“AN ANALYTIC STUDY ON BANK FRAUDS AND SCAMS”

CHAPTER 1:

1.1 INTRODUCTION
The Indian banking sector has experienced considerable growth and changes since liberalisation of
economy in 1991. Though the banking industry is generally well regulated and supervised, the sector
suffers from its own set of challenges when it comes to ethical practices, financial distress and
corporate governance. This study endeavours to cover issues such as banking frauds and mounting
credit card debt, with a detailed analysis using secondary data (literature review and case approach)
as well as an interview-based approach, spanning across all players involved in reporting financial
misconduct. The report touches upon the case of rising NPAs in the past few years across various
scheduled commercial banks, especially public sector banks. The study finally proposes some
recommendations to reduce future occurrence of frauds in Indian banking sector. The credibility of
third parties such as auditing firms and credit rating agencies is also questioned in the study and is
believed to be a significant contributor amongst other causes, such as oversight by banks and
inadequate diligence.

Banks are considered as necessary equipment for the Indian economy. This particular sector has
been tremendously growing in the recent years after the nationalisation of Banks in 1969 and the
liberalisation 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.

In recent years, instances of financial fraud have regularly been reported in India. Although banking
frauds in India have often been treated as cost of doing business, post liberalisation the frequency,
complexity and cost of banking frauds have increased manifold resulting in a very serious cause of
concern for regulators, such as the Reserve Bank of India (RBI). RBI, the regulator of banks in India,
defines fraud as - A deliberate act of omission or commission by any person, carried out in the
course of a banking transaction or in the books of accounts maintained manually or under computer
system in banks, resulting into wrongful gain to any person for a temporary period or otherwise,
with or without any monetary loss to the bank. A well-organized and efficient banking system is an
essential pre-requisite for the economic growth of every country. In modern era, banking industry
plays an important role in the functioning of organized money markets, and also acts as a conduit for
mobilizing funds and channelizing them for productive purposes. It has been observed during the
last 50 years that even the sophisticated markets and long-functioning banking systems have had
significant bank failures and bank crisis on account of increasing magnitude of frauds and scams.
Banks, therefore, need to get their customers actively involved in their fraud prevention efforts as
customers may be willing to switch to competing banks if they feel left in the dark about those
efforts. Since banking industry is a highly-regulated industry, there are also a number of external

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compliance requirements that banks must adhere to in the combat movement against fraudulent
and criminal activity

Fraud is defined as a criminal deception committed by a person who acts in a false and deceitful
way. There is a string of offences under a variety of legislation and essentially the suspect will
demonstrate some form of dishonesty and/or deception.

Fraud is an intentionally deceptive action designed to provide the perpetrator with an unlawful gain
or to deny a right to a victim. Fraud can occur in finance, real estate, investment, and insurance. It
can be found in the sale of real property, such as land, personal property, such as art and
collectibles, as well as intangible property, such as stocks and bonds. Types of fraud include tax
fraud, credit card fraud, identity theft, wire fraud, securities fraud, and bankruptcy fraud.
Counterfeit activity can be carried out by one individual, multiple individuals or a business firm as a
whole.

Many times, the perpetrator of fraud is aware of information that the intended victim is not allowing
the perpetrator to deceive the victim. The individual or company committing fraud is taking
advantage of information asymmetry specifically, that the resource cost of reviewing and verifying
that information can be significant enough to create a disincentive to fully invest in fraud prevention.

Banking fraud occurs when someone attempts to take funds or other assets from a financial
institution or from customers of that institution by posing as a bank official.

One of the most important responsibilities that a bank or financial institution has is to protect the
integrity of the institution by working hard to protect the financial assets that it holds. In order to do
so, the bank or financial institution must be certain to address the issue of bank fraud. Bank fraud
can be defined as an unethical and/or criminal act by an individual or organization to illegally
attempt to possess or receive money from a bank or financial institution.

1.1 DEFINITION:

Bank fraud is defined as using deception to steal money or assets from a bank, financial
institution, or a bank’s depositors. For legal purposes, a financial institution includes credit
unions and banks that are federally insured. This includes Federal Reserve banks, the Federal
Deposit Insurance Corporation (FDIC), mortgage lending agencies, and other institutions that
accept deposits of money or other financial assets. In general, bank fraud may involve any
deliberate action aimed at defrauding a financial institution. It may involve an intentional action
aimed at receiving assets, money, securities, credits, or property from a financial institution
through the use of fake or false information. The law provides a fairly broad definition of bank
fraud, and there are several facets of this offense that should be considered.

Banking has been defined under section 5(b) of the Banking Regulations Act 19491, “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 It is the
use of potentially illegal means to obtain money, assets, or other property owned or held by a
financial institution, or to obtain money from depositors by fraudulently posing as a bank or
other financial institution. In many instances, bank fraud is a criminal offence. While the specific
elements of particular banking fraud laws vary depending on jurisdictions, the term bank fraud

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 applies to actions that employ a scheme or artifice, as opposed to bank robbery or identity theft.
For this reason, bank fraud is sometimes considered to be a white-collar crime. Trials in courts
take place when such bank frauds and crimes take place.

MEANING:
Fraud is a worldwide issue that affects all continents and all sectors of the economy. As

per RBI, fraud can be described as – any conduct by which one person intends to gain a
dishonest advantage over another. Fraud encompasses a wide-range of illicit practices and
illegal acts involving intentional deception or misrepresentation. The Institute of Internal
Auditors- ‘International Professional Practices Framework
(IPPF) (2009) defines fraud as: ―Any illegal act characterized by deceit, concealment, or
violation of trust. These acts are not dependent upon the threat of violence or physical force.
Frauds are perpetrated by parties and organizations to obtain money, property, or services; to
avoid payment or loss of services; or to secure personal or business advantage. Fraud affects
organizations in several areas including financial, operational, and psychological. While the
monetary loss owing to fraud is significant, the full impact of fraud on an organization can be
staggering. In fact, the losses to reputation, goodwill, and customer relations can be devastating.
As fraud can be perpetrated by any employee within an organization or by those from the
outside, therefore, it is important to have an effective fraud management program in place to
safeguard your organization’s assets and reputation

Bank fraud is a criminal act that occurs when a person uses illegal means to receive money or
assets from a bank or other financial institution. Bank fraud is distinguished from bank robbery
by the fact that the perpetrator keeps the crime secret, in the hope that no one notices until he
has gotten away. The term bank fraud also refers to attempts by a person to obtain money from
a bank’s depositors by falsely pretending to be a bank or financial institution

Related Legal Terms and Issues

Assets – Property or finances owned by an individual or entity, and regarded as having value.
Identity Theft – The illegal acquisition and use of an individual’s personal identifying information,
usually for financial gain.

Trial – A formal presentation of evidence before a judge and jury for the purpose of determining
guilt or innocence in a criminal case, or to make a determination in a civil matter.

1.2 HISTORICAL BACKGROUND

There are certain types of bank frauds and scam, let us have a look at some frauds and scams:

Accounting fraud
In order to hide serious financial problems, some businesses have been known to use fraudulent
bookkeeping to overstate sales and income, inflate the worth of the company's assets, or state a
profit when the company is operating at a loss. These tampered records are then used to seek
investment in the company's bond or security issues or to make fraudulent loan applications in a

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final attempt to obtain more money to delay the inevitable collapse of an unprofitable or
mismanaged firm. Examples of accounting frauds: Enron and World Com and Ocala Funding. These
companies manipulated the books in order to appear as though they had profited each quarter,
when in fact they were deeply in debt.

Demand draft fraud:

Demand draft fraud typically involves one or more corrupt bank employees. Firstly, such employees
remove a few demand drafts leaves or demand draft books from stock and write them like a regular
demand draft. Since they are insiders, they know the coding and punching of a demand draft. Such
fraudulent demand drafts are usually drawn payable at a distant city without debiting an account.
The draft is cashed at the payable branch. The fraud is discovered only when the bank's head office
does the branch-wise reconciliation, which normally take six months, by the time the money is gone

Remotely created check fraud:

Remotely created checks are orders of payment created by the payee and authorized by the
customer remotely, using a telephone or the internet by providing the required information
including the MICR code from a valid check. They do not bear the signatures of the customers like
ordinary cheques. Instead, they bear a legend statement "Authorized by Drawer". This type of
instrument is usually used by credit card companies, utility companies, or telemarketers. The lack of
signature makes them susceptible to fraud. The fraud is considered Demand Draft fraud in the US.

Uninsured deposits:
A bank soliciting public deposits may be uninsured or not licensed to operate at all. The objective is
usually to solicit for deposits to this uninsured "bank", although some may also sell stock
representing ownership of the "bank". Sometimes the names appear very official or very similar to
those of legitimate banks. For instance, the unlicensed "Chase Trust Bank" of Washington D.C.
appeared in 2002, bearing no affiliation to its seemingly apparent namesake; the real Chase
Manhattan Bank is based in New York. Accounting fraud has also been used to conceal other theft
taking place within a company.

Bill discounting fraud:

Essentially a confidence trick, a fraudster uses a company at their disposal to gain the bank's
confidence, by posing as a genuine, profitable customer. To give the illusion of being a desired
customer, the company regularly and repeatedly uses the bank to get payment from one or more of
its customers. These payments are always made, as the customers in question are part of the fraud,
actively paying any and all bills the bank attempts to collect. After the fraudster has gained the
bank's trust, the company requests that the bank begin paying the company up front for bills it will
collect from the customers later. Many banks will agree, but are not likely to go whole hog right
away. So again, business continues as normal for the fraudulent company, its fraudulent customers,
and the unwitting bank. As the bank grows more comfortable with the arrangement, it will trust the
company more and more and be willing to give it larger and larger sums of money up front.

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Eventually, when the outstanding balance between the bank and the company is sufficiently large,
the company and its customers disappear, taking the money the bank paid up front and leaving no-
one to pay the bills issued by the bank.

Duplication or skimming of card information:

This takes a number of forms, ranging from merchants copying clients' credit card numbers for use
in later illegal activities or criminals using carbon copies from old mechanical card imprint machines
to steal the info, to the use of tampered credit or debit card readers to copy the magnetic stripe
from a payment card while a hidden camera captures the numbers on the face of the card.

Some fraudsters have attached fraudulent card stripe readers to publicly accessible ATMs, to gain
unauthorised access to the contents of the magnetic stripe, as well as hidden cameras to illegally
record users' authorisation codes. The data recorded by the cameras and fraudulent card stripe
readers are subsequently used to produce duplicate cards that could then be used to make ATM
withdrawals from the victims' accounts.

Cheque kiting:

Cheque kiting exploits a banking system known as "the float" wherein money is temporarily counted
twice. When a cheque is deposited to an account at Bank X, the money is made available
immediately in that account even though the corresponding amount of money is not immediately
removed from the account at Bank Y at which the cheque is drawn. Thus, both banks temporarily
count the cheque amount as an asset until the cheque formally clears at Bank Y. The float serves a
legitimate purpose in banking, but intentionally exploiting the float when funds at Bank Y are
insufficient to cover the amount withdrawn from Bank X is a form of fraud.

Forged or fraudulent documents:

Forged documents are often used to conceal other thefts; banks tend to count their money
meticulously so every penny must be accounted for. A document claiming that a sum of money has
been borrowed as a loan, withdrawn by an individual depositor or transferred or invested can
therefore be valuable to someone who wishes to conceal the fact that the bank's money has in fact
been stolen and is now gone.

Forgery and altered cheques:

Fraudsters have altered cheques to change the name (in order to deposit cheques intended for
payment to someone else) or the amount on the face of cheques, simple altering can change
Rs.100.00 into Rs.100,000.00. (However, transactions for such large values are routinely investigated
as a matter of policy to prevent fraud.) In its place of tampering with a real cheque, fraudsters may
alternatively attempt to forge a depositor's signature on a blank cheque or even print their own
cheques drawn on accounts owned by others, non-existent accounts, etc. They would subsequently
cash the fraudulent cheque through another bank and withdraw the money before the banks realise
that the cheque was a fraud.

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Fraudulent loan applications:
These take a number of forms varying from individuals using false information to hide a credit
history filled with financial problems and unpaid loans to corporations using accounting fraud to
overstate profits in order to make a risky loan appear to be a sound q1investment for the bank.

Fraudulent loans:
One way to remove money from a bank is to take out a loan, which bankers are more than willing to
encourage if they have good reason to believe that the money will be repaid in full with interest. A
fraudulent loan, however, is one in which the borrower is a business entity controlled by a dishonest
bank officer or an accomplice; t e "borrower" then declares bankruptcy or vanishes and the money is
gone. The borrower may even be a non-existent entity and the loan merely an artifice to conceal a
theft of a large sum of money from the bank. This can also be seen as a component within mortgage
fraud.

Empty ATM envelope deposits:

A criminal overdraft can result due to the account holder making a worthless or misrepresented
deposit at an automated teller machine in order to obtain more cash than present in the account or
to prevent a check from being returned due to non-sufficient funds. United States banking law
makes the first $100 immediately available and it may be possible for much more uncollected funds
to be lost by the bank the following business day before this type of fraud is discovered. The crime
could also be perpetrated against another person's account in an "account takeover" or with a
counterfeit ATM card, or an account opened in another person's name as part of an identity theft
scam. The emergence of ATM deposit technology that scans currency and checks without using an
envelope may prevent this type of fraud in the future.

The fictitious 'bank inspector':

This is an old scam with a number of variants; the original scheme involved claiming to be a bank
inspector, claiming that the bank suspects that one of its employees is stealing money and that to
help catch the culprit the "bank inspector" needs the depositor to withdraw all of his or her money.
At this point, the victim would be carrying a large amount of cash and can be targeted for the theft
of these funds.
Other variants included claiming to be a prospective business partner with "the opportunity of a
lifetime" then asking for access to cash "to prove that you trust me" or even claiming to be a new
immigrant who carries all their money in cash for fear that the banks will steal it from them – if told
by others that they keep their money in banks, they then ask the depositor to withdraw it to prove
the bank hasn't stolen it.

Money laundering:
The term "money laundering" dates back to the days of Al Capone; Money laundering has since been
used to describe any scheme by which the true origin of funds is hidden or concealed. Money
laundering is the process by which large amounts of illegally obtained money (from drug trafficking,

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terrorist activity or other serious crimes) is given the appearance of having originated from a
legitimate source.

Wire transfer fraud:

Wire transfer networks such as the international SWIFT interbank fund transfer system are tempting
as targets as a transfer, once made, is difficult or impossible to reverse. As these networks are used
by banks to settle accounts with each other, rapid or overnight wire transfer of large amounts of
money are commonplace; while banks have put checks and balances in place, there is the risk that
insiders may attempt to use fraudulent or forged documents which claim to request a bank
depositor's money be wired to another bank, often an offshore account in some distant foreign
country. There is a very high risk of fraud when dealing with unknown or uninsured institutions.

The risk is greatest when dealing with offshore or Internet banks (as this allows selection of
countries with lax banking regulations), but not by any means limited to these institutions. There is
an annual list of unlicensed banks on the US Treasury Department web site which currently is fifteen
pages in length. Also, a person may send a wire transfer from country to country. Since this takes a
few days for the transfer to "clear" and be available to withdraw, the other person may still be able
to withdraw the money from the other bank. A new teller or corrupt officer may approve the
withdrawal since it is in pending status which then the other person cancels the wire transfer and
the bank institution takes a monetary loss.

TOP FIVE BANK SCAM:

Bank of India: Rs 754.77 crore.

Indian Overseas Bank: Rs 771.07 crore.
Union Bank of India: Rs 458.95 crore.
Bank of Baroda: Rs 456.53 crore.
Allahabad Bank: Rs. 330.68 crore.

1.3 STATEMENT OF THE PROBLEM AND ISSUES

With various measures initiated by the RBI, numbers of banking fraud cases have declined, but
amount of money lost has increased in these years. Prima facie, an initial investigation in these cases
has revealed involvement of not only mid-level employees, but also of the senior most management
as was reflected in the case of Syndicate Bank and Indian Bank. This raises serious concern over the
effectiveness of corporate governance at the highest echelons of these banks. In addition, there has
been a rising trend of non-performing assets (NPAs), especially for the PSBs, thereby severely

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impacting their profitability. Several causes have been attributed to risky NPAs, including global and
domestic slowdown, but there is some evidence of a relationship between frauds and NPAs as well.
The robustness of a country’s banking and financial system helps determine its production and
consumption of goods and services. It is a direct indicator of the well-being and living standards of its
citizens. Therefore, if the banking system is plagued with high levels of NPAs then it is a cause of
worry, because it reflects financial distress of borrower clients, or inefficiencies in transmission
mechanisms. Indian economy suffers to a great extent from these problems, and this served as the
prime motivation for the authors to carry out this detailed study of frauds in the Indian banking
system and examining frauds from different angles.

