place when employee feels that the working conditions are
unjustified in the organization. These conditions make the argument of committing
fraud more justified (Well, 2005). But this theory was not able to connect with the
real situation as the proven employee theft cases were very low as the information
provided in the study was very less to conclude anything and the information related
to employee theft which was available was somewhat not reliable (Mustaine &
Tewksbury, 2002). This theory also suffers with the same issues of motivation and
rationalization just like fraud triangle theory.

4. The Fraud Diamond Theory

The fraud diamond theory was an upgraded model of fraud triangle theory. It was
propounded by Wolfe and Hermanson (2004). They gave the fourth dimension to the
present model of Cressy i.e. offender’s capability, here by the word capability they
meant technical expertise and confidence to commit crime or to leave the crime
situation. This model in all contains four variables which were motivation,
opportunity, rationalization and capability to commit the crime. With the addition of
forth element of offender’s capabilities Wolfe and Hermanson were able to overcome
the limitations of fraud triangle theory.

The study conducted by Omar and Mohd. Din (2010) also mentioned that this forth
element gave a clear view of social circles for committing a crime. They clarified
that the person, who has the expertise of doing and manipulating the things
technically, will sooner or later be the part of the crime. It may be by the wish of
himself or with the wish of others committing crime. In another study Anadarajan &
Kleinman (2011) relate all the four variables in their study. As per them the theory of
Fraud diamond completes the limitations of Cressy’s triangle theory, as where there
is probable opportunity, motivation and rationalization to commit crime, there must
be a capability in the offender to commit that crime. Otherwise the fraud will never
get successful. Always when any fraud takes place, there is a team of conspirators
who plan and commit the same.

5. The Fraud Scale Theory

Another theory on Fraud was “Fraud Scale”, propounded by Steven Albrecht in

1980’s. The theory of fraud scale was given by Steven Albrecht (Albrecht et al.,

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1983) in which he used some of the elements of Cressy’s theory which helps to
understand the behavior of the fraudsters. The theory of fraud scale explains the
concept compiled with three main factors just like Cressy’s model. The first element
used by him was the situational pressure, which was alike the financial pressure
element used by Cressy; second element of his study was perceived opportunity
which is again one of the element used by Cressy which tells about the opportunity to
commit the fraud which includes the laxities in the working culture and environment
of the organization. And the third and last element of fraud scale theory was
employee’s personal integrity which explains about the personal ethics of employee
in the working area.

Figure 1.6: Fraud Scale Theory

Source: Albrecht et al. (1983)

In the above figure Albrecht explained that when the three conditions of situational
pressure, opportunities to commit fraud and personal integrity to commit fraud are
low then the fraud level is high on the scale. In this situation, the possibility of fraud
occurrence is very high. In the above model it was shown that the two elements i.e.
situational pressure and opportunities to commit fraud are in opposite direction as
compared to the personal integrity. If the personal integrity is high in a person then
he always thinks for his own moral values and it will always restrict the person to
commit the fraud.

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Other Theories of Fraud

Apart from the above mentioned traditional theories, Biegelman (2013) has given
some more theories of fraud in his book ‘Faces of Fraud’. For many years he acted as
a fraud investigator, and he explained each of his theory as a real situational example.
These theories explained the actual cause as how and why fraud had taken place.

6. Tip of the Iceberg Theory

This theory as predicted by the author highlights that fraud is just like the iceberg,
actually fraud is that small part of the big blunder which is hidden or unseen till the
time of investigation, just like the iceberg where the small pieces of iceberg are
hidden on to the surface inside. Talking about the corporate fraud, it can be seen that
it is always detected when a detailed investigation comes into the picture. He quoted
a perfect example of an insurance company where it was found that due to
manipulation in the property claim of a homeowner, many other fraud related to this
scam were hidden by the company and with the investigation of one claim others too
were detected. By the end of this investigation many people found involved in the
scam and prosecuted as guilty.

7. Potato Chips Theory

In this next theory of Potato chips, author explained that first fraud is just like a
potato chip which actually forces anybody to do it again. The success of one fraud
makes the fraudster confident and also makes him addictive to commit it again and
again. Just like a potato chip which when once taken can’t be stopped to have it
again. This theory perfectly explores the common behavior of the fraudster, in which
the researcher tries to connect the two situations where he gave the details that when
a fraudster commits a fraud and get successful in that, then he automatically
inculcate the confidence in himself not to be caught further also. Biegelman (2013)
in his book perfectly correlated this situation with an example that it is greed of an
employee, talking about an organization he told that a long time employed person
was allegedly found to be guilty of committing frauds, repeating same again and
again, as being an old employee and success of doing fraud, makes him confident to
commit it again and again.

As per the author such a greedy employee, who is found to be guilty in the

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organization must be fired from the organization, as this employee have already been
addictive of committing crime, so cannot be stopped, even one successful act made
him bolder and bolder every time achieving success. Hence, it is safe to get rid of
these kinds of employees; otherwise it could prove to be a great damage to the
organization.

8. Rotten Apple Theory

It is a longtime saying that one rotten apple can spoil the entire barrel and the saying
is very true in the real time picture as well. The same can be correlated with the
situation of fraud also, as one fraud which is uncaught can emphasize the other
employees also to commit the same. Biegelman (2013) explained in his book that a
group leader has a strong impact on his colleagues, which ultimately proves that if
the leader is corrupt or if he is committing the fraud in the organization it will very
soon influence the subordinates. This activity is just like a termite which will slowly
and gradually eat the entire organization. Because, the true leaders always inspire the
others, and on the other part if we see it is also possible that for a bigger fraud one
can shake hand with other employees also. In this way the idea of one person can
influence the thinking of others too. However, if we talk about a person who is a bad
leader can spoil the attitude of working of his juniors. In simple words, a person who
does not follow the rules and regulations of the organization will ultimately effect the
working environment of the organization and the people following that person will
also start doing disrespect of the organization’s culture. More rules would be broken
down and resulting into more frauds in the organization.

