Chapter 2

Lecture 2.2: Legal Regime to Control Banking Frauds

INTRODUCTION:
 Banks are considered as necessary equipment for the Indian economy. This particular
sector has been tremendously growing in the recent years after the nationalization of
Banks in 1969 and the liberalization of economy in 1991.
 Due to the nature of their daily activity of dealing with money, and even after having
such a supervised and well-regulated system it is very tempting for those who are
either associated the system or outside to find faults in the system and to make
personal gains by fraud.
 A bank fraud includes a considerable proportion of white-collar crimes being
investigated by the authorities. These frauds, unlike ordinary crimes, the amount
misappropriated in these crimes runs into lakhs and crores of rupees.
 Bank fraud is a federal crime in many countries, defined as planning to obtain
property or money from any federally insured financial institution. It is sometimes
considered a white-collar crime.
 Banking has been defined under Section 5(b) of the Banking Regulations Act 1949.
According to it banking means accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise. To understand
the concept of Bank Fraud, we need to understand the concept of fraud and the
various types of frauds and the ways to detect the same and the prevention of the
same.

WHAT IS A FRAUD?
 Generally, A dishonest act or behaviour through which one person gains or tries to
gain an advantage over another which results in the loss of the victim, directly or
indirectly is called as fraud.
 Under the IPC, fraud has not been defined directly under any particular section, but it
provides for punishments for various acts which lead to commission of fraud.
However, sections dealing with cheating, concealment, forgery, counterfeiting,
misappropriation and breach of trust cover the same adequately.
 The Contract Act under Section 17 states fraud means and includes any of the acts by
a party to a contract or with his connivance or by his agents with the intention to
deceive another party or his agent or to induce him to enter in to a contract:
1. The suggestion, as a fact of that which is not true or by one who doesn’t believe it to
be true;
2. The active concealment of a fact by one having knowledge or belief of the fact;
3. A promise made without any intention of performing it;
4. Any other act fitted to deceive; and
5. Any such act or omission as the law specially declares to be fraudulent.
By reading the relevant IPC provisions and Contract Act, the essential requirements for fraud
are:
1 Representation of an Act
2 Fact
3 Believed to be false
4 Inducement of Act

Bank Frauds and elements:

 As stated earlier, the amount of loss sustained as outcome fraud exceeds the losses
due any other crime(s) put together. With the rising banking business, cheats in banks
are additionally expanding and the fraudsters are turning out to be increasingly
complex and shrewd.
 In an offer to keep pace with the evolving times, the banking segment has
differentiated its business complex. Substitution of the theory of class banking with
mass banking in the post-nationalization period has tossed a great deal of difficulties
to the administration on accommodating the social duty with financial reasonability
 The four most important elements for constituting fraud are; the active involvement of
the staff, failure to follow the instructions and guidelines of the bank by the staff,
collusion between businessman, executives and politicians to bend the rules and
regulations and any other external factors.

LEGAL REGIME TO CONTROL BANK FRAUDS:

 The Indian Penal Code,1860
 Criminal Procedure Code, 1973
 The Negotiable Instruments Act, 1881
 The Reserve Bank of India Act, 1934
 SARFAESI Act, 2002
 The Banking Regulations Act, 1949

IMPACT OF FRAUD IN INDIA

 “Offences related to banking activities are not only confined to banks but have a
harmful impact on their customers and society at large”.
 Many recent fraud incidents reported are related to fix deposits, loan disbursements,
and credit and debit card frauds and ATM based frauds.
 All these frauds show that not only they undermine the profits, reliability of services
and operating efficiencies but can also have an impact on the society and the
organization itself.
 With the increase in the gravity of such instances it is impacting the profitability of
the sector and there is an increase in the NPAs.
 This rise in the NPA is a serious threat to the Indian Banking Industry as the
sturdiness of a country’s banking and financial sector determines the quality of
products and services. It is also a direct indicator of the living standards and wellbeing
of people.
 Thus, if there is high level of NPAs in the banking system, then it reflects the distress
of borrower and the inefficiencies in the transmission mechanism. The Indian
economy suffers greatly due to these incidents.
 Fraud has also hampered the growth of this establishment/ industry.
 It is a huge killer for the business sector and underlying factor to all human
endeavours.
  It also increases the corruption level of a country.
 Even after there are various measures taken by the RBI to limit or decrease the
frequency of frauds, the amount of money lost is still on the rise.