Banks are the engines that drive the operations in the financial sector, money markets and growth of
an economy. With the rapidly growing banking industry in India, frauds in banks are also increasing
very fast, and fraudsters have started using innovative methods. In the modern era, there is ―no
silver bullet for fraud protection. The use of neural network-based behaviour models in real-time has
changed the face of fraud management all over the world. Banks that can leverage advances in
technology and analytics to improve fraud prevention will reduce their fraud losses. Recently,
forensic accounting has come into limelight due to rapid increase in financial frauds or white-collar
crimes. Fraud is a “serious problem” for the banks. Fraud has quickly become a multibillion-dollar
problem for the banking and finance industry. A report by The Association of Certified Fraud
Examiners (ACFE, 2018) found that organizations lose approximately 5% of their annual revenues to
fraud. To put this in perspective, according to a business insider article (2019) the top five banks in
the world reported revenues of just over $1300 trillion, this would equate to over $65 billion in fraud
losses for these companies alone. The emergence of fast fraud, which is where cybercriminals
exploit weaknesses in digital fraud prevention systems to steal customer assets, is a major
contributor to the fraud losses banks experience daily.

The banking industry is undergoing a radical shift, one driven by new competition from FinTechs,
changing business models, mounting regulation and compliance pressures, and disruptive
technologies. The emergence of Fin-Tech/non-bank starts up is changing the competitive landscape
in financial services, forcing traditional institutions to rethink the way they do business. As data
breaches become prevalent and privacy concerns intensify, regulatory and compliance requirements
become more restrictive as a result. And, if all of that wasn’t enough, customer demands are
evolving as consumers seek round-the-clock personalized service. these and other banking industry
challenges can be resolved by the very technology that’s caused this disruption, but the transition
from legacy systems to innovative solutions hasn’t always been an easy one. That said, banks and
credit unions need to embrace digital transformation if they wish to not only survive but thrive in
the current landscape.

PROBLEMS SUCH AS:

1. Increasing Competition
The threat posed by Fin Techs, which typically target some of the most profitable areas in financial
services, is significant. These new industry entrants are forcing many financial institutions to seek
partnerships and/or acquisition opportunities as a stop-gap measure; in fact, Goldman Sachs,
themselves, recently made headlines for heavily investing in FinTech.

In order to maintain a competitive edge, traditional banks and credit unions must learn from

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Fin Techs, which owe their success to providing a simplified and intuitive customer experience. Also,
the competition nowadays has increased in numbers and with a rapid growth and the number of
fraud cases are increasing day by day with new technologies updates and new techniques.

2. A Cultural Shift
From artificial intelligence (AI)-enabled wearables that monitor the wearer’s health to smart
thermostats that enable you to adjust heating settings from internet-connected devices, technology
has become ingrained in our culture — and this extends to the banking industry.

In the digital world, there’s no room for manual processes and systems. Banks and credit unions
need to think of technology-based resolutions to banking industry challenges.

Therefore, it’s important that financial institutions promote a culture of innovation, in which
technology is leveraged to optimize existing processes and procedures for maximum efficiency. This
cultural shift toward a technology-first attitude is reflective of the larger industry-wide acceptance of
digital transformation.

3. Regulatory Compliance
Regulatory compliance has become one of the most significant banking industry challenges as a
direct result of the dramatic increase in regulatory fees relative to earnings and credit losses since
the 2008 financial crisis. From Basel’s risk-weighted capital requirements to the
Dodd-Frank Act, and from the Financial Account Standards Board’s Current Expected Credit Loss
(CECL) to the Allowance for Loan and Lease Losses (ALLL), there are a growing number of regulations
that banks and credit unions must comply with; compliance can significantly strain resources and is
often dependent on the ability to correlate data from disparate sources. Overcoming regulatory
compliance challenges requires banks and credit unions to foster a culture of compliance within the
organization, as well as implement formal compliance structures and systems.

Technology is a critical component in creating this culture of compliance. Technology that collects
and mines data, performs in-depth data analysis, and provides insightful reporting is especially
valuable for identifying and minimizing compliance risk. In addition, technology can help standardize
processes, ensure procedures are followed correctly and consistently, and enables organizations to
keep up with new regulatory/industry policy changes.

4. Changing Business Models

The cost associated with compliance management is just one of many banking industry challenges
forcing financial institutions to change the way they do business. The increasing cost of capital
combined with sustained low interest rates, decreasing return on equity, and decreased proprietary
trading are all putting pressure on traditional sources of banking profitability. In spite of this,
shareholder expectations remain unchanged. This culmination of factors has led many institutions to
create new competitive service offerings, rationalize business lines, and seek sustainable
improvements in operational efficiencies to maintain profitability. Failure to adapt to changing
demands is not an option; therefore, financial institutions must be structured for agility and be
prepared to pivot when necessary.

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5. Rising Expectations
Today’s consumer is smarter, savvier, and more informed than ever before and expects a high
degree of personalization and convenience out of their banking experience. Changing customer
demographics play a major role in these heightened expectations: With each new generation of
banking customer comes a more innate understanding of technology and, as a result, an increased
expectation of digitized experiences. Millennials have led the charge to digitization, with five out of
six reporting that they prefer to interact with brands via social media; when surveyed, millennials
were also found to make up the largest percentage of mobile banking users, at 47%. Based on this
trend, banks can expect future generations, starting with Gen Z, to be even more invested in
omnichannel banking and attuned to technology. By comparison, Baby Boomers and older members
of Gen X typically value human interaction and prefer to visit physical branch locations. This presents
banks and credit unions with a unique challenge: How can they satisfy older generations and
younger generations of banking customers at the same time? The answer is a hybrid banking model
that integrates digital experiences into traditional bank branches. Imagine, if you will, a physical
branch with a self-service station that displays the most cutting-edge smart devices, which
customers can use to access their bank’s knowledge base. Should a customer require additional
assistance, they can use one of these devices to schedule an appointment with one of the branch’s
financial advisors; during the appointment, the advisor will answer any of the customer’s questions,
as well as set them up with a mobile AI assistant that can provide them with additional
recommendations based on their behaviour. It might sound too good to be true, but the branch of
the future already exists, and it’s helping banks and credit unions meet and exceed rising customer
expectations.
Investor expectations must be accounted for, as well. Annual profits are a major concern - after all,
stakeholders need to know that they’ll receive a return on their investment or equity and, in order
for that to happen, banks need to actually turn a profit. This ties back into customer expectations
because, in an increasingly constituent-centric world, satisfied customers are the key to sustained
business success - so, the happier your customers are, the happier your investors will be.

6. Customer Retention
Financial services customers expect personalized and meaningful experiences through simple and
intuitive interfaces on any device, anywhere, and at any time. Although customer experience can be
hard to quantify, customer turnover is tangible and customer loyalty is quickly becoming an
endangered concept. Customer loyalty is a product of rich client relationships that begin with
knowing the customer and their expectations, as well as implementing an ongoing client-centric
approach.

In an Accenture Financial Services global study of nearly 33,000 banking customers spanning 18
markets, 49% of respondents indicated that customer service drives loyalty. By knowing the
customer and engaging with them accordingly, financial institutions can optimize interactions that
result in increased customer satisfaction and wallet share, and a subsequent decrease in customer
churn.

Bots are one new tool financial organizations can use to deliver superior customer service. Bots are a
helpful way to increase customer engagement without incurring additional costs, and studies show
that the majority of consumers prefer virtual assistance for timely issue resolution. As the first line of
customer interaction, bots can engage customers naturally, conversationally, and contextually,

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thereby improving resolution time and customer satisfaction. Using sentiment analysis, bots are also
able to gather information through dialogue, while understanding context through the recognition
of emotional cues. With this information, they can quickly evaluate, escalate, and route complex
issues to humans for resolution.

7. Outdated Mobile Experiences

These days, every bank or credit union has its own branded mobile application — however, just
because an organization has a mobile banking strategy doesn’t mean that it’s being leveraged as
effectively as possible. A bank’s mobile experience needs to be fast, easy to use, fully featured (think
live chat, voice-enabled digital assistance, and the like), secure, and regularly updated in order to
keep customers satisfied. Some banks have even started to reimagine what a banking app could be
by introducing mobile payment functionality that enables customers to treat their smart phones like
secure digital wallets and instantly transfer money to family and friends.

8. Security Breaches
With a series of high-profile breaches over the past few years, security is one of the leading banking
industry challenges, as well as a major concern for bank and credit union customers. Financial
institutions must invest in the latest technology-driven security measures to keep sensitive
customer safe, such as: Address Verification Service (AVS)

AVS “checks the billing address submitted by the card user with the cardholder’s billing address on
record at the issuing bank” in order to identify suspicious transactions and prevent fraudulent
activity.
End-to-End Encryption (E2EE)
E2EE “is a method of secure communication that prevents third-parties from accessing data while
it’s transferred from one end system or device to another.” E2EE uses cryptographic keys, which
are stored at each endpoint, to encrypt and decrypt private messages. Banks and credit unions
can use E2EE to secure mobile transactions and other online payments, so that funds are securely
transferred from one account to another, or from a customer to a retailer.

Authentication
Biometric authentication “is a security process that relies on the unique biological characteristics of
an individual to verify that he is who he says he is. Biometric authentication systems compare a
biometric data capture to stored, confirmed authentic data in a database.” Common forms of
biometric authentication include voice and facial recognition and iris and fingerprint scans. Banks
and credit unions can use biometric authentication in place of PINs, as it’s more difficult to replicate
and, therefore, more secure.

Location-based authentication (sometimes referred to as geolocation identification) “is a special

procedure to prove an individual’s identity and authenticity on appearance simply by detecting its
presence at a distinct location.” Banks can use location-based authentication in conjunction with
mobile banking to prevent fraud by either sending out a push notification to a customer’s mobile

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device authorizing a transaction, or by triangulating the customer’s location to determine whether
they’re in the same location in which the transaction is taking place.
Out-of-band authentication (OOBA) refers to “a process where authentication requires two different
signals from two different networks or channels by using two different channels, authentication
systems can guard against fraudulent users that may only have access to one of these channels.”
Banks can use OOBA to generate a one-time security code, which the customer receives via
automated voice call, SMS text message, or email; the customer then enters that security code to
access their account, thereby verifying their identity. Risk-based authentication (RBA) - also known
as adaptive authentication or step-up authentication - “is a method of applying varying levels of
stringency to authentication processes based on the likelihood that access to a given system could
result in its being compromised.” RBA enables banks and credit unions to tailor their security
measures to the risk level of each customer transactions.

9. Antiquated Applications
According to the 2019 Gartner CIO Survey, over 50% of financial services CIOs believe that a greater
portion of business will come through digital channels, and digital initiatives will generate more
revenue and value. However, organizations using antiquated business management applications or
siloed systems will be unable to keep up with this increasingly digital-first world. Without a solid,
forward-thinking technological foundation, organizations will miss out on critical business evolution.
In other words, digital transformation is not just a good idea - it’s become imperative for survival.

While technologies such as block chain may still be too immature to realize significant returns from
their implementation in the near future, technologies like cloud computing, AI, and bots all offer
significant advantages for institutions looking to reduce costs while improving customer satisfaction
and growing wallet share.

Cloud computing via software as a service and platform as a service solution enable firms previously
burdened with disparate legacy systems to simplify and standardize IT estates. In doing so, banks
and credit unions are able to reduce costs and improve data analytics, all while leveraging leading
edge technologies. AI offers a significant competitive advantage by providing deep insights into
customer behaviours and needs, giving financial institutions the ability to sell the right product at
the right time to the right customer. Additionally, AI can provide key organizational insights required
to identify operational opportunities and maintain agility.

10. Continuous Innovation

Sustainable success in business requires insight, agility, rich client relationships, and continuous
innovation. Benchmarking effective practices throughout the industry can provide valuable insight,
helping banks and credit unions stay competitive. However, benchmarking alone only enables
institutions to keep up with the pack — it rarely leads to innovation. As the cliché goes, businesses
must benchmark to survive, but innovate to thrive; innovation is a key differentiator that separates
the wheat from the chaff. Innovation stems from insights, and insights are discovered through
customer interactions and continuous organizational analysis.

Insights without action, however, are impotent — it’s vital that financial institutions be prepared to
pivot when necessary to address market demands while improving upon the customer experience.

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Financial service organizations leveraging the latest business technology, particularly around cloud
applications, have a key advantage in the digital transformation race: They can innovate faster. The
power of cloud technology is its agility and scalability. Without system hardware limiting flexibility,
cloud technology enables systems to evolve along with your business.

1.4 HISTORY OF BANKING AND FRAUDS

Modern banking in India originated in the last decade of the 18th century. Among the first banks
were the Bank of Hindustan, which was established in 1770 and liquidated in 1829-32; and the
General Bank of India, established in 1786 but failed in 1791.
Banking system is considered as backbone of a nation’s economy. Banking procedures were carried
by informal methods in ancient world. However, formal banking has been developed as the “LIFE
BLOOD” of the trade and commerce from 20th century. In India, banking has developed from the
primitive to modern stage of banking in a fashion that has no parallel in the world history.

Today, India banking system into commercial banks (Both public, private banks, schedules and non-
scheduled), Regional rural banks, cooperative banks etc.

The largest and the oldest bank which is still in existence is the State Bank of India (S.B.I). It
originated and started working as the Bank of Calcutta in mid-June 1806. In 1809, it was renamed as
the Bank of Bengal. This was one of the three banks founded by a presidency government, the other
two were the Bank of Bombay in 1840 and the Bank of Madras in 1843. The three banks were
merged in 1921 to form the Imperial Bank of India, which upon India's independence, became the
State Bank of India in 1955. For many years the presidency banks had acted as quasi-central banks,
as did their successors, until the Reserve Bank of India was established in 1935, under the Reserve
Bank of India Act, 1934.

Information Technology had a great impact on the Indian banking system. The use of computers led
to the introduction of online banking in India. The use of computers in the banking sector increased
many folds after the economic liberalisation of 1991 as the country's banking sector has been
exposed to the world's market. Indian banks were finding it difficult to compete with the

13
international banks in customer service without the use of information technology. The RBI set up a
number of committees to define and co-ordinate banking technology. These have included:

In 1984 was formed the Committee on Mechanisation in the Banking Industry (1984) whose
chairman was Dr.C. Rangarajan Deputy Governor, Reserve Bank of India. The major
recommendations of this committee were introducing MICR technology in all the banks in the
metropolises in India [41] This provided for the use of standardised cheque forms and encoders.

In 1988, the RBI set up the Committee on Computerisation in Banks (1988) headed by Dr C
Rangarajan. It emphasised that settlement operation must be computerised in the clearing houses of
RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and Thiruvananthapuram. It further stated that there
should be National Clearing of inter-city cheques at Kolkata, Mumbai, Delhi, Chennai and MICR
should be made operational. It also focused on computerisation of branches and increasing
connectivity among branches through computers. It also suggested modalities for implementing on-
line banking. The committee submitted its reports in 1989 and computerisation began from 1993
with the settlement between IBA and bank employees' associations.

In 1994, the Committee on Technology Issues relating to Payment systems, Cheque Clearing and
Securities Settlement in the Banking Industry (1994) was set up under Chairman W S Saraf. It
emphasised Electronic Funds Transfer (EFT) system, with the BANKNET communications network as
its carrier. It also said that MICR clearing should be set up in all branches of all those banks with
more than 100 branches.

In 1995, the Committee for proposing Legislation on Electronic Funds Transfer and other Electronic
Payments (1995) again emphasised EFT system.

In July 2016, Deputy Governor Rama Gandhi of the Central Bank of India "urged banks to work to
develop applications for digital currencies and distributed ledgers."
LIBERALISATION IN 1990’S
In the early 1990s, the then government embarked on a policy of liberalisation, licensing a small
number of private banks. These came to be known as New Generation tech-savvy banks, and
included Global Trust Bank (the first of such new generation banks to be set up), which later
amalgamated with Oriental Bank of Commerce, IndusInd Bank, UTI Bank (since renamed Axis Bank),
ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India,
revitalised the banking sector in India, which has seen rapid growth with strong contribution from all
the three sectors of banks, namely, government banks, private banks and foreign banks.

The next stage for the Indian banking has been set up, with proposed relaxation of norms for foreign
direct investment. All foreign investors in banks may be given voting rights that could exceed the
present cap of 10% at present. In 2019, Bandhan bank specifically, increased the foreign investment
percentage limit to 49%. It has gone up to 74% with some restrictions.

The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the
4–6–4 method (borrow at 4%; lend at 6%; go home at 4) of functioning. The new wave ushered in a
modern outlook and tech-savvy methods of working for traditional banks.

All this led to the retail boom in India. People demanded more from their banks and received more.

For bankers, bad loans due to an economic downturn is par for the course. Bigger worry is
corporate fraud. With ‘extend and pretend’ coming to an end, banks are hesitant to report frauds.
For a better system, banking industry needs to be prompt in reporting and action. As per the latest
Reserve Bank of India (RBI) data, an unprecedented 6,801 frauds, totalling Rs 71,500 crore, were

14
detected in FY19. That amounts to a 15% rise in volume and 80% climb in value from last year. This
rise eclipses the FY18 banking fraud at Punjab National
Bank NSE 0.45 % (PNB), the most infamous in India’s history when it was revealed that over the
course of 7-8 years, fugitive diamond merchants Nirav Modi and Mehul Choksi allegedly siphoned off
nearly Rs 13,000 crore from the lenders.