The Biegelman (2013) connected the same with the perfect example that when a
manager was using his corporate credit card with a wrong purpose or for his personal
purpose, and his subordinates knew the fact, then after a time period they will also do
the same kind of acts. In another case where the manager was weak in the directions
and controlling his team, then this leniency was one of the reasons of fraud to take
place as the subordinates had a clear way of doing such an act. So, as per the author
the policy of ‘trust but verify’ should be opted by every organization.

9. Low-Hanging Fruit Theory

This theory explains the scenario of low level frauds in any organization. According

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to Biegelman (2013), a person is committing frauds at a lower position should be
removed immediately as and when the fraud identified, as the delay in doing so can
lead to a serious fraud activity. No doubt that the frauds which are of high risk nature
such as financial statement fraud and other frauds related to accounting should be
given more importance, but with this it is also important that one should keep an eye
on the frauds which are committed on a lower level. Because, these lower level
fraudsters can further lead to a big blast of fraud in the organization as they gradually
gain the knowledge of loopholes in the environment of organization. In this regard,
author has perfectly presented an example that the fraudulent employees by having
the authority and opportunity many times took the wrong benefit. In a similar case,
an employee who was responsible for ordering the material from the vendor in the
organization was showing the extra items in the invoice with the involvement of
vendor but not ordering those items physically. This kind of fraud was initially on
very low level but if the management ignores these activities then these kinds of
activities result in heavy losses to the organization. So, this will be appropriate to say
that if these “low hanging frauds” will not be taken under serious consideration, they
can further damage many things of the organization.

So, this is important to take a serious note on these low hanging frauds, and they
should not be ignored at any point of time. Also these kinds of frauds do not take
much of the investigative time and moreover, by removing such fraudulent employee
from the organization, the entire workforce will get the message that the organization
is strict on the part of frauds and does not give laxity for this kind of act.

10. Addition by Subtraction Theory

The theory of addition by subtraction as given by Biegelman (2013) is all about the
clearing the roots of frauds. It means, if the organization take a proactive step at the
very point when the fraud occurs, the process of fraud will stop there only and will
not go at higher level. Because, as the fraudulent employee grows in the
organization, he will go on further for pursuing the higher level frauds, in the same
way if the organization takes the action by removing that employee from the
organization then this process will stop with this activity. By removing this risk a
company saves many resources and it will ultimately improve the working
environment of the organization. However this theory sounds very simple to listen

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but in actual scenario it is very hard to implement it. But if the organization will
show the zero tolerance to the frauds, it will ultimately make the environment very
clean, and make the employees on high alert.

The theory is very clear that it aims at removing the actual source of fraud and
further elaborates that by subtracting the actual culprit from the organization it is
securing its future as if this employee will grow in the firm it will lead to many more
fraud and may add many more fraudsters.

11. Fraudster as Employee Theory

Employees play a vital role in the growth of the organization. Here, in this theory
Biegelman (2013) explained that the employee who are corrupt and commit frauds,
are actually taking wrong benefit of their position and authority. However, a good
employee always maintains the integrity of the business and always thinks for the
betterment of the organization, as they think that if the organization will grow, they
will get more success and better future. On the other hand, the fraudster employees
always find the loopholes in the internal control system and how to break down the
system for committing the fraud. These kinds of employee always think for earning
easy money and do not think for the future but only try to earn wrongful money by
adopting wrong ways of doing that. Further, the author explained that the superiors
have to understand that the attitude of each and every employee should closely be
observed and the guilty fraudsters should immediately be dismissed from their
positions, as they will always harm the organization.

1.11 Statement of the Problem

Banks deal with public money. Bankers have the responsibility to safeguard interest
of their depositors and all stakeholders. Bankers have to take decisions on day to day
basis within the prescribed discretionary power structure. So, bankers need to be
prudent, cautious and circumspect while taking decisions.

Presently, the Indian Baking Sector has been going through a troubled times from
last few decades. The reason behind this stressful condition of banking sector is the
increasing number and volume of banking frauds. Although, all the Indian banks
including the Reserve bank of India are taking various preventive, anti-corruption
and educative measures for reducing the harm of frauds in banking sector. But, still

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there is a wide gap between the actual and standard set of preventive practices
adapted by the Indian commercial banks.

Fraud is not only shrinking the profit margins of the banking sector as a whole but
also somewhere is the main reason of decreasing confidence of stakeholders. The
system needs a detailed report which can guide the authorities with the main root
cause of the problem.

1.12 Summary

This chapter had outlined the introduction of the banking, its evolution in India,
which includes the different stages of its development and along with this; the
introduction of one of the major problem associated with banking growth in today’s
challenging global business environment was highlighted as the banking frauds.
Firstly, the theoretical concept of banking fraud in relation to its meaning, types and
the various theories propounded by different authors provided a base for finding the
statement of the problem. Furthermore, the theoretical concept of the prevention and
vigilance concept in relation to bank fraud gave an analytical turn to the research
problem. For the enhancement of the theoretical concept associated with the banking
frauds, the study moved to the next section of review of related studies in the field of
financial and banking fraud.

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References

Albrecht, S., Howe K., & Romney, M. (1983), Deterring Fraud: The Internal
Auditor’s Perspective, Altamonte Springs, FL: The Institute of Internal Auditor’s
Research Foundation).

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