CLASSIFICATION OF FRAUD AND PREVENTION

 To maintain uniformity in fraud reporting, frauds have been classified on the basis of
types and provisions of the Indian Penal Code, and the reporting guidelines for the
same has been prescribed by RBI.
 The Reserve Bank of India classifies Bank frauds in the following categories:
1. Misappropriation and criminal breach of trust.
2. Fraudulent encashment through forged instruments, manipulation of books of account
or through fictitious accounts and conversion of property.
3. Unauthorized credit facilities extended for reward or for illegal gratification.
4. Negligence and cash shortages.
5. Cheating and forgery.
6. Irregularities in foreign exchange transactions.
7. Any other type of fraud not coming under the specific heads as above.

MECHANICS OF BANK FRAUDS

1. DEPOSIT ACCOUNT FRAUDS:
The following types of frauds are generally committed;
a) Value inflation of cheques deposited
b) Changing the nature of the cheques (Crossed to bearer)
c) Operating a dormant account fraudulently
d) Non deposition and misappropriation by agents

Preventive Measures:
a) Careful and systematic examination procedures of cheques and other transactions.
b) Separation of book keeping and Cash handling operations.
c) Using Black light, adhesive tapes and pathfinders to ensure that originality and
prevent material alteration.

2. PURCHASED BILL FRAUDS:

These are generally expensive and can take the following forms:
a) Discount on Stolen or Fake Railways Receipts and motor receipts along with other
necessary bills.
b) Forged/ fake bills with inflated value, drawn on sister concern are discounted.
c) Fake/ Forged bills for valueless goods are discounted.

Preventive Measures:
 a) Examining the receipts properly and strictly by confirming from the concerned
authorities.
b) In case of auction, inform the authorities regarding the interest of the bank in the
property so as to get information in case of non-collection of goods.
c) Establishing a better connection between the purchaser and the seller in case of
dispatch of proceeds.
d) Strict examination before discounting the bill.

3. HYPOTHECATION FRAUD:
Cash advances, against pledged goods, as security are fertile field for frauds.
a) Unauthorized removal of hypothecated good from the godowns.
b) Some of the stocked goods in large quantity may have less value
c) Inflation of stock statements.
d) Valueless and meaningless stocks are offered as security.
e) Hypothecating same goods in favour of different banks.

Preventive Measures:
a) Strict examination of the bank representative’s and borrower’s credential

b) Only marketable goods to be accepted as security

c) Proper evaluation of stocks
d) Verification of statements of stocks

4. LOAN FRAUD:
The following types of frauds are generally committed;
a) Two different person taking loan on the same item or product
b) People taking loan without a providing actual address and disappearing at the time
of repayment.
c) Loan taken for one purpose but used for a different purpose i.e loan taken for
agriculture but used for personal purposes
d) Borrowing is denied when the particular person is alleged of non-payment.

Preventive Measures:
a) Proper verification of documents and the purpose for taking the loan

b) Including the local authorities as to verify the authencity of the loan purpose and
authentication
c) In case of a substantial amount of loan taken, it should be checked by the
competent authority.
5. COMPUTER RELATED FRAUDS:
 To provide efficient and fast service, most of the branches of the banks except
the ones in the rural and remote areas have been computerized. Not many
frauds relating to computers have yet been reported so far as computerization
in the Indian banks is of recent origin.
 But in the western countries where virtually everything is computerized, a
large number of cybercrimes in the banking sector are reported on a regular
basis. There is a need to analyse the nature of such crimes so that appropriate
preventive measures may be devised.
 Normally following types of frauds are committed-
(a) Spy software is devised by the cyber criminals to crack the passwords. They enter
into the computer system of the banks and manipulate the data to transfer the money from
other’s accounts.
(b) Computer virus is created by the mischief mongers who find way into the
computer system by way of e-mails. These viruses destroy the data stored in the computers
and slow down the entire computer system. It is sometimes alleged that the manufacturers of
anti-virus software themselves create virus so that their product may be sold in the market.
(c) Hackers are computer experts who steal the passwords and access the classified
information stored in the computer system. They do not even fear to “raid” the government
departments including military establishments to carry out their nefarious design to destroy
and mutilate the date stored in the computer systems. Such acts are committed normally not
for any material gain but to derive mental satisfaction out of other’s sufferings.
(d) Wiretapping is a crime committed by tapping the wire of the ATMs of the banks
to withdraw money out of other person’s account. The fraudster, in this case, attaches a
wireless microphone to the telephone line connecting the ATM with the bank’s computer and
records signals through wiretapping while a customer is using the ATM. These signals are
later on utilized for withdrawing money.
 The Government of India enacted the Information Technology Act, 2000 to
provide for punishment and penalties in respect of frauds committed in respect
of computers. Section 43 of the said Act provides for hefty damages up to
rupees ten lakhs payable by the offender to the person affected in case there
are unauthorized acts committed in respect of another person’s computer
system like access, downloads or taking copies of the information or data
stored, introduction of computer contaminant or computer virus, damages to
the computer or its system etc.
 Further, the said Act also provides for punishment with imprisonment up to
three years for tampering with computer source documents and for
hacking the computer systems.