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 organisation 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 well-being 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.

In order for it to be fraud in the legal sense the person on whom the fraud was sought to be
committed should have necessarily fallen prey to it. If an attempt of fraud is made but the person
concerned was not actually deceived, it is not ‘fraud’ as understood legally. Bank fraud is a fraud
committed on banks mainly by fraudulent representations using false documents. Bank fraud
concerns all citizens. It is a very sensitive issue as it affects the public faith on which the whole
Banking system is pre-dominantly based.

Bank fraud includes all sorts of misappropriations, embezzlements, manipulations of negotiable

instruments like cheques, bank drafts, bills or statements of accounts, securities etc. With the boom
in banking business, bank frauds are also on the rise. Bank fraud is covered under Indian Penal Code.
Cheques are a major area where frauds are committed by putting counterfeit signature on the
cheque. This is probably the most common bank fraud committed. Another kind of fraud is the
hypothecation fraud, wherein money is fraudulently obtained against some kind of security. A fair
economic system requires a fair financial system with public confidence bestowed on it. Several
preventive measures can be taken to avoid it e.g., Right recruitment, Eternal alertness, adherence to
rules, training courses etc. In the present-day economic system, banks play a very important role in
the economic development of the country. Nowadays, banks have diversified their activities and are
getting into new schemes and services that create opportunities for financial inclusion. As the
banking sector is flourishing, it is getting plagued by some operational problems such as frauds etc

Financial Stability Report of the Reserve Bank of India (RBI) shows, that the Indian banking system
reported about 6,500 instances of fraud involving over ₹30,000 crore in 2017-18. Central Vigilance
Commission (CVC) analysed the top 100 banking frauds in different sectors and has also suggested
some measures that will help avoid such unethical activities in the future.

Banking frauds attracted national attention when the Punjab National Bank reported earlier this year
that it had been defrauded by companies related to jeweller Nirav Modi and Mehul Choksi. Several
other cases of large banking frauds were reported subsequently, which raised questions about the
ability of banks to contain them.

15
Let us have a look at some biggest scams in India (1990-2010)
1. Harshad Mehta & Ketan Parekh Stock Market Scam (1992)-Harshad Mehta siphoned lump sum
money from the banking system and raised a large fund for himself by producing seamlessly original
looking fake bank receipts, many banks lent him huge amounts of money assuming that they were
doing this in return of government securities.

Ketan Parekh also executed similar scam and looted Bank of India of around $30 million.
Investigated by: Securities Exchange Board of India.
2. The Hawala Scandal (1996)-The major political players were accused of having accepted hefty
bribes from the hawala brokers who basically fund terrorism around the globe and also alleged
connections about payments being channelled to Hizbul Mujahideen militants in Kashmir. This scam
was an evidence of open political loot taking place in the country.

Investigated by: Central Bureau of Investigation (CBI).

3. Bihar fodder scam (1996)-Popularly known as the ‘Chara Ghotala’, Bihar’s most famous scam
involved the fabrication of “vast herds of fictitious livestock” for which fodder, medicine and animal
husbandry equipment was allegedly procured.

4. Stamp paper Scam (2002)-Popularly referred to as the Telgi Scam involved printing & selling of
forged/duplicate stamp papers to banks and other financial institutions. Investigated by: Special
Investigation Team.

5. Satyam Scam (2009)-The biggest corporate scam in the history of India that shattered the peace
of Indian investors. The account books were fudged & the profit figures and revenues were falsely
inflated for years by the Founder & Chairman of Satyam. The company was taken over by Tech
Mahindra. Investigated by: Central Bureau of Investigation (CBI).

6. Commonwealth Games Scam (2010)-Took place during the Commonwealth Games, 2010 in New
Delhi. Out of the estimated amount, only half was actually spent for the event.

Various hefty payments were made in the name of non-existent parties. Investigated by:
Central Bureau of Investigation (CBI).
Here are some of the biggest scams that disturbed the country's banking system post 2010: In 2011,
investigative agency CBI revealed that executives of certain banks such as the Bank of Maharashtra,
Oriental Bank of Commerce and IDBI created almost 10,000 fictitious accounts, and an amount of Rs
1,500 crore worth loans were transferred.

Another scam that was unfolded in 2014 was the bribe-for-loan scam involving ex-chairman and MD
of Syndicate Bank SK Jain for involvement in sanctioning Rs R. 8,000 crore. In 2014, Vijay Mallya was
also declared a wilful defaulter by Union Bank of India, following which other banks such as SBI and
PNB followed suit.

In 2015, another fraud that raised eyebrows involved employees of Jain Infra projects, who
defrauded Central Bank of India to the tune of over Rs 2,000 crore.

One of the biggest banking frauds of 2016 is the one involving Syndicate Bank, where almost 380
accounts were opened by four people, who defrauded the bank of Rs 10 billion using fake cheques,
Letter of Undertakings (Lou’s) and LIC policies.

16
The fresh bank fraud to the tune of Rs 11,450 crore involving diamond merchant Nirav Modi. It has
come to light that the company, in connivance with retired employees of PNB, got at least 150 Lou’s,
allowing Nirav Modi Group to defraud the bank and many other banks who gave loans to him.

1.5 IMPORTANCE OF BANK AND PROBLEMS, IMPACT AND GOVERNANCE ON BANK

FRAUDS.
The banking sector was always deemed to be one of the most vital sectors for the economy to be
able to function. Its importance as the “lifeblood” of economic activity, in collecting deposits and
providing credits to states and people, households and businesses is undisputable.

In all economic systems, banks have the leading role in planning and implementing financial policy.
The difference lies with prioritizing goals and their way of achievement. Based on the neo-liberal
model, achieving greater profits by using all means is an end in itself, while in the socialistic systems
bank operations also aim at improving economy in general and at satisfying social needs.

Banks are one of the important financial pillars and the oldest financial intermediaries in the
financial system. India has adopted a system of planning. In the First Five Year Plan, the importance
of banking system for economic development was recognized in which it was emphasized that the
banking system should be fitted into the scheme of development and growth of saving and their
utilization. The steps were also taken to confirm the social purposes. Contribution of banking system
on economic development is depends upon the governing policy. Banks are essential for all type of
economic systems whether they are developed or developing. In the case of developing country, it
cannot progress without setting a sound banking system.

In developing country banking is most important because these countries are generally facing the
problems like shortage of capital, mobilization of resources, channelizing those to priority sectors
etc.

The financial crisis of 2008, and the way the governments chose to save the banks by laying the
burden on taxpayer shoulders while exercising austerity policies, triggered a cycle of discussion over
many crucial issues

Frauds take place when someone tries to conceal or hide the facts. Deliberate deception, tricking,
intended cheating to gain advantage and so on. Such frauds mainly occur in banking sector with
huge amounts in a very deceitfully way. While there are many types of frauds, there are five major
frauds that can cause most damage:

1. Financial statement fraud.

2. Asset misappropriation.
3. Theft of intellectual property and trade secrets.
4. Healthcare, Insurance and Banking.
5. Consumer fraud.

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Frauds can take many shapes and can impact organisation in many ways-not just financially. There
are few proper steps and measures to protect the bank against vulnerabilities. Let us focus on
banking frauds, its detection and prevention.

RBI GUIDELINES

Reserve bank of India (RBI) is the apex body. It is India’s central bank, which controls the issue and
supply of the Indian rupee. It is the regulatory body of the entire banking system in India. Also, RBI
plays an important role in the development strategy of Government of India. The precautions and
prevention from fraudsters are issued by the RBI guidelines. Here are the guidelines regarding
reporting of frauds to RBI:

Frauds involving Rs. 1 lakh and above

Fraud reports should be submitted in all cases of fraud of Rs. 1 lakh and above perpetrated through
misrepresentation, breach of trust, manipulation of books of account, fraudulent encashment of
instruments like cheques, drafts and bills of exchange, unauthorised handling of securities charged
to the bank, misfeasance, embezzlement, misappropriation of funds, conversion of property,
cheating, shortages, irregularities, etc.

Fraud reports should also be submitted in cases where central investigating agencies have initiated
criminal proceedings Suo motto and/or where the Reserve Bank has directed that they be reported
as frauds.

Banks may also report frauds perpetrated in their subsidiaries and affiliates/joint ventures. Such
frauds should, however, not be included in the report on outstanding frauds and the quarterly
progress reports refer below.

The fraud reports in soft copy format involving all categories of frauds and hard copy format
involving frauds of Rs. 5 lakh and above should be sent to the Central Office (CO) as also the
concerned Regional Office of RBI, Department of Banking Supervision, under whose jurisdiction the
Head Office of the bank falls, in the format given in FMR – 1, within three weeks from the date of
detection. However, fraud reports in hard copy format involving frauds of Rs. 1.00 lakh and above
and less than Rs. 5.00 lakh should be sent to the concerned Regional Office of RBI, Department of
Banking Supervision only.

It is evident that post liberalization era has showered new colours of growth upon the Indian
banking sector but simultaneously it has also posed some serious challenges. One of them being rise
in frauds and NPAs. Thus, proper measures should be taken beforehand to stop such frauds in future
and prevent crisis in banks.

VARIOUS REASONS BEHIND FRAUDS:

1.Poor banking governance: Most frauds show that banks did not observe due diligence, both before
and after disbursing loans. Poor level of checks and balances in the banking system is one of the
reasons.

18
2.Poor monitoring: Lack of technology and fraud monitoring agencies to detect frauds makes the
problem more complex. There is an absence of an effective mechanism to monitor the credit flow.
Flawed risk-mitigation design, which creates an excessive focus on credit or market risks, but focuses
less on operational risks also leading to more breaches.

3.Technological backwardness: Excessive dependence on manual supervision, at both external and

internal levels makes it impossible to manually control and supervise the sheer volume of
transactions.

4.Immoral behaviour: The disintegrating moral fibre of Indian businessmen, bankers and other
white-collar professionals, nepotism in internal committees of banks, unnecessary political
interventions lead to increased frauds.

5.Political interference: The political pulls and pressures on investigating agencies, and longdrawn
processes of legal system act less as a deterrent.

IMPACT OF SUCH FRAUDS:

1. This unhealthy development of rising fraudulent activities afflicting the banking sector impinges
their credibility adversely.

2. Frauds add to Non-Performing Assets and lead to loss of banks and economy. The Gross
NPAs to Gross Advances Ratio has shown a rising trend over the years
3. Frauds and fraudulent activities wreak severe financial dilemmas on banks and their clients, as
well as cause a significant reduction in the quantum of money accessible for economic
development.

4. Frauds have a significant impact on profitability of the Indian banking sector. Profitability of banks
is on a steady decline which needs to be an eye opener as it poses a threat to the economy.

GOVERNANCE AND MEASURES:

1. Banking governance need an overhaul with proper checks and balance in places. Indian banks
need significant improvements in operation and governance standards to work in an effective
manner, by constantly working on the loopholes so that the banking sector can contribute more to
the growth of the economy.

19
2. Accountability need to be established among the bank managers and other administrators. 3.
While it may not probable for banks to conduct their operations in a zero-fraud milieu, proactive
measures, such as conduct of risk assessment of policies and procedures can aid banks to
circumvent their risk of contingent losses resulting from frauds.

4. The data analysis technology can be leveraged by banks to detect frauds at the incipient stage
itself and reduce their loss causing impact significantly.

5. Law enforcement agencies should work in such a way that they don’t end up creating an
environment of fear, affecting the flow of credit to productive sectors.

6. Apart from improving capabilities in the banking system, accountability of third-party service
providers such as auditors and lawyers should also be fixed.

7. Assessment of working capital limit should be done before the flow of credit.
8. Awareness should be created about loop holes, consequences of bypassing procedural aspects
and benchmarks should be provided for evaluating genuineness of various essential documents.

9. The investigation should be done to find out the trail of diversion of funds and whether any
money has been remitted abroad.

10. The Banks should pay the required attention to the area of internal control system and the fraud
prevention measures to ensure compliance of instructions issued by them from time.

CHAPTER 2
Research and methodology
2.1 Objective of the study:

The objective IS TO aims to identify the procedural lapses and various other causes responsible for
bank frauds. The study seeks to know the perception of bank employees towards bank frauds and
their compliance towards implementation of preventive mechanism.
It also evaluates the factors that influence the degree of compliance .

The objective of the policy, namely "State Bank of India Compensation Policy (Banking Services)"
(hereinafter called the Policy), is to establish a system whereby the Bank compensates the customer
due to deficiency in service on the part of the Bank or any act of omission or commission, directly
attributable to the Bank.
Fraud is the worldwide phenomenon that affects all continents and all sector of the economy. With
the rapidly growing banking industry in India, frauds increasing fast, and fraudsters have started
using innovative methods. Shockingly, banking industry in India dubs rising frauds as in inevitable
cause of business. one of the most challenging aspects in the Indian aspects into make banking
transactions free from electronic crime. There is no “once silver bullet” to stop all frauds forever.
While leveraging the power of data analysis software, banks can detect frauds owner and reduce the
negative impact of significant losses owing to frauds.
A bank is a financial institution which is involved in borrowing and lending money. Banks take
customer deposits in return for paying customers an annual interest payment. The bank then
uses the majority of these deposits to lend to other customers for a variety of loans.

20
Many a time, the borrowers are not traceable. ATM: Money is withdrawn using cloned ATM cards.
Cash credit: Frauds involve falsification of the books of accounts and removal of goods and property
hypothecated to the banks without their knowledge. Term loan: This is the biggest contributor to
the frauds.
Total frauds at banks rise 74 per cent to Rs 71,543 crore in 2018-19: RBI

2.2 Hypothesis:

The number of studies on fraud and fraud detection methods has grown in management literature,
especially since the occurrence of corporate scandals in the 1990s. These studies include those that
investigate the probability of occurrence of accounting and corporate fraud.
In the studies mentioned, one point of interest can be verified: banking institutions have not been
analysed in isolation. Because of the importance of these institutions for the economic context, it is
clear that the losses from a fraud in a large bank will be felt by the economy in general, since these
institutions act as financial intermediaries and providers of external capital for other economic
activities. Therefore, understanding and finding ways of preventing and detecting corporate fraud in
banking institutions is crucial for society as a whole.

In light of this, the hypothesis created by Cressey (1953) stands out, enabling fraudulent behaviour
by managers in corporations to be examined using an analysis with three dimensions: pressure,
opportunity, and rationalization. This hypothesis reports that individuals who occupy positions of
trust in the financial area (financial trust) can violate this trust if they have some particular financial
problem that cannot be shared. These individuals, in their capacity as agents of the corporation,
believe that this particular problem can be resolved secretly, even if for this they have to violate the
trust placed in them. By justifying the breaking of trust as a means of resolving their financial
problems, these individuals may use financial resources to their own benefit, even if they self-
sustain a false feeling of seriousness in their actions Cressey (1953).

Cressey’s hypothesis (1953), which is also known as the fraud triangle, considers three dimensions of
fraudulent behaviour: pressure, opportunity, and rationalization. Pressure, also known as
motivation, requires the existence of financial problems that cannot be shared; opportunity would
be to secretly resolve these problems by violating financial trust; and rationalization of the
fraudulent act would be viewing it as necessary and justifiable for resolving the financial problems.
Cressey’s fraud triangle (1953) has been used both by the literature and in accounts auditing
practice to investigate the occurrence of accounting and corporate fraud. In the literature, the
studies by Brazel et al. (2009), Lou and Wang (2009), and Troy et al. (2011) stand out, which manage
to elaborate econometric models based on Cressey’s triangle (1953) to detect fraud. In practical
terms, Cressey’s hypothesis (1953) has been used by standardizing organizations as a tool for
detecting fraud (Higson & Kassem, 2013), as can be observed in the rules of the American Institute
of Certified Public
Accountants (AICPA, 2002) - Statement on Auditing Standards n. 99 (SAS n. 99) -, of the
Federal Accounting Council (CFC, 2009) - Resolution n. 1.207 of 2009 -, and of the International
Accounting Standards Board (IASB) - ISA 240 of 2009.

21
It bears mentioning that Brazilian studies on corporate fraud are still in their infancy ( Murcia &
Borba, 2005; Silva, 2007). Most of the Brazilian studies have different scopes from that of this paper,
concentrating on analysing red flags, whether via auditor perception or via the creation of new
structures (Murcia & Barba, 2007; Murcia, Barba, & Schmehl, 2008), using data on international
companies to calculate the probability of fraud (Wuerges & Borba, 2014) or mapping patterns of
corporate fraud (Imoniana & Murcia, 2016). Therefore, carrying out studies to calculate the
probability of corporate fraud occurring in the Brazilian context is of academic relevance.
In light of this theoretical gap and of the importance of the Cressey fraud triangle in the theoretical
and empirical contexts, the general aim of this study is established, which is to investigate the
occurrence of corporate fraud, as well as indications of fraud, in Brazilian banking institutions, by
using detection variables from agency theory, criminology, and the economics of crime.
This article fills a technical-scientific gap that currently exists in the Brazilian literature on corporative
fraud, by combining the theoretical framework of agency theory, of criminology, and of the
economics of crime. In addition, it focuses on a sector that is usually excluded from analyses due to
its specific characteristics and shows the application of multinomial logit panel data regression with
random effects, which is rarely used in studies in the area of accounting. The aim of this study is to
investigate the occurrence of corporative fraud, as well as cases of fraud in Brazilian banking
institutions, by using detection variables related to the Cressey fraud triangle. Research into fraud
and methods of detecting fraud has grown in management literature, especially after the occurrence
of various corporative scandals in the 1990s. Although regulatory agencies have increased their
investments in monitoring and control, fraud investigations and convictions are still common in the
day-to-day administration of banks, as can be seen in the Brazilian Central Bank and the National

Financial System Resource Council’s databases of punitive proceedings. We believe that this article
will have a positive impact in the area of accounting sciences, since it involves corporative fraud in a
multidisciplinary form and because it provides the incentive to use a quantitative tool that can help
increase the development of similar studies in the area. This study tested the theory that the
dimensions of the fraud triangle condition the occurrence of corporative fraud in Brazilian banking
institutions. Thirty-two representative variables of corporative fraud were identified in the
theoretical-empirical review, which were reduced to seven latent variables by the principal
component analysis. Finally, the seven factors formed the independent variables in the multinomial
logit models used in the hypothesis tests, which presented promising results.

* THEORETICAL BACKGROUND

Agency Theory

The agency relationship is one of the oldest and most common forms of codified social interactions
(Ross, 1973) and is present in complex societies. Examples of agency relationships include: boss-
worker, doctor-patient, adviser-administrator, and relationships between parents and children.
Functional dependency, among other reasons, determines that agency relationships are extremely
common (Mitnick, 1975). These relationships include those of the owners and managers of
corporations, derived from the separation between ownership and control, which is the object of
study of agency theory.

22
According to Demsetz (1983) and Veblen (2001/1921), the separation between ownership and
control sought greater management efficiency. The delegation of decision-making authority,
according to Barnea, Haugen, and Senbet (1985), is an essential characteristic of modern
corporations, in which shareholders delegate their authority to a professional who has managerial
skills. However, as Berle and Means (1932) and Demsetz (1983) observe, one of the main problems
with regards to the relationship derived from the separation between ownership and control is that
of ensuring that managers in fact work towards the aim of achieving the owners’ objectives, since
their interests are not always convergent.

Agency theory seeks to analyse the relationship between agents and principals. For this, a contract
metaphor is used, in which the relationship between agents and principals is formalized in
contractual terms (Jensen & Meckling, 1976) that can contain clauses to outline the agent’s
behaviour, with the intention that he/she acts to fulfil the principals’ expectations.

The differences between the parties’ aims give rise to the conflicts known as agency problems.
Clearly, agency problems emerge when the conflicts of interest between agents and principals, or
between the principals themselves, affect the operation of the company’s businesses (Barnea et al.,
1985).

These agency problems, whatever the relationship, can damage the efficient functioning of a
company. In order to minimize these problems, the owners incur agency costs, which can be
subdivided into manager monitoring costs, spending on contractual guarantees from the agent, and
residual losses (Jensen & Meckling, 1976; John & Senbet, 1998).

Monitoring costs consist of limiting divergences from the principal, via the creation of appropriate
incentives for the agent, which will limit any abnormal activities. These costs can be subdivided into
mechanisms for incentivizing and monitoring agents’ actions.

Incentive costs involve the agents’ remuneration structure and system of financial incentives, while
monitoring mechanisms are related to the corporate governance system, including the use of
internal and external audits and formal systems of controls (Jensen & Meckling, 1976).

Commitment expenses are resources that agents will receive in the form of a guarantee that they
will not make decisions that damage the principal, as well as for guaranteeing that the principal will
be compensated if the agent makes such decisions (Jensen & Meckling, 1976).

The residual cost/loss is the monetary value resulting from the reduction in the principal’s well-being
which occurs in situations in which of the agent’s decisions present divergences with regards to the
decisions that would maximize the principal’s well-being. This loss occurs when the cost of the total
execution of a contract exceeds its benefits (Fama & Jensen, 1983).

However, even with the occurrence of the agency costs described above, and with the creation of
contracts with restriction clauses and incentives for managers’ actions, monitoring of managers’
behavior is imperfect, due to the fact that managerial actions are not observable (Denis, Denis, &
Sarin, 1999). Like Denis et al. (1999), Jensen and Meckling (1976) observed that the management
literature indicates the existence of imperfect monitoring in the agency relationship, resulting from
the failure of monitoring costs to resolve agency problems. Thus, even with monitoring mechanisms,
agents may not work in favor of the principals’ interests.

23
Economics of Crime

The first indications of the application of economic concepts in the area of criminology were
observed in the studies by Cesare Beccaria (1819/1764) and Jeremy Bentham (2000/1781), which
were forgotten until the 1960s. Gary Becker (1968), a Nobel Prize laureate in 1992, reignited the
discussion on the theory of crime via the economic prism and emphasized that his effort in
determining an economic structure for criminal behaviour can be seen as a resurrection and
modernization of the pioneering studies.

Becker (1968) revitalized the main idea from Bentham (2000/1781) by suggesting that a useful
theory on criminal behaviour can dispense with special anomie theories, psychological inadequacies,
or the inheritance of special characteristics, and he extended the usual choice analysis of
economists. For the author, criminals are like any other person and behave as rational utility
maximisers. Thus, a person becomes “criminal” when the function between cost and benefit of illicit
activities is greater than other activities involving legal alternatives (Becker, 1968).

Based on the work of Becker (1968), economists have invaded the field of criminology, using the
comprehensive individual rational behaviour model. This model, assuming that individual
preferences are constant, can be used to predict how alterations in the probability of the severity of
sanctions and socioeconomic factors can affect the amount of crime (Eide, Rubin, & Shepherd,
2006).

In the literature on the economics of crime, studies are observed that analyse the relationship
between previous performances and corporate crimes (Alexander & Cohen, 1996), the effect of
gender on corporate crimes (Steffensmeier, Schwartz, & Roche, 2013), and a verification of the
impact of psychological variables on white collar crime, using individuals who have not committed
crimes as a control sample in their experiment ( Blicket , Schlegel,

Fassbender, & Klein, 2006). These studies, and others related to corporate fraud and agency theory,
will enable variables to be identified to measure the probability of corporate fraud.

Corporate Fraud

Fraud, in its wider sense, can cover any gains obtained through crime, which uses error as its main
modus operandi (Wells, 2011). However, although all fraud involves some type of error, not all
errors are necessarily frauds.

Conan (2008) observed that the legal definition of fraud is generally presented as false intentional
representation regarding a material point and which causes a loss to a victim.

Corporate fraud is related to the corporate environment and can be conceptualized as fraud
committed by or against a corporation (Singleton & Singleton, 2010). Costa and Wood Jr.

24
(2012, p. 465) conceptualize corporate fraud as a series of illicit actions and conducts carried out in

a conscious and premeditated manner by members of an organization’s senior management, which

take place in a process, aiming to serve own interests and with the intention of harming third-

parties.

The United States Justice Department defines corporate fraud in three main areas: accounting fraud
or financial fraud, insider trading, and obstructive conduct (American Institute of Certified Public
Accountants, 2006, cited by Rezaei & Riley, 2010).

Fraud in financial statements can be conceptualized as the deliberate misrepresentation of a

company’s financial conditions, carried out by distorting or intentionally omitting values or
disclosure in the accounting statements in order to mislead the users of this information (Association
of Certified Fraud Examiners, 2008, cited by Singleton & Singleton, 2010). With regards to corporate
insider trading, this is mainly related to the improper appropriation of corporate assets by senior
executives. As for obstruction of justice conduct, this refers to criminal convictions for giving a false
testimony at the Securities and Exchange Commission (SEC) and influencing or threatening other
witnesses.

In this study, the type of fraud addressed is corporate, whose areas are related to financial fraud and
insider trading. Conan (2008) argues that fraud constitutes the intentional neglect of a system and a
deliberate attempt to violate this system to make personal gains, and that most company systems
are not created to detect and prevent fraud. Thus, in an attempt to contribute by showing ways to
detect corporate fraud, the Cressey fraud triangle (1953) will be used, which is detailed in the next
item.

Cressey’s fraud triangle.

One of the most brilliant students of Sutherland, Donald R. Cressey studied at the University of
Indiana during the 1940s (Wells, 2011). At this teaching institution he took a doctorate in
criminology and became interested in the behaviour of fraudsters. This interest led him to write his
doctoral thesis, for which he used interviews carried out with 200 prisoners convicted of fraud. With
the results of the research, Cressey (1953, p.30) formulated a final hypothesis, known today as the
fraud triangle. This hypothesis assumes that:

Trusted persons become trust violators when they conceive of themselves as having a financial
problem that is non-shareable and are aware this problem can be secretly resolved by violation of
the position of financial trust, and are able to apply to their own conduct in that situation
verbalizations which enable them to adjust their conceptions of themselves as users of the entrusted
funds and properties.

The elements of this triangle are shown in Figure 1.

25
Figure 1 The Cressey fraud triangle

Pressure, also known as incentive or motivation, refers to something that happens in the personal
life of the fraudster and that creates a stressful need, thus motivating the fraudster (Conan, 2008;
Singleton & Singleton, 2010). Cressey (1953) showed that in all of the cases found in the interviews,
non-shareable problems precede the criminal violation of financial trust. For the author, the violator
considers various different situations to produce problems that are structured as non-shareable.
These problems are related with the status required by the offender or with maintaining his/her
status.

The analysis carried out by Cressey (1953) is consistent with the literature on fraud by indicating that
the conditions related to immorality, emergencies, increased needs, reversals in the business
environment, and a high standard of living are important for violations of trust. However, relevance
only verifies whether these conditions produce non-shareable problems for people that occupy a
position of trust. This situation will only have the effect of creating, in the person of trust, the desire
for specific results - the pressure -, related with the solution to the problem, and which can be
produced by the criminal violation of financial trust (Cressey, 1953).

Opportunity presupposes that fraudsters have the knowledge and chance to commit fraud. The logic
is that the individual will commit fraud as soon as he/she holds a position of trust, knows the
weaknesses in the internal controls, and obtains sufficient knowledge regarding how to successfully
commit the crime (Singleton & Singleton, 2010).

For Cressey (1953), technical knowledge is acquired before the existence of the nonshareable
problems and, consequently, the individual’s ability to perceive that the nonshareable problem can
be resolved by violating the position of trust involves the application of general information to
specific situations. Thus, when pressure, which is the existence of non-shareable problems, is added

26
to such opportunities derived from the individual’s knowledge, the potential for fraud is greater
(Singleton & Singleton, 2010).

Rationalization is a cognitive process of self-justification (Marcin, 1979; Rahm, Krosnick, & Breuning,
1994; Scheufele, 2000). This concept is widely discussed by sociologists, psychologists, and
psychiatrists. In his hypothesis, Cressey (1953) perceived that fraudsters rationalize their trust-
violating conduct as acceptable and justifiable behaviours by the intention to resolve a given
problem classified as non-shareable. So, rationalization is the process in which an employee mentally
determines that fraudulent behaviour is the correct attitude, considering that the company can
absorb the consequences of this act or that no shareholder or stakeholder will be materially affected
by the execution of the fraud (Conan, 2008; Singleton & Singleton, 2010). According to Cressey
(1953), the rationalization used by violators is necessary and essential for the criminal violation of
financial trust, as it is by way of this that the individuals find pertinent and real reasons to act; that
is, they convince themselves that carrying out the violation of financial trust is a justifiable and
acceptable act.

Thus, according to Cressey (1953), the occurrence of fraud is conditioned by the joint existence of
three dimensions: pressure, opportunity, and rationalization. In accordance with that assumption,
this study used Cressey’s hypothesis (1953) to elaborate and test hypothesis 1.

the three dimensions of the fraud triangle together condition the occurrence of corporate fraud in
Brazilian banking institutions.

EMPIRICAL ANALYSIS METHODOLOGY

The study is classified as empirical with a quantitative approach. To carry out the work, the first step
was to identify the banking institutions for which the Brazilian Central Bank (CB) made available data
involving quarterly financial information (QFI). Two hundred thirty-one institutions were found with
data from January 2001 to December 2012. It bears mentioning that from December 2012 the CB
ceased to publish quarterly information on the institutions under its supervision, following Circular
letter n. 3,630 of 2013 (Brazilian Central Bank [CB], 2013).

As there was the need to also collect data from the Annual Information Forms (AIFs) and the
Reference Forms made available to the market, the decision was made to work with only publicly-
held banking institutions with AIFs covering no fewer than three whole years. Due to this limitation,
44 banking institutions composed the research sample. As the data were gathered and organized
quarterly, a panel of 2,112 lines of observations was obtained.

In order to identify the existence or not of corporate frauds, the decisions reported by the CB and by
the National Financial System Resource Council (NFSRC) were adopted. The former issues first
instance decisions while the latter is tasked with judging, in the second and third instance, the
punitive administrative proceedings applied by the CB. In the period from 2001 to 2012, 123 punitive
proceedings were found, spread over 27 banking institutions and corresponding to 61.36% of the 44
in the sample. The organizations that did not form part of the offender’s report formed the control
sample for the study, therefore enabling different patterns to be identified between two groups of
institutions: with and without corporate frauds.

27
It is worth mentioning that the choice of punitive administrative proceedings was based on
internationally published empirical studies on corporate/accounting frauds, such as those by
Beasley (1996), Brazel et al. (2009), Erickson et al. (2006), Lennox and Pittman (2010), Troy et al.
(2011), and Wang et al. (2010). In these articles, the authors used the Accounting and Auditing
Enforcement Releases, published by the SEC, which contemplate press releases on administrative
and/or civil proceedings.

Note that for the classification of the proceedings the concept of corporate fraud was observed,
which is fraud committed by or against a corporation (Singleton & Singleton, 2010). This concept
enables the analysis of each sentence imposed on the banking institutions analysed. So, cases were
analysed in which the claim was related with foreign exchange operations, rural credit and debts,
investment funds, share repurchases, and the accounting of these institutions.

*Econometric Modelling

The economic modelling developed is based on the empirical analysis procedures proposed in the
studies by Beasley (1996), Brazil et al. (2009), Crutchley et al. (2007), Erickson et al. (2006), Lennox
and Pittman (2010), and Wang et al. (2010), which were previously cited in this study and are geared
towards measuring the probability of occurrence of corporate fraud. The calculation of this
probability derives from qualitative choice econometric models, such as logit and probity, in which
the dependent variable is binary, with 1 referring to the presence of the attribute and 0 referring to
the absence of the attribute, and the attribute being defined by the occurrence of the event, in this
case corporate fraud. The logit and probity qualitative choice models can also be extended to
multinomial approaches, in which the dependent variable can take one of several attributes in order
to cover a greater number of possible occurrences for the studied phenomenon.

This possibility of greater detailing of the dependent variable enables a better adjustment of the
data collected in this research to the empirical analysis methodology, since the occurrence of
corporate fraud associated with the administrative proceedings of banking institutions is
characterized by the existence of intermediary behaviours, given that an institution that is being
investigated can be convicted or cleared in the administrative proceeding. In summary, the
dependent variable can assume the following behaviours:

Absence of the attribute: banking institution without administrative proceeding;

Presence of the attribute: banking institution investigated in an administrative proceeding;

Presence of the attribute: banking institution cleared in an administrative proceeding; Presence of

the attribute: banking institution convicted in an administrative proceeding.

Figure 2 clarifies the three different categories of the dependent variable:

28
 Qualitative
choice vriable

withh adm. with

without punitive
prceedig- adm.proceedg-
adm. proceedig
wihout convictio with coviction

Figure 2 Characterization of the dependent variable

According to Hilbe (2009), the multinomial probability distribution is an extension of the binomial
distribution. The multinomial model to test the functional relationship between corporate fraud and
the independent variables can be specified as:

LnΩ m\b(x)=lnPr(y=m\x)Pr(y=b\x)=xβm/b,form=1toj

(1)

In which

x= f (pressure, opportunity, rationalization, controlvariables)

where the set of variables x will be represented by the elements of the fraud triangle and by the
control variables, which will be subsequently described.