6. CHEQUE FRAUDS:
This constitutes the biggest volume of bank frauds. This crime is done in the
following forms:
a) Cheques are stolen, filled and signed spuriously and encashed.
 b) The signed cheques are stolen and are encashed with alterations, if needed
c) Cheques issued by organisations for employees are duplicated
d) Alteration of cheques to increase the amount or change the beneficiary or add an
additional beneficiary.
e) Cheque Kitting: Cheque Kiting exploits a system in which, when a cheque is
deposited to a bank account, the money is made available immediately even though it is not
removed from the account on which the cheque is drawn until the cheque actually clears.

Preventive Measure:
a) The instrument must contain a proper date
b) The cheque must be checked thoroughly and the character should be verified
c) Checking the signatures which should be genuine.
d) The amount should be checked that it should be written in both numerical and
words.
e) Checking cheque kitting

7. DISHONOUR OF CHEQUES
Dishonour of cheques or cheque bounces are a very serious problem and it is
becoming even bigger. To cope with this issue which was affecting the smooth business
transactions, the Government of India has introduced the Negotiable Instruments Act, 1881
which provides for provisions to deal with cases of cheque bounce under section 138 to 142.
The Supreme Court of India in a landmark judgement Indian Bank Association vs. Union of
India has also provided with new guidelines to deal with cheque bounce cases.
Section 138 of the Negotiable Instruments Act, 1881 “Where any cheque drawn by
a person on an account maintained by him with a banker for payment of any amount of
money to another person from out of that account for the discharge, in whole or in part, of
any debt or other liability, is returned by the bank unpaid, either because of the amount of
money standing to the credit of that account is insufficient to honour the cheque or that it
exceeds the amount arranged to be paid from that account by an agreement made with that
bank, such person shall be deemed to have committed an offence and shall, without prejudice
to any other provisions of this Act, be punished with imprisonment for 1[a term which may
be extended to two years], or with fine which may extend to twice the amount of the cheque,
or with both: Provided that nothing contained in this section shall apply unless—
(a) the cheque has been presented to the bank within a period of six months from the
date on which it is drawn or within the period of its validity, whichever is earlier;
(b) the payee or the holder in due course of the cheque, as the case may be, makes a
demand for the payment of the said amount of money by giving a notice in writing, to the
drawer of the cheque,2[within thirty days] of the receipt of information by him from the bank
regarding the return of the cheque as unpaid; and
 c) the drawer of such cheque fails to make the payment of the said amount of money
to the payee or, as the case may be, to the holder in due course of the cheque, within fifteen
days of the receipt of the said notice.”

8. CREDIT AND DEBIT CARD FRAUD:

The introduction of plastic money also brought in the frauds as a natural evil fall out.
As a greater number of people using them there is more and more chances of fraud in the
related sector. The case is much worse in foreign countries where the general usage is much
higher than in India. The various modes of credit/ debit card fraud are:
a) Abuse of genuine cards: The genuine cards are stolen while in transit from the
institution to the user or from the owners and sometimes the card is stolen, and there is a
misuse of the stolen cards. Even in some cases the cardholders falsely report about their card
being stolen and go on a shopping spree before the acquirer bank suspends the transactions or
block the card.
b) Altered Cards :An altered card is an original card only which is altered by the
fraudster by giving a new name and if replaces the signature strip also then he gets genuine
account number from a bunco bankster. It is very abnormal and can damage the security
features of the card provided by the bank.
c) White Plastics :The duplicate fraudulent cards are called as white plastics. They
are the copy of the original genuine cards. They have pictorial similarities but doesn’t have
the safety features.
d) Impersonation frauds : These are also called as application frauds. The fraudster
assumes the name and address of some well know personality and collects the card.

Preventive Measures:
i. Speeding up the transmission of information about the stolen or altered card through
a dedicated website.
ii. Appointing trained operators to recognise and differentiate between genuine and
original cards
iii. Monitoring the working of the sale terminals periodically to detect unscrupulous
merchants.

CONCLUSION
These frauds are a creation of the experienced criminals, frantic customers or someone
associated with the banking system or a bunco bankster or their collusion. Most of time with
a strict vigilance and examination of various documents, their work can easily be detected.
The preventive measures stated above in this module will surely help if followed correctly in
combating the issue of bank frauds. Information of the conceivable avenues can keep the
banker cautioned and subsequently help in battling the frauds. These Frauds are now
becoming more and more frequent and can be considered as one of the main reasons for
damaging the economy of the country and with such high profile frauds happening all over
the country, it has become necessary to put a check to these activities and if possible to create
a more stringent legislation to deal with these issues. Sticking to the rules and eternal
vigilance is the basic preventive measure