Equation 1 : presents the relationship between the dependent variable, y, and the independent
variables, x. The attribute in reference, which will be compared to the others, is represented by b,
while the number of categories is presented as m. To solve the equations j, the following equation is
used to calculate the predicted probabilities:

29
 (2)

The collected data present the behaviours of the banking institutions studied over the years,
forming transversal and longitudinal cross-sections. These cross-sections can be analysed by forming
a simple pooling, when the estimated parameters are constant for all for all the observation units
and for all the periods, or by forming a panel of data, when the estimated parameters are variables
for each observation unit over time, which in the multinomial case are estimated by random effects.
A study conducted by Karlson (2011) compared the two approaches and found that the simple
pooling tend to underestimate the parameter estimates compared to the random effects models. It
bears mentioning that in both models the estimation method used is maximum likelihood.

In light of this, in order to test the established hypotheses, we opted for the estimation of the two

types of multinomial logit models: the simple pooled one and the random effects one, so as to then

compare them. In order to provide an overview of how this study was operationalized in terms of

econometric modelling, Figure 3 was elaborated.

30
Figure 3 Flowchart to determine the most appropriate econometric modelling

As in the flowchart shown in Figure 3, depending on the specificity of the dependent variable and in
light of the layout of the research data, the pooling of 44 banking institutions in accordance with
their longitudinal data series was considered, in order to verify whether the model should following
simple pooling or panel data under random effects.

The first step in applying the methodology was to calculate the Cramer and Ridder (1991) test, with the aim
of verifying whether this model can be used as simple pooling. This test assumes a high
multinomial logit with (S +1) states and two pooling candidate states/levels, s 1 and s 2The null
hypothesis assumes that s 1 and s 2have the same regressor coefficients, except the effect; that is:

βs1=βs2=βs

(3)

31
Thus, for the models in which the Cramer and Ridder (1991) test indicated that the multinomial logit model
could be analysed, the irrelevant alternatives hypothesis was tested. In this hypothesis
(IIA), the appropriateness of using the multinomial model is ensured. Thus, the Hausman-McFadden (1984) test
and the Small-Hsiao (1985) test were applied, and alternatively, the suest-base Hausman test to verify the
independence of the irrelevant alternatives, and consequently, the assumption of independence
between the error terms.

For the models in which the Cramer and Ridder (1991) test indicated that simple pooling was not the best
alternative, a multinomial logit model with random effects was used. For this model, the Stata v.13
program was used, which made it possible to measure the multinomial logit models with random
effects using the gsem command. This command enables models with multilevel data to be
adjusted. The adjustment of these models makes it possible to simultaneously treat the level effect
in groups, for example by including random effects such as non-observable effects in the group of
companies.

An additional comparison between the multinomial logit, traditional, and with random effects
models was carried out by analysing the information criteria - Akaike information criterion (AIC),
Schwartz Bayesian information criterion (BIC), and likelihood ratio test (LR) -, with the aim of
guaranteeing the choice of that which best adjusts to the data.

It is important to highlight that the multinomial logit model with fixed effects was not considered in
the analysis because up to the final date of carrying out this study its integration into the program
used - Stata v.13 - had not been concluded, although in 2011 the researcher Klaus Pforr submitted
the programming for this insertion. Other statistical software was not studied, with the exception of
SPSS and Gretl. So, it cannot be affirmed that the multinomial model with fixed effects has not been
implemented in different programs.

Independent variables

The set of independent variables, X i,t was mostly defined with the help of the literature on agency
theory and the economics of crime and empirical studies on fraud and earnings management in
banking institutions. The description of these variables, of the data collection and research sources,
as well as the control variables used, are presented in tables 1, 2, and 3.

Cressey (1953
Table 1 shows the independent variables used to measure the pressure dimension of the )
fraud triangle:

Table 1 Variables used - pressure dimension

Dimension of the fraud triangle: pressure

NO. Variable Description and data collection source
1 FIR_ASS Financial intermediation revenue divided by total assets. Source: QFI.
2 VAR_NI Variation in net income. Source: QFI.
The bank’s operating income divided by the operating income of the market
leader bank. Source: QFI.
3 SHARE_MARK
4 ROA Operating income divided by total assets. Source: QFI.

32
 5 ROE Net income divided by net equity. Source: QFI.
Dummy to indicate whether the directors receive a share in the company’s
profit. Source: AIFs and RFs.
6 SHARE_NI
Value of quarterly remuneration divided by total assets. Source: board of
directors minutes, AIFs, and RFs.
7 QUART_REM
Deviation in quarterly fixed remuneration. Source: board of directors
minutes, AIFs, and RFs.
8 DEV_REM
Dummy for remuneration received below the average remuneration paid by
the market of publicly-traded banks.
9 D_DEV_REM
RFs = Reference Forms; AIFs = Annual Information Forms; QFI = quarterly financial information.

The auditing rules, Resolution n. 1,207 of 2008 ( CFC, 2009

), and SAS n. 99 (AICPA, 2002
), elaborated in
Cressey fraud triangle (1953
accordance with the ), establish two types of sources of incentive or
pressure that produce fraudulent financial information when management is under pressure -
external and internal sources - to achieve earnings targets or expected financial results.

As internal and external sources of pressure, two items stand out that can serve as indicators of the
pressure dimension: the performance to be achieved by the agents and perceived remuneration,
which influences the standard of living of these agents. As internal sources of pressure, the studies
by Alexander and Cohen (1996) and Macey (1991) are used, which originate from the area of criminology and
the economics of crime. According to Macey (1991), self-interested managers become involved in criminal
conduct in the name of their organizations not to benefit the shareholders but to maintain their
positions. Also according to the author, the threat of a lower than ideal performance can lead to
managers preferring a higher level of risk in order to increase the company’s performance. This can
lead the manager to manipulate the financial statements with the aim of increasing the institution’s
performance, thus achieving the performance targets set by the owners and resulting in them
maintaining their current position. Thus, in order to measure the institutions’ performance, the
financial intermediation revenue was used, as well as the variation in the institution’s net income,
the return on assets and on investments, and the level of market share in relation to the leading
banking institution. For these variables, a positive and significant behaviour is expected in relation to
the probability of fraud; the higher its value, the greater the possibility of fraud occurring. As
external sources of pressure, variables related to the structure of the managers’ remuneration were
used, since this is interconnected with their personal standard of living.

The managers’ remuneration structure, or compensation policies, according to agency theory, aims
to give incentives for the agent to select and plan actions that increase the wealth of shareholders
(Jensen & Murphy, 1990). Thus, using articles on this theory, the following variables were outlined: fixed
remuneration, profit share, and an indicator of remuneration perceived below the market average.
Fixed remuneration and profit share, as well as remuneration policies, could indicate an inverse
relationship with the probability of fraud. As remuneration perceived below the market average, a
positive relationship with the probability of fraud is expected, given that managers can use
fraudulent means to “correct” perceived economic inequality. It bears mentioning that as a pressure
point Cressey (1953) highlighted the relationship between employees and employers, in which the former
can feel undervalued in relation to their status in the organization. This feeling can derive from

33
perceived economic inequalities, such as payment and a feeling of being overloaded with tasks or
being undervalued (Wells,
2011).

Table 2 presents the independent variables used to measure the opportunity dimension.

Table 2 Variables used - opportunity dimension

NO. Variable Description and data collection source

Number of independent board of director members squared.
10 IBM2 Source: AIFs and RFs.
Number of board of director members squared. Source:
11 TBD2 AIFs and RFs.
Number of fiscal council members squared. Source: AIFs and RFs.
12 TFC2
13 SIZE_DIR Number of company directors.
Dummy for companies that are listed in the corporate
governance segments of the BM&FBOVESPA. Source:
14 SEAL_GOV BM&FBOVESPA Daily Bulletin.

Dummy to indicate whether the auditing company is one of the

Big Five or not. Source: CB auditing reports.
15 BIG_FIVE
16 ADA_EXP Allowance for doubtful accounts. Source: QFI.
17 TTOT_ASS Value of total assets. Source: QFI.
CB = Brazilian Central Bank; RFs = Reference Forms; AIFs = Annual Information Forms; QFI = quarterly
financial information.

The opportunity dimension includes weak corporate governance structure as well as other working
conditions that enable the manager to commit fraud ( Brazel et al., 2009).

Corporate governance mechanisms enable the owners of a corporation to exercise control over the
activities of insiders and managers, so that their objectives are protected ( John & Senbet, 1998). Thus, if
these mechanisms are not adequate and present fragilities, the possibilities of corporate fraud
occurring is increased. To measure such mechanisms, the number of independent board members
was used, as well as the size of the fiscal council, the size of the board of directors, the auditing firms
considered as Big Five, company seals of corporate governance issued by the São Paulo Stock,
Commodities, and Futures Exchange (BM&FBOVESPA), and the size of the institution’s executive
board.

It bears mentioning that Arthur Andersen, Deloitte, Ernst & Young, KPMG, and Price were
considered as the Big Five. Currently the auditing companies are called the Big Four, as a result of

34
the demise of Arthur Andersen in 2002. As the period of this study covers that year, the decision was
made to follow the same treatment given by Lennox and Pittman (2010), by including this company and using
the original denomination - Big Five.

Note that the independent members, board of directors size, and fiscal council size variables were
squared to capture the fact that coordination, communication, and decision-making problems make
the board’s performance difficult when the number of directors increases (Yermack, 1996). Thus, the size
of the board of directors and the number of independent members help in the effectiveness of the
corporate governance up to a certain point, since as the board grows the incremental cost of adding
members will be greater than the monitoring benefit, thus constituting a convex function.

Also, as independent variables, the allocation for doubtful accounts and company size were
included. Lou and Wang (2009) found that complex transactions are accompanied by a high inherent risk due
to the involvement of a high degree of management judgment and subjectivity.

The allowance for doubtful accounts will identify earnings management opportunities for the
manager, given the use of subjective criteria in its accounting. This variable is used to detect
earnings management in banking institutions ( Deboskey & Jiang, 2012), precisely because of the discretion and
subjectivity that managers have to estimate it and the difficulty involved in the auditing of this
variable (Deboskey & Jiang, 2012).

When the size of the organization increases, managers have a greater amount of resources at their
disposal, as well as there being an increase in the complexity of operations and in the agency
conflicts between owners and managers ( Ryan & Wiggins, 2001). Thus, when the size of the company
increases together with the complexity of its operations and the conflicts derived from the agency
relationship, managers can use this environment to execute corporate fraud.

Table 3 shows the independent variables used to measure the rationalization dimension of the Cressey
fraud triangle (1953) and also those used as control variables.

Table 3 Variables used - rationalization dimension

NO. Variable Description and data collection source
18 AGE CEO age. Source: AIFs and RFs.
19 DEGREE_MAN Dummy for CEO with degree. Source: AIFs and RFs.
20 SP_MAN Dummy for CEO with specialization. Source: AIFs and RFs.
Dummy for CEO with strict sensu post-graduation. Source:
21 STRICTU_MAN AIFs and RFs.
Dummy for CEO with degree in the business area. Source: AIFs and
RFs.
22 CDAB
Dummy for CEO with lato sensu post-graduation in the business area.
Source: AIFs and RFs.
23 CLSPAB
Dummy for CEO with strict sensu post-graduation in the business
area. Source: AIFs and RFs.
24 CSSPAB

35
 Percentage of the number of female directors over the total number
of members of the fiscal council. Source: AIFs and RFs.

25 PERC_WOM_FC
PERC_WOM_BD Percentage of the number of female directors over the total number
of members of the board of directors. Source: AIFs and RFs.

26
Percentage of the number of female directors over the total number
of members of the executive board. Source: AIFs and RFs.

27 PERC_WOM_EB
Dummy to indicate alterations in the legislation with the aim of
increasing the punishment for financial crimes. Law n. 12,683 of 2012
(Brazil, 2012).
28 PUNI
Control variables
Dummy for multiple and commercial banks. Source: CB registration
data.
29 TYP_BK
Dummy for the international accounting standards convergence
period.
30 CONVERG
Dummy for state controlled banks (federal, state, and municipal
government). Source: AIFs and RFs
31 STATE
Dummy to indicate the subprime crisis period (July 2007 to
32 CRISIS April 2009)
CB = Brazilian Central Bank; CEO = chief executive officer; RFs = Reference Forms; AIFs = Annual
Information Forms.

In an attempt to measure the rationalization dimension, the demographic characteristics of the

executives were used. These characteristics, although considered incomplete and imprecise proxies
of the executives’ cognitive structures, are taken as valid because of the difficulty in obtaining
conventional psychometric data on senior executives ( Hambrick, 2007). For this, the following demographic
variables were used: age of the chief executive officer (CEO), his/her training in any area, his/her
training on courses related to the area of business, the predominance of females on the fiscal
council, on the board of directors, and in management, and a punishment factor.

For Troy et al. (2011), younger managers are more likely to rationalize accounting fraud as an acceptable
decision. Thus, Zahara et al. (2007) emphasize that younger managers tend to take risks as a way of more
quickly achieving career progression. As for older ones, they tend to be more analytical in their
decision making, executing decisions with more care, seeking more information, and carrying out a
more precise diagnosis of the information gathered.

36
Therefore, age appears to be an indicator of an individual/manager’s moral development.

With regards to educational training, studies such as those by Gioia (2002), Hambrick and Mason (1984), and
Rest and Thoma (1985
) recognize the role of education in the ethical behavior of managers, as well as
empirically proving this relationship has a positive association with moral development ( Rest & Thoma,
1985). Also, Troy et al. (2011) affirm that managers without knowledge in the area of business will tend to
rationalize fraud as an acceptable decision, unlike those trained in the area of business, who will be
more aware of potential repercussions and penalties of unethical behaviour. In light of the claims of
the various authors, it is perceived

that managers’ educational training can be directly associated with the act of committing fraud.

To analyse managers’ gender, support was sought from the studies by Kelley et al. (1990), Reynolds (2006), and
Zahra et al. (2007
), which indicate that male managers are more likely to accept unethical behaviour to
achieve their objectives. Moreover, Steffensmeier et al. (2013) determined that female executives can be more
ethical in their decision making. Therefore, it can be inferred that a female predominance can
negatively influence in the probability of corporate fraud occurring.

The use of a punitive factor was derived from the studies by Cressey (1953) and Becker (1968). In his model, the
latter pondered that criminal individuals consider the effect of punishment in their decision to
commit a crime or not. Thus, the effect of an increase in punishment is expected to negatively
impact the probability of corporate fraud.

In order to measure the effect of punishment on the probability of corporate fraud occurring, the
decision was made to use the normative alterations that increased the punishments applied to
crimes against the National Financial System (NFS). The alterations in the legislation were qualified
by a dummy. It bears mentioning that the legal instruments that discipline crimes against the NFS
were researched and of these only Law n. 9,613 of 1998 ( Brazil, 1998) against crimes of money and illicit
laundering in the financial system was altered. The alteration occurred via Law n. 12,683 of July 2012
(Brazil, 2012), which raised the penalties applied to institutions involved in crimes and their
representatives.

For the model, four control variables were also defined: type of bank, convergence with the
international accounting rules, state control, and subprime crisis. The first variable was used to
identify the type of bank classified by the CB according to their activities - multiple or commercial
bank.

The second variable was employed with the aim of distinguishing the period in which the conversion
to the international accounting rules came into effect, in accordance with Resolution n. 3,786 of
2009 (CB, 2009). It bears mentioning that, according to CB information, the accounting norms
established by the National Monetary Council and by the CB, embodied in the Accounting Plan for
Institutions of the National Financial System (COSIF), present divergences in relation to the
international accounting rules issued by the IASB, representing partial convergence with the
international accounting rules.

In order to moderate the effect of the control and ownership of the banking institutions, the
inclusion of variables that identify whether the control is state or foreign was considered. These two
types of categories have different characteristics from the other banking institutions. Foreign banks
need to deal with different environments and regulations: regulations in their country of origin and

37
those of the foreign institution. State banks can operate with government subsidies, besides having
a more complex governance due to the presence of one more agent: the politician ( Silva, 2004).
However, in this study foreign control was not differentiated, given that for the banking sector,
87.38% of total assets in 2012 are of banks with Brazilian capital, besides the limited number of
banking institutions with foreign control, corresponding to six of the 44 institutions analysed.

The fourth control variable was included to analyse the effect of the subprime crisis. Thus, the
variable will indicate the crisis period occurring from mid-2007 to April of 2009 ( Maciel et al., 2012).

It is worth noting that in light of the research period, January 2001 to December 2012, the variables
derived from the financial statements and the fixed remuneration of management were monetarily
corrected. For this, the monetary correction index was used, as well as the general index of prices-
internal availability (IGP-DI), calculated monthly by the Getúlio Vargas Foundation. This procedure
enabled an analysis of the impact of these variables in a space of time without the influence of
inflation.

It is perceived that the number of independent variables presented in tables 1, 2, and 3 is too high,
totalling 32, and this number of variables may have an impact on the accuracy of the model to be
estimated for hypothesis 1, due to the problems derived from the

multicollinearity of the independent variables. One option for minimizing this problem is the
application of data reduction techniques, such as factor analysis.

Factor analysis is a multivariate technique that provides tools for examining the structure of the
inter-relationships in a large number of variables, defining sets of strongly inter-related variables,
known as factors (Hair Jr., Black, Robin, Anderson, & Tatham, 2009). To apply this technique, first the following
tests were carried out: (i) Bartlett sphericity, to analyse whether the variables are intercorrelated,
and (ii) Kaiser-Meyer-Olkin (KMO), to measure the adequacy of the sample. For Hair Jr. et al. (2009), the
closer to 1 the KMO value is, the better the sample will fit the factor analysis. The author states that
the researcher should consider a general value above

0.50 to apply the factor analysis.

The technique applied enabled the generation of components, called factors, which were rotated by
the orthogonal varimax method to simplify their analysis. These factors were allocated instead of the
32 variables reported in tables 1, 2, and 3 and used to test hypothesis 1 of this study, via the
application of the multinomial logit model.

It is important to mention that the logit model to be estimated can lose its predictive character due
to the application of the factor analysis technique. The inclusion of new observations in the database
will imply the need to employ the technique again, whose action can alter the parameters estimated
in this study. However, it is worth highlighting that the results of the study enable important
variables to be identified to calculate the probability of fraud occurring. These variables can be used
both in new academic studies and by market professionals, such as regulators, auditors, and
investors.

38
4. EMPIRICAL ANALYSIS

The use of factor analysis to reduce the data resulted in the data in Table 4.

Table4 Factor analysis: hypothesis 1

39
As the results of Table 4 show, the Bartlett sphericity test indicates that the null hypothesis was
rejected at a 1% level of significance, therefore the analysed variables are correlated. The KMO test
statistic, with a value of 0.718, shows that the proportion of the variance in the data can be
considered as common to all of the variables, thus validating the use of the factor analysis in this
study. Note that the subprime crisis variable was removed from the sample as it did not present a
high correlation with any other variable used. The variable for CEO with a stricto sensu post-
graduation course in any area was also excluded as it presented a correlation of 100% with the
variable for CEO with stricto sensu post-graduation in the area of business, in order to avoid
redundancy. As observed in Table 4, seven factors were extracted as they presented Eigen values
above 1.00. These factors, in their totality, are able to explain 69.91% of the cumulative variance.

In Table 4 it is verified that the variables from each dimension - pressure, opportunity, and
rationalization -, numbered in tables 1, 2, and 3, were distributed between the factors, except
factors 3 and 6, in which variables from the rationalization dimension were grouped. Due to this
dispersion of variables, it was decided not to rename them, thus preserving the individual
characteristics of the variables with high factor loads, grouped in the different factors. Therefore,
factor 1 contemplates variables from the pressure and opportunity dimensions; factor 2 contains
variables from the opportunity and rationalization dimensions and control variables; factor 4
contains variables from the pressure and opportunity dimensions; factor 5 contemplates variables
from the three dimensions and one control variable; and factor 7 is composed of variables related to
the pressure and rationalization dimensions.

40
The factors presented in Table 4 were used as independent variables to process equations 1 and
2, which were previously described and whose results are available in Table 5. Note that the
multinomial logit panel model was operationalized by the Stata v.13 software.

Table 5 Relationship between corporate factors and frauds: hypothesis 1

1: proxy for indications of corporate fraud; 2: proxy for occurrence of corporate fraud; AIC = Akaike
information criterion; BIC = Bayesian information criterion; LR = likelihood ratio.

**: p < 0.01; **: p < 0.05; * p < 0.1.

From examining the results in Table 5, it is verified that the results of the Cramer and Riddler test (1991) indicate
that the groupings among the alternatives cannot be carried out at a 1% level of significance. Thus,
the econometric analysis of hypothesis 1 cannot be carried out via simple pooling of the data and it
is necessary to treat them as a panel and consider the existence of non-observed heterogeneity
between the banking institutions. That is, the banks present peculiar characteristics that
differentiate them over time. So, the multinomial logit model with random effects represents the
most appropriate model for estimating the parameters of the functional relationships established in
the study.

The additional comparison tests also indicate that the logit model with random effects best adjusts
to the data. This can be observed in the results of the LR test and via the AIC and BIC information
criteria. The LR test shows a p-value of less than 0.05, implying that the constrained model is more
adequate. The values of the AIC and BIC information criteria for the multinomial logit model with
random effects were lower than those of the traditional logit model, which enables it to be inferred
that the model with random effects appear to be more adjusted to the data in the study.

41
Considering the probability of indications of corporate fraud, in Table 5 (column B1) it is observed
that factor 1 presents a positive and significant relationship. In this factor, the variables with the
highest factor load are: level of market share, size of the executive board, size of the institution,
quarterly remuneration, and deviation from remuneration paid by the market, in that order, and
with a factor load above 0.85 (Table 4, column A). It bears mentioning that these variables were
characterized as representative of the pressure and opportunity dimensions. The level of market
share and the variables interlinked with remuneration represent measures for company
performance and compensation structure, which denotes elements of the pressure dimension. As
for the size of the executive board and the size of the institution, these can be considered as
explaining the opportunity dimension.

Due to factor 1 having indicated a positive behaviour with the probability of indications of fraud, it is
perceived that the variables derived from the pressure dimension present a coherent behaviour with
the findings of Alexander and Cohen (1996) and Macey (1991), both from the area of criminology. In these,
below-ideal performance can lead managers to prefer a higher level of risk to increase company
performance, such as by manipulating results. With regards to the variables classified as
remuneration items, Macey (1991) argues that in order to achieve their objective of satisfying or
maintaining a particular level of income, managers can achieve this either through work and ability,
or by becoming involved in criminal activities.

For the size of the executive board variable, it is verified that an executive board with a greater
number of members can represent a measure of power compared with board of directors ( Brazel et al.,
2009
) and can also imply an increase in monitoring costs and problems for the board of directors to
coordinate these directors. As for the size of the institution, this can result in an environment that is
more conducive to indications of corporate fraud. According to Alexander and Cohen (1996), what promotes an
environment with a greater number of opportunities for committing fraud is the size of the
organization. Thus, for the variables that denote measured items of the opportunity dimension in
factor 1, it is observed that given that its factor loads are positive and the factor is positively and
significantly related with the probability of indications of fraud, the results are consistent with the
empirical results of studies on accounting fraud, agency theory, and criminology.

For the probability of corporate fraud occurring, it is verified that factor 2 ( Table 5, column B2)
shows a positive and significant relationship with the occurrence of corporate fraud. For this factor,
it is observed that the variables with the highest factor load, above 0.84 (Table 4, column B), are the
size of the fiscal council and companies under state control. With these, the former was considered
as an element of the opportunity dimension and the latter as a control variable. The behaviour of
the size of the fiscal council was expected to be the opposite to that of factor 2. However, given the
positive factor load, this was not found. This variable aims to monitor management acts, offer an
opinion on particular issues, and express the shareholders’ position ( Trapp, 2009). It would therefore be
an element of monitoring management actions.

As for the factor load for the state control variable, this shows an interesting result. Because it is
positive, it is consistent with the relationship between factor 2 and the probability of corporate
fraud occurring, which is positive and significant. This result is consistent with the most recent cases
of corporate fraud in Brazil, such as those of Petrobrás and Correios ( Brito, 2014; Ministério Público Federal,
2014), indicating that these companies provide greater opportunities to execute corporate fraud.

Also, for the probability of occurrence of corporate fraud, it is observed that factors 4 and 5 indicate
negative and significant behaviour in relation to this probability.

42
As variables with loads higher than 0.62 (Table 5, column D), factor 4 presents the return on the
assets of the banking institution and the size of the board of directors. As this factor is negatively
related with the probability of fraud occurring, an alignment is perceived between the result
obtained with the size of the board of directors, given that it is positively correlated with this factor.
This result is consistent with agency theory, in that the composition of the board of directors is a
fundamental corporate governance mechanism in market economies, as it exercises control over the
executive board (Byrd, Parrino, & Pritsch, 1998; John & Senbet, 1998). As for return on assets, this indicated an
unexpected behavior. Classified as a pressure element and especially as a measure of the
institution’s performance, its influence was expected to be inverse to the probability of fraud,
however this did not occur. The financial intermediation revenue variable presented an expected
result, consistent with factor 4 and therefore not contributing with its negative relationship to the
probability of fraud occurring, which supports the writings of Alexander and Cohen (1996) and Macey (1991).

Finally, factor 5 gathered the following variables of the opportunity and rationalization dimensions
of the Cressey fraud triangle (1953), as well as a control variable: independent members, predominance of
females on the executive board, punishment, and convergence with the international accounting
rules. Factor 5 presented a negative and significant relationship for the probability of occurrence of
corporate fraud. In this, the variables with a factor load above 0.50 (Table 4, column E) showed a
positive correlation with the factor, therefore contributing to the negative relationship found for the
probability of corporate fraud occurring. Note that the results obtained for independent members
are consistent with agency theory, given that a greater proportion of independent members -
outsiders - on the board of directors reduces the probability of corporate fraud occurring, as seen in
Beasley (1996
).

As for the predominance of females on the executive board and punishment, these are in
accordance with the writings from the area of criminology. The results for females are similar

to those of Steffensmeier et al. (2013) and the claims of Kelley et al. (1990), Reynolds (2006) and Zahra et al. (2007)

concerning the behaviour of females with regards to fraud. According to these authors, female

managers are less susceptible to committing fraudulent acts than male managers. The results for

punishment are bolstered by the studies by Becker (1968), Eide et al. (2006), and Murphy (2012) in the area of

criminology and the economics of crime. According to these studies, punishment is an important

situational factor in the decision-making process with regards to committing a criminal act or not.

As it was observed in the results of the research, variables from the three dimensions of the Cressey
fraud triangle (1953
), even when grouped in factors, were significant for measuring the probability of
corporate fraud. This is consistent with the arguments of Cressey (1953), in which the absence of any
one of the dimensions would prevent the violation of financial trust; that is, committing fraud.
Therefore, because of the results obtained with factors 2, 4, and 5, hypothesis 1, which states that
the three dimensions of the fraud triangle together condition the occurrence of corporate fraud in
Brazilian banking institutions, cannot be rejected.

43
Based on the results put forward in Table 5, which were discussed in the previous paragraphs, an

econometric model is presented for measuring the probability of corporate fraud occurring in

banking institutions, in its final specification:

2.3 Scope

• The Policy is based on principles of transparency and fairness in the treatment of customers.

• It is designed to cover deficiency in service in areas relating to account operations,

collections and remittances etc., as specified in this Policy.

• Grant of compensation under this Policy is without prejudice to the Bank's rights in
defending its position before any Court of Law, Tribunal or any other forum duly constituted
to adjudicate banker-customer disputes and does not constitute admission of liability or any
other issue, of any nature whatsoever for the purposes of Adjudicatory proceedings.

Non-submission of control returns to controlling authorities in respect of loans sanctioned /

purchase of bill/ excess drawing permitted etc by the branches. Submission of stock statements
at periodical intervals, as provided in the bank’s manual is not insisted upon. This should be
done always. 63.46% of respondents take stock statement always while 36.54% do it often or
occasionally. The physical inspection of the quantity and quality of goods is not conducted by a
surprise check to examine and verify the goods. Inspection of hypothecated stocks conducted by
the branch officials is tardy and indifferent. Only 51.92% of respondents always inspect the
quantity and quality of goods pledged periodically. The banks prescribed rules and procedures
are not strictly followed in the matter of control of security represented by hypothecation
charges. Security documents are often found seriously short and the unscrupulous borrower
takes full advantage of it. The bank does not ensure that its name boards are prominently
displayed at the place where the hypothecated goods are stored. Hypothecated stocks are not
adequately insured against proper risk. It should be always ensured by the officer in charge that
there is proper the security and suitability of the goods pledged through periodic inspection. But
only 48.72% respondents do inspect always while rest deviate from such practice more or less. It

44
 is not ensured that the borrower is dealing exclusively with the lending bank. No such
undertaking is obtained nor is such exclusive dealing ensured subsequently from time to time.
Only 48.72% of the respondents always ensure that the borrower is dealing exclusively with the
lending bank. (Refer to Appendix II).

No serious attempt is initially made to verify the character and antecedents of the borrower, in
particular the individual borrower. The end use of funds withdrawn is not verified. Prescribed
margins are not kept while calculating the drawings power. Undue haste is shown in cases of
takeover of borrower accounts from other banks. (Refer to Case 3 and Case 4 in Appendix I) The
bank does not obtain periodical statements of party wise, age wise, outstanding debts and continues
to allow drawing power on the basis of all entries. But only 42.31% take periodic statement of party
wise and age wise outstanding debt always. (Refer to Appendix II) Spurious letter of credit
apparently opened by the other banks, are tendered to the branches concerned with bills of
discounting under them. The branches do not follow elementary precautions of having signatures
appearing in the letter of credit verified by the official of branch. (Refer to Case 5 in Appendix I)
Discussion on frauds cannot be complete without analysis of human behaviour. An employee in an
organization is like a fish in an ocean. Nobody can determine when and how much water a fish has
consumed.

Likewise, a corrupt and dishonest person in an organization can commit frauds with impunity. Bank
management in India has its own recruitment boards. The usual modus operandi of the boards is to
give a general ability test, hold an interview and the selection is complete after medical examination.
Psychiatric and Psychological revaluation for banking services is not being done at all in India. The
respondents have given 4.31-weight age to corrupt officer in charge as a reason responsible for bank
frauds. The total number of bank employees against whom the action has been taken for their
involvement in cases of bank fraud during 2002, 2003 and 2004 were 5459, 5237 and 4311
respectively.

2.4 LIMITATION
Misconduct by bank traders could persist as a problem if fraud cases are treated as the actions of an
individual ‘bad apple’. Improving the team climate is what is really needed to reduce the likelihood
of fraud. This is according to psychologists Wienke Scholten (until recently

Behaviour & Culture Supervisory Officer at De Nederlandsche Bank/DNB) and Naomi Ellemers
(Distinguished Professor of Utrecht University) in an academic article.

45
Bad apple
In cases of fraud, banks often depict the perpetrator as a bad apple. Most banks believe that their
eradication will solve the problem. Scholten: “That approach means that there is no further
investigation of the conditions that enabled this misconduct. It is also why these kinds of fraudulent
practices continue to happen at banks.” As long as banks cling to the ‘bad apple theory’ and act
accordingly, misconduct by traders will remain a persistent problem. “The removal of a single
fraudster does not solve the problem. The overall team culture plays a major role in misconduct by a
trader.”

Combating unethical conduct

Using a socio-psychological model, dubbed the ‘Corrupting Barrels Model’, that outlines how
misconduct emerges and is perpetuated within teams, the psychologists present tips on combating it
in their article. According to Scholten, improvements to the team climate reduce the likelihood of
unethical conduct. “In the team, you need to investigate how traders and managers handle mistakes
made, whether there is a culture of envy caused by pay inequality or favouritism, and whether team
members are actually aware of the moral implications of their activities.”

Five ways to combat bank frauds are highlighted below as:

1. Adopt appropriate technologies:
An inclusive mix of strong authentication systems; analytics software; and bank services,
positive pay and payee verification, for example, can greatly reduce an organization’s
exposure to fraud. It is important to have layers of protection.
2. Beef up your internal controls:
Sarbanes Oxley mandates that companies pay strict attention to their internal controls. But
even the most thorough Sarbanes-Oxley compliance effort cannot provide comprehensive
protection against fraud. Proactive organizations will want to put additional controls in
place, including rigorous approval procedures and careful separation of duties. That is
especially true of disbursement processes, such as wire transfers.
3. Screen job applicants carefully:
One of the biggest security problems company’s face is fraud perpetrated by trusted
insiders. Key finance functions such as treasury must conduct background checks on
potential hires, and companies should also consider drug testing and honesty testing. It is
the first line of defence.
4. Educate your workforce:

46
 Employees need to understand how damaging fraud can be to the organization. They must
be able to recognize signs of fraudulent activity and know how to report it. In addition,
treasury employees will need to be trained in the correct use of the company's fraud
protection tools and technologies.
5. Prosecute thieves:
Many organizations fire employees who are caught stealing but avoid prosecuting them for
fear of bad publicity. A zero-tolerance policy goes a long way toward reducing the risk of
illegal activity. Likewise, managers should immediately turn over any evidence of suspected
fraud to law enforcement agencies.

2.5 DATA COLLECTION

A look at the data on banking frauds detected indicates that the number has exponentially risen in
the past decade. Loan frauds constituted the highest percentage of frauds in FY 2019according to
RBI data

More frauds under lens

While the number of bank frauds detected rose by 45% in FY '19 compared to FY '09, the amount of
money involved spiked 35 times in the same period. The average quantum of a fraud has increased
over the past decade, from ₹0.4 crore in FY09 to ₹10 crores in FY '19 ‘

47
PSB’S I pickle

Public Sector Banks accounted for the highest number of frauds and quantum (90.2%). In the chart
on the right, each circle represents a type of banking institution, while the size indicates average
amount

per
fraudulent transaction in FY '19

48
2.4 Techniques and tools

Many a time, the borrowers are not traceable. ATM: Money is withdrawn using cloned ATM cards.
Cash credit: Frauds involve falsification of the books of accounts and removal of goods and property
hypothecated to the banks without their knowledge. Term loan: This is the biggest contributor to
the frauds.
Measures to control banking frauds
Some of other promising steps to control frauds are: educate customers about fraud prevention,
make application of laws more stringent, leverage the power of data analysis technologies, follow
fraud mitigation best practices, and employ multipoint scrutiny.

8 most common methods that fraudsters use to steal your online banking details

Online banking frauds are on the rise. With fraudsters using various channels to trap users, it
becomes necessary to take preventive measures to avoid such frauds. In one of the biggest online
fraud in the country, a man recently lost Rs 11 crore. Little doubt then that on their part, banks too
keep warning their customers about such frauds. Here are 9 most common ways that fraudsters use
to steal online banking details and dupe people of their money.

1 Online shopping refund

2 Online banking details
3 Online scams
4 Online KYC

49
 5 Online frauds
6 KYC
7 Fraudsters 8 Banking

This fraud is related to online shopping. Customer receives an SMS in context of online
shopping or cashback. He/she is asked to share confidential details such as grid card details,
ATM card PIN, UPI PIN, debit card number and CVV. Under this method, fraudster installs
malware/spyware using chip embedded in public charging spots. This chip copies your
sensitive data and installs malware on your smartphone, whenever connected. Under this
fraud, the customer receives a call and is asked for transaction banking details such as OTPs
or user ID delivered on your registered mobile number. The fraudster then forwards
activation SMS on your phone which is later used to gain access of your bank account. Using
this method, the caller asks to install system assistance apps such as TeamViewer, Quick
Support and Any Desk. These apps give the fraudster your smartphone's complete access. In
this method, fraudsters send malicious link via SMS or emails that asks recipient to share
his/her confidential details such as grid card details, ATM card PIN, UPI PIN, debit card
number and CVV. These usually come via WhatsApp or SMS offering cashbacks on online
shopping. These messages are usually phishing attempts which try to lure people into
sharing their online banking details. In this, fraudsters claim to be calling from a popular e-
commerce platform (say Amazon or Flipkart) and offer refund on any recent online
transaction made. They try to trap the online shopper by promise of refund and take his/her
bank or credit/debit card details. This is another common online fraud that many people
have fallen to. In fact, Paytm has warned its users against KYC fraud. This scam starts with a
call from someone claiming to be a customer service officer from your bank or Paytm KYC
executive. The callers try to scare by saying that your bank, card or Paytm account will be
blocked or something similar. The entire aim is to convince you to download remote access
apps like Any Desk or TeamViewer. Not really new, this fraudulent method is used by
criminals to trick gullible smartphone users who end up losing money in matter of minutes.
SIM swap or simply SIM card exchange is basically registering a new SIM card with your
phone number. Once this is done, your old SIM card becomes invalid and your phone will
stop receiving signal. Now, once the fraudsters have your phone number, they will get OTPs
on their SIM card. With this they can initiate bank transfer and even opt to shop online after
getting OTPs. This fraud too starts with a call from a person who pose as an executive from
Airtel, Vodafone or Jio. He or she then asks you that it's a routine call to improve call drop
problem, signal reception or promise to help you increase mobile internet speeds.

Device fingerprinting tracks a series of identifiable hardware and software attributes to recognize a
user’s (or fraudster’s) device.

• Behavioural analytics monitor navigation techniques and other aspects of a user’s online behaviour
to search for anomalies or suspicious activity.

50
• Malware detection searches for potentially fraudulent changes to a user’s Web browser to assess
whether it's been compromised.

• Knowledge-based authentication presents a series of static or dynamic and supposedly secret

questions to establish a user’s identity.

• Password tokens give a user a one-time only password that must be entered before it expires.
• Out-of-band authentication challenges a user to access a one-time-only password or code that is
sent to another device, such as a mobile phone or land line.

• Transaction signing requires a user to digitally sign each transaction.

• Endpoint protection requires a user to download a one-time-only, secure browser to access a

website.

• Voice printing records attributes of a caller’s speech over time and matches those attributes
against subsequent calls. Voice printing is an example of biometrics, which use unique physical
traits, or characteristics to identify individuals.
However, as technology advances, we are seeing a distinct proliferation of more complex fraud
schemes. At the same time, we are seeing more breakthroughs in the use of technology to detect
fraud. Strategies that we have used in just the past few years will become completely outdated, as a
fresh set of tactics will debut.50 To minimize the potential damage of fraud, companies need to
invest not just in more advanced technology but in people and policies for detecting attacks as
quickly as possible. While the networks are just too large to prevent every attack from occurring,
detection is crucial. Most companies do not have adequate protocols and staff in place to deal with
incidents of fraud. While advanced technology serves as a great tool to combat fraud, the issue
should be viewed as more than just an IT problem and looked at as a business problem. Remember,
the cost of trying to prevent fraud is far less expensive to a business than the cost of fraud
committed on a business.

Chapter 3:

Literature review:

Brief Literature Review

The aftermath of the great depression in 1930s in the USA saw enforcement of Glass-Stage all act
(GSA) with an objective to reduce risks to financial system and tackle conflict of interests that exist in
banking, by separating commercial banking functions from ‘risky’ investment banking functions.
However, over time, a series of dilutions gradually rendered GSA ineffective which was finally
repealed in 1999. With globalization, Kohler (2002) in his speech at a conference on humanizing the
global economy stressed the need to increase transparency of financial structures as well as to raise

the surveillance of international capital markets. In mid-1990’s, World Bank laid out a welldefined
strategy to combat different types of frauds and corruption, and jointly with the IMF created
financial sector assessment program (FSAP), to assess, diagnose and address potential financial
vulnerabilities. FSAP has undergone several transformations and wider acceptance over the years,

51
since its inception in 1999. Mergers of giants in the banking industry gave birth to the concept of
“too big to fail”, which eventually led to highly risky financial objectives and financial crisis of 2008.
In response to the 2008 crisis, Dodd-Frank wall-street reform and consumer protection act (DFA)
was enacted in 2010. DFA gave birth to various new agencies to help monitor and prevent
fraudulent practices. Volcker rule, a part of DFA, banned banks from engaging in proprietary trading
operations for profit. Post crisis, IMF has worked towards making risk and vulnerabilities assessment
framework effective, by advocating greater transparency and information sharing, along with
empowered supervisory and regulatory bodies, as well as greater international collaboration
towards regulation and supervision of financial institutions. Gaps were identified under financial
surveillance as well as on the frequency of such surveillance especially in economies with truly
systemic financial sectors, whose failure might trigger a financial crisis. According to literature,
approximately one in three banking crises followed a credit boom, which shows a correlation
between relaxed credit expansion policies by banks and crises. Another major sector distraught with
fraudulent practices is the credit card market. However, given that credit card usage in India is
predominantly for transactional purposes, the macroeconomic impact of fraudulent practices is less
significant and is not considered further in this study. Indian banking system has remained plagued
with growth in NPAs during recent years, which resulted in a vicious cycle affecting its sustainability.
Chakrabarty (2013) noted in his speech that, while most numbers of frauds have been attributed to
private and foreign banks, public sector banks have made the highest contribution towards the
amount involved. Key findings in RBI (2014b) included the stress of asset quality and marginal
capitalization faced by public sector banks, and various recommendations to address these issues.
Rajan (2014) stressed on good governance and more autonomy to be conferred to public sector
banks to increase their competitiveness and to be able to raise money from markets easily. In
response to the common perception that increasingly strict regulations will make business
opportunities take a hit, Raju (2014) stated that, regulations do not seem to be a bar in functioning
of banks after the crisis. Subbarao (2009) was of the opinion that without broad-based trust and
presumption of honest behaviour, there wouldn’t be a financial sector of the current scale and size.
He called the emergence of a moral hazard problem in the banking system as privatization of profit
and socialization of costs. To maintain uniformity in fraud reporting, frauds have been classified by
RBI based on their types and provisions of the Indian penal code, and reporting guidelines have been
set for those according to RBI (2014a and 2015a). Towards monitoring of frauds by the board of
directors, a circular was issued as per RBI (2015b) to cooperative banks to set up a committee to
oversee internal inspection and auditing, and plan on appropriate preventive actions, followed by
review of efficacy of those actions. Impartial policy guidelines and whistle-blower policy are vital to
empower employees to handle frauds. RBI also issued a circular and introduced the concept of red
flagged account (RFA), based on the presence of early warning signals (EWS), into the current
framework, for early detection and prevention of frauds. Gandhi (2014) discussed the prime causes
of growing NPAs and recognised the absence of robust credit appraisal system, inefficient
supervision post credit disbursal, and ineffective recovery mechanism as key barriers addressing
those aspects. Gandhi (2015) stressed on the basic principles that can go a long way in preventing
fraud, namely the principles of knowing the customer and employees as well as partners. He also
pointed out the significance of a robust appraisal mechanism and continuous monitoring. Locale
(2014) reveals that the share of retail loan segment in total NPAs continues to stay high, of which
credit card loans (2.2 percent) have the third-highest contribution after personal and housing loans.
Livshits, MacGee, Tertilt (2015) empirically suggest that the rise in consumer bankruptcy can largely
be accounted by the extensive margin and lower stigma associated with it. It also suggests that
financial innovations have led to higher aggregate borrowings, which has resulted in higher defaults.
A study by Assocham (2014) finds strong correlation between sustainable credit growth, leading to

52
healthy asset creation, and GDP growth. It emphasizes robust credit assessment and use of early
warning systems to monitor asset quality of institutions.

Group wise summary of bank fraud cases

Note: Data pertains to the period from March 31, 2010 to March 31, 2013. Source:
Chakraborty (2013).

Figure 2: Group wise summary of advance related fraud cases

Note: Data pertains to the period from March 31, 2010 to March 31, 2013. Source:
Chakrabarty (2013).

According to findings of Deloitte (2015), number and sophistication of frauds in banking sector have
increased over the last two years. Around 93 percent of respondents suggested an increase in fraud
incidents and more than half said that they had witnessed it in their own organizations. Retail

53
banking was identified as the major contributor to fraud incidents, with many respondents saying
that they had experienced close to 50 fraudulent incidents in the last 24 months and had lost, on an
average of Rupees ten lakhs per fraud. In contrast, survey respondents indicated that the non-retail
segment saw an average of 10 fraud incidents with an approximate loss of Rupees two crore per
incident. Many respondents could not recover more than 25 percent of the loss.
The risks undertaken by banks are still a cause of worry although it has moderated a bit. This is
indicated by the bank stability indicator. Similarly, banks were worried by poor asset quality. System
level credit risk is determined by gross NPA ratio which is expected to be around 5.4 percent by
September 2016 and 5.2 percent in March 2017 as per RBI (2015c). Further, the ratio of stressed
assets has increased significantly in the last few years. As of September 2015, stressed and written
off assets (SWA)4 are at 14.1 percent. The trends however are divergent, with public sector banks
having an SWA of 17 percent and private sector banks having an SWA of 6.7 percent according to
Mundra (2016). As far as credit risk is concerned, 16 out of 60 banks (26.5 percent market share)
were not able to cover their expected losses from their current framework. RBI states that NPAs
from retail banking are just 2 percent, whereas NPAs from corporate banking are 36 percent. Given
the size of transactions in corporate banking, it is important that banks implement a robust
monitoring mechanism post sanction and disbursement of facilities, and be vigilant to early signs of
stress in the borrower accounts.5 India has witnessed a massive surge in cybercrime incidents in the
last ten years - from just 23 in 2004 to 72,000 in 2014-15 (Figures 3 and 4). As per the government's
cyber security arm, computer emergency response team-India (CERT-In), 62,189 cyber security
incidents were reported in just the first five months of 2015-16.

Figure :3 Cyber frauds

Source: PWC India and ASSOCHAM (2014).

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Figure 4: Identity Theft Fraud

Source: PWC India and ASSOCHAM (2014)

Interview Based

A semi-structured interview was conducted by the authors with various officials of the banking
industry and investigating agencies. Detailed projects can be made available on request. Thus, from
the study, the authors were able to come up with the following insights and key findings: -
1. Fraud detection procedure in public sector banks: The authors analysed the process of fraud
detection and reporting in a public sector bank and who are the various players involved in this
process. Following is a step by step illustration of the same (Figure 5).

a) First, a fraud is internally reported to senior management of a bank. These may include chief
general managers, executive directors, chairman and managing director. They may also be reported
to vigilance department of the bank.

b) If reported to the vigilance department of the bank, it investigates the fraud and then reports it
to both senior management as well as the central vigilance commission (CVC) to whom they are
required to report monthly.

c) Although CVC can report fraud directly to investigating agencies like CBI, usually final decision to
either report fraud to an external agency or to deal with it internally is made by senior management
of the bank. Depending upon size of the bank, amount of money involved in fraudulent activity and

55
number of third parties involved, senior management may choose to deal with the fraud internally
or file an FIR and report it to either local police or CBI.

d) A committee of the RBI also independently monitors fraudulent behaviour in banks and reports
its observations on quarterly basis to central board of the RBI. The board may then report the matter
to either central vigilance commission or ministry of finance (MoF).

e) Auditors, during the course of their audit, may come across instances where transactions in
accounts or documents point to possibility of fraudulent transactions in accounts. In such a situation,
auditor may immediately bring it to the notice of top management and if necessary to audit
committee of board (ACB) for appropriate action.

f) Employees can also report fraudulent activity in an account, along with the reasons in support of
their views, to the appropriately constituted authority (Table 1), under the whistle blower policy of
the bank, who may institute a scrutiny through the fraud monitoring group

(FMG). The FMG may ‘hear’ the concerned employee in order to obtain necessary clarifications.
Protection should be available to such employees under the whistle blower policy of the bank so
that fear of victimization does not act as a deterrent.

Figure 5: Flow Chart depicting procedures post Fraud Detection and Reporting in PSBs

CHAPTER 4
Data Analysis:

Analysis Research

As per the RBI, bank frauds can be classified into three broad categories: deposit related frauds,
advances related frauds and services related frauds. Deposit related frauds, which used to be
significant in terms of numbers but not in size, have come down significantly in recent years, owing
to a new system of payment, and introduction of cheque truncation system (CTS) by commercial
banks, use of electronic transfer of fund, etc. Advances related fraud continue to be a major

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challenge in terms of amount involved (nearly 67 percent of total amount involved in frauds over
last 4 years), posing a direct threat to the financial stability of banks. With ever-increasing use of
technology in the banking system, cyber frauds have proliferated and are becoming even more
sophisticated in terms of use of novel methods. Also, documentary credit (letter of credit) related
frauds have surfaced causing a grave concern due to their implications on trade and related
activities. The data reveals that more than 95 percent of number of fraud cases and amount involved
in fraud comes from commercial banks. Among the commercial banks, public sector banks account
for just about 18 percent of total number of fraud cases, whereas in terms of the amount involved,
the proportion goes as high as 83 percent. This is in stark contrast with private sector banks, with
around 55 percent of number of fraud cases, but just about 13 percent of the total amount involved
in such cases (Figure 1). The PSBs are more vulnerable in case of big-ticket advance related frauds (1
crore or above) in terms of both number of fraud cases reported and total amount involved (Figure
2). The correlation between rising level of NPAs of public sector banks and frauds probably indicates
lack of requisite standards of corporate governance leading to more instances of high value bank
loan default and possible collusion between corporate entities and high echelon bank officials. Also,
in case of private banks, high number of fraud cases with relatively low cost of fraud indicates very
nature of fraud - online/cyber/technology related frauds with a high frequency of occurrence and
relatively low associated cost.

4.2

Reason for higher advance related frauds in public sector banks and rising NPAs: Higher advance
related frauds of above rupees one crore loans (87 percent of total amount involved in loan worth
rupees one crore or above in value) (Figure 2) in public sector banks as compared to private sector
banks (11 percent of total amount involved) could be due to the proportion of the loan advanced by
both PSBs (~ 70 percent) and private sector banks (~ 30 percent) especially in large and long
gestation projects like infrastructure, power or mining sectors. Also, the higher number of fraud
cases reported by PSBs (65 percent of total) as compared to PVBs (19 percent of total) may be
attributed to stringent oversight of CVC in PSBs. It may also be due to a possible
underreporting/evergreening of loans on the part of the

PVBs, evidenced by RBI’s measures to curb such practices in recent times. 7 The reason for large
NPA’s of PSBs could be attributed to greater amount of lending/exposure to mining, infrastructure
and power sector projects, whose performance and associated cash flows closely follow the
economic cycle of boom and recession. Also, in India, post - 2008 global crisis, a number of
governance and other external issues such as policy paralysis, inordinate delay on account of
stringent environmental laws/regulation, Supreme Court decision on coal mines as well as weak
demand crippled these sectors and resulted into weaker cash flows. These developments severely
affected the ability of such firms to service their loans leading to higher NPAs. There is an ongoing
debate on the nexus between rising NPAs in the banking system and the increasing incidence of
fraud. A former CBI director, in 2013, had raised the point that, amount involved in bank frauds had
increased almost 324 percent in last three years while large ticket fraud cases involving amounts of
Rs. 50 crore and above had increased tenfold. He also pointed to reluctance on part of banks to

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declare bad accounts as frauds despite there being clear-cut manifestation of malfeasance CBI
(2014).
There are some limitations that emerged in the discussion. One limitation is that bankers take the
project at their face value during inspection. Even today due diligence across several public sector
banks is weak. The banks keep the outstanding amount as current assets and hence the original
costing basis of asset valuation shows no loss of money. Shareholders are hence not aware for a long
time. The classification of bad debts is also delayed considerably for a long time across all banks in
India. Also, due diligence involves whether the project has got all necessary approvals, illustratively,
a selling agreement as power-purchase agreement with the state government electricity board.
Receivables from the government are taken for granted by the bankers but when the project goes
sick these cash-flows are not realizable. 3. Third party agencies involved: Big loan advance frauds are
not so easy to commit and it often results because bank officials collude with borrowers and
sometimes even with officials of third parties such as advocates or chartered accountants (CAs). In
such cases, the third parties such as the CAs or the advocates often get away as it is nearly
impossible for the banks to prove criminal intent on the part of such persons due to various reasons
such as lack of clear understanding of legal matters to bankers, and lack of expertise and legal advice
on this subject, and unwillingness to reveal some sensitive data to courts/ public domain. Also,
selfregulatory bodies of advocates, auditors or accountants like bar council and the institute of
chartered accountants of India do not generally bar their errant members. Also, in this context, cost
of pursuing such individuals and delay caused by courts often deter the PSBs. The role of auditors
was further analysed in order to identify gaps and loopholes that exist in the current system.
Auditors can be classified into three main types: a) Bank auditors – There are two main types of
auditors that work for a bank to look into financial statements of its borrowers. They work in
different capacities in terms of their scope and knowledge. They can be held responsible for any
misreporting under common legal framework due to faith placed on them by banks. The two types
of auditors are: i. Statutory auditor – These look into financial statements of all borrowers that
borrow from a bank. These are external auditors.
ii. Concurrent auditor – These help supplement the functioning of bank in terms of internal checks
and check on financial statements of its borrowers. These may be external/internal auditors b)
Statutory auditors of the borrower – These auditors work for the borrower firm and help in
reporting their financial statements. c) Special auditors – These auditors work on a case by case basis
independently and are not associated with any firm or bank. They help provide an external view on
statements reported by the borrower to the bank. In our discussions, one factor that emerged was
that there is a lack of competent auditors in India. The reasons were: a) Staffing of auditors in banks:
The staffing of auditors is generally very competitive and price driven. It is a relatively low paying job
which means only so much effort is put in by auditors to do their work. Also, the skill-set of many
young auditors is low. This coupled with low standards of training meted out to them leaves them at
a disadvantage in terms of the benefit of observation and experience. In addition, the auditors have
clerks/article ship students working with them, who can be easily manipulated. b) Training given to
auditors: The standards of training imparted to bank auditors are very low. Unlike as in the case of
forensic auditing, they are not generally questioned regarding the veracity of documents they
produce and no one challenges the financial information that they generate. In some cases, they are
not equipped with the working knowledge of different instruments used by banks and are
technically handicapped. c) Attention to early warning signals: As a consequence of low pay benefits
and training standards, it has been observed that auditors do not generally pay attention to the
various early warning signs that can help an organization recognize potential fraudulent malpractices
in existence. d) Weaker enforcement of laws in our country: Law enforcement agencies in India are
burdened with excessive work pressure and therefore have to choose between different

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assignments. This is due to insufficient resources and manpower available at their disposal. In such
situations, auditors happen to be most dependent for law enforcement agencies.
Moreover, according to discussions, many officials in law enforcement agencies lack necessary skill-
sets and financial expertise to identify and deal with fast moving financial frauds. 8 4. Poor appraisal
system and monitoring mechanism in PSBs: The initial project appraisal process in PSBs is as good as
that of PVBs. But monitoring post sanction of loan is weaker in PSBs compared to the PVBs on
account of diverse loan portfolio, lack of expertise and modern technological resources, and lack of
manpower and motivated employees, who are not appropriately incentivized to detect early frauds
or prevent them. 5. Corporate governance and other HR issues: The root cause of weak corporate
governance at highest level is directly linked to the very process of appointment of highest level of
officials and poor compensation structure of highest level functionaries. The weakness in selection
process for top level management as documented in RBI (2014b) results into weak governance at
the highest level. Also, there is a serious issue in terms of pay structure in higher echelons of PSBs,
which is markedly lower than their counterparts in PVBs. The only good factor in PSBs is prestige of a
post that a person holds. The inability to hire competent professionals and expertise from market
(lateral hiring) due to existing recruitment policy, flight of officials to greener pastures and private or
foreign banks, poor compensation structure, unionization challenges as well as lack of adequate
training in contemporary fraud prevention techniques are key HR issues, which indirectly contribute
to bank frauds. 6. Senior management and board of directors: At times, senior management
themselves may like to cover-up some cases to meet their short term targets and goals, and create a
good picture for the shareholders. In fraud cases, within the banks, with suspected involvement of
senior management, there is significant resistance while prosecuting officers in level 4 or above.
Most of the officers retire before they can be booked for a fraud. Once retired, pension regulations
apply to them making them immune to any financial penalty.
If the case is finally taken up in the court of law, a public prosecutor represents the bank. The public
prosecutor is usually overburdened with pending cases. Additionally, from the bank’s perspective,
having already lost substantial amount in fraud, they allocate limited budget for prosecutions,
making it easier for the guilty to escape. 7. Bank employees: Incentive structure for employees needs
a re-evaluation and gives too much importance to short term targets. This incentivizes the
employees to give preference to short term targets only and not exercise proper due diligence.
Hence, they take more risk than is usually the norm or resort to unethical means. There have been
instances of frauds involving collusion of staff with third party agents like auditors to indulge in
fraudulent activities on customers. Detection of such frauds takes a long time, and is only discovered
when there are customer complaints of fraudulent cases. The customers who are victim of
fraudulent activities by the bank, due to identity theft etc., could have avoided so, by following
appropriate preventive measures and customer awareness guidelines. Political reasons may also be
responsible for indulgence in loans proceed which has substantial risk of being defaulted or
defrauded, especially when a

red flag is raised on the loan. As legal opinion is not the strength of a banker, advocate’s directions in
that matter assume importance. Frauds also result from lack of awareness of staff towards
appropriate procedures in place and red flags they should be aware of. Technology related frauds
are primarily due to nonadherence to standard procedures and systems in place, by the employees.
Even when any employee detects some fraudulent activities in existence involving people in power,
whistle blower protection policy does not guarantee adequate safety. PSBs in India had prepared a
five-point action plan to make them more competitive, which included suggestions like introduction
of performance management systems and incentives in banks. Smaller banks should focus on the
areas of their strength (to optimize capital utilization) among other reform plans. The banks

59
demanded creation of bank board bureau and bank investment committee and empowerment of
banks on certain decision making capabilities, in line with RBI (2014b). Additionally, they demanded
simplification of credit insurance process and strengthening of legal framework for debt recovery,
apart from more usage of technology.

8. Borrowers and clients of banks: Frauds may also arise solely from the borrower’s side.
Companies have been found to take part in ‘high sea sales’ with investment from Indian banks but
the funds are either routed for other purpose or are not repaid after the sale has been made and
instead, routed to other channels, resulting in a NPA. Such breach of contract is another instance of
fraud since the funds are not utilized for the purpose they were initially set out and based on the
project evaluated by the banker. 9. Legal aspects of frauds and role of investigative agencies:
Investigating and supervisory bodies like central vigilance commission (CVC) or central bureau of
investigation (CBI) are already overburdened with many pending investigations and have limited
resources at their disposal. The biggest hurdle in pursuing fraudsters is proving criminal intent on
their part in the court of law. Most of the bank frauds are detected very late and by that time,
fraudsters get enough time to wipe out trails and it becomes very difficult to establish criminal intent
due to loss of relevant documents and non-availability of witnesses. Also, while pursuing fraudsters,
banks and investigation agencies face many operational issues. Bankers are not experts in legal
paperwork, and formal complaints against fraudsters drafted by them often lack incisiveness. Also, in
absence of a dedicated department handling fraud matters, investigating officers (CBI/police) have
to deal with multiple departments and people within the bank, which often results into poor
coordination and delay in investigation. This results in very low conviction rate for fraudsters (less
than 1 percent of total cases). Even after conviction in fraud cases,

there is no legal recourse to recover the amount lost in the bank frauds and the country’s legal
system is perceived to be very soft on defaulters. Also, lack of strong whistle-blower protection law
inhibits early detection in case of involvement of internal employees.
10. Judicial system: The long and elaborate judicial process is another major deterrent towards
timely redressal of fraud cases. The delay in judiciary to prosecute those guilty of fraudulent
practices, could lead to dilution of evidence as well as significant cost building on part of the victim
bank. Also, wilful default is still not considered as a criminal offence in India. Fraudsters, both big and
small, take undue advantage of these means of evasion and commit maligned activities without risk
of conviction. 11. Technological and coordination perspective: RBI has an elaborate set of early
warning signals (EWS) for banks to curtail frauds. However as of now, there are inadequate tools and
technologies in place to detect early warning signals and red flags pertaining to different frauds. The
authors’ interaction with a former chairman of a big public sector bank shockingly revealed that
there is only one provider of vigilance and monitoring software for banks and price discovery is poor.
Even the biggest of public sector banks cannot afford to buy that software. Also, lack of coordination
among different banks on fraud related information sharing is another major roadblock.

4.3

Different types of frauds caused Rs. 6,600 crores of loss to the Indian economy in 2011-12, and
banks were the most common victims in swindling cases; insider enabled fraud accounted for 61% of
fraud cases. However, Soni and Soni25 concluded that “cyber fraud in the banking industry has
emerged as a big problem and a cause of worry for this sector.”

Similarly, another survey conducted by Deloitte26 shows that “banks have witnessed a rise in the
number of fraud incidents in the last one year, and the trend is likely to continue in the near future.”

60
The Deloitte India Banking Fraud Survey Report Edition II added, “the number of frauds in banking
sector have increased by more than 10% over the last two years. Banks witnessed rise in level of
sophistication with which frauds were executed.”8 It is universally accepted that continued
prevalence of frauds will have long-term bad consequences for banks, customers, investors,
government and the economy in general. The year-wise details, beginning from 2000-01 to 2013-14,
regarding the number and amount of frauds reported by the Indian banking sector to the RBI, are
shown in Table 2. The following broad generalizations can be made. During the last six years, from
2000-01 to 2005-06, the number of fraud cases has shown a constantly rising trend. For example, in
2000-01 there were 1858 cases of frauds, which substantially jumped to 2658 fraud cases in 2005-
06. However, in 2006-07 and 2007-08, the number of fraud cases declined sharply from 2568 to
1385, respectively. In fact, the amount involved in fraud cases has also increased very sharply from
the lowest level of Rs. 374.97 crore during 2002-03 tothe highest level of Rs. 1134.39 crore during
2005-06. The year 2007-08 was an exceptional year in which the amount of loss caused due to fraud
declined to Rs. 396.86 crore. In sharp contrast to this, year 2005-06 was also a very significant year
for the banking industry, since this year witnessed the highest ever fraud loss of Rs. 1134.39 crore.
Keeping in view the loss of Rs. 451.04 crore in 2004-05, the loss of Rs. 1134.39 crore in 2005-06,
works out to about 2.5 times the loss of previous year. Moreover, the scenario of number of frauds
and amount involved has significantly changed from 2008-09 to 2013-14. For example, 24,791 cases
of frauds were reported in 2009-10, which showed a constant trend of decline till 2012-13. Number
of fraud cases reported were 19,827 in 2010-11, which declined to 14,735 cases in 2011-12, and
13,293 cases in 2012-13 (a decline of 46.37%), respectively. As against this, the trend has reversed
when we have a look at the amount of loss suffered by banks during the same period. For instance,
the amount of loss suffered has increased very sharply from Rs. 2037.81 crore in 2009-10 to Rs. 8646
crores in 2012-13, an increase of 324.27%. As Pai and Venkatesh27 (2014) reported, “As on March
31, 2014 banks reported total loss of Rs. 169,190 crores from
29,910 cases. In 2012-13, Rs. 13,293 crore of fraud was detected from 8646 cases.” During
Apr.-Dec. 2014, PSBs suffered losses of Rs. 11,022 crores from 2100 fraud cases involving Rs. one
lakh or more. During same period, 46% more amount was lost due to frauds compared to last full-
year. With the advent of mobile and internet banking, the number of banking frauds in the country
is on the rise as banks are losing money to the tune of approximately Rs. 2,500 crore every year.
While the figure for 2010-11 was Rs. 3,500 crores, for the current financial year (till September) it is
about Rs. 1,800 crores.
Further, state-wise list of information on banking frauds shows Maharashtra (Mumbai) reporting the
highest number of cases to the RBI. In the last financial year, banks in the Maharashtra reported
1,179 cases with Rs. 1,141 crores being lost to such frauds.

Maharashtra is followed by Uttar Pradesh with 385 cases during the same period.

4.4 surveys:
According to an economic crime survey performed by PwC in 2018, fraud is a billion-dollar business
and it is increasing every year: half (49 percent) of the 7,200 companies they surveyed had
experienced fraud of some kind.

61
Most of the frauds involves cell phones, tax return claims, insurance claims, credit cards, supply
chains, retail networks, purchase dependencies and turn out a big problem both for governments
and businesses.
Investing in fraud detection can take the following benefits:
• Promptly react to fraudulent activities
• Reduce exposure to fraudulent activities
• Reduce economic damages caused by frauds
• Recognise the vulnerable accounts more exposed to frauds
• Increase trust and confidence of the shareholders of the organisation
A good fraudster can work around the basic fraud detection techniques, for this reason developing
new detecting strategies it is very important for any organisation and fraud detection must be
considered a complex and always-evolving process.
Phases and Techniques
Fraud detection process starts with a high-level data overview with the goal of discovering some
anomalies and suspicious behaviours inside the dataset, e.g. we could be interested in looking for
weird credit card purchasing. Once we have found the anomalies we have to recognise their origin,
because each of them could be due to frauds, but also to errors in the dataset or just missing data.
This fundamental step is called data validation, and it consists in errors detection, followed by
incorrect data correction and missing data filling up.
Once data was cleaned up the real phase of data analysis can start; after the analysis is completed
all the results must be validated, reported and graphically presented.
To recap, the main steps in the detection process are the following:
• Data collection
• Data preparation
• Data analysis
• Report and presentation of results
• Arcade Analytics fits very well for the last steps, as it is a tool conceived to create captivating and
effective reports that allows to share in a very easy way the results of a specific analysis by
composing different widgets in complex dashboards.
• The main widget is the Graph Widget, it allows users to visually see relationships and connections
within their datasets and find meaningful connections and relationships. Moreover, all the
widgets present in the same dashboard can be connected in order to make them interact with
each other. In this way we will be able to see in the outcoming dashboard bidirectional
interactions between the graphs, data tables and the traditional charts widgets.

62
• The chart distributions will be computed according to the partial datasets of the correspondent
primary widgets, making the final report dynamic and interactive. But that is not at all, Arcade
can be useful for several techniques in the data analysis steps. Let’s see how then!
Data analysis often relies on automated processes exploiting statistical methods and artificial
intelligence techniques, that are commonly classified respectively in supervised and
unsupervised techniques.
Among the statistical methods we can found:
• Data processing
• Statistical parameters calculation, relevant for the specific domain
• Models and probability distributions
• Time series analysis
• Clustering and classification of entities, in order to find associations and patterns among data.
Arcade offers several tools to perform single and multi series analyses exploiting an efficient full text
search engine and inverted indices, that assure good performances in computing statistical
parameters and distributions on the whole data source.

63
 Global Transactions/Orders type distribution

These methods are good to identify statistical classification and infer rules: these rules can be then
used to define rule-based classifiers, supervised learning algorithms that use rules of If (fulfils certain
conditions) and Then (appropriate category).
Moreover, Arcade offers good support to time series analysis: by using the timeline feature you can
see your data in the form of graph and how it changes over the time.

In this way we can analyse when the relationships between specific items or entities appeared by
exploiting a time filtering window, to narrow your temporal analysis to a specific and customisable
range.

64
Then you can interact with this analysis by zooming in and out: by changing the grain you can
perform a simple temporal top down analysis starting from a wider view, useful to see at a first
glance how the events are distributed over the time, till reaching each single event if needed.
Obviously in each perspective you can move back and forth through time.

Beside the statistical methods, it could be helpful put beside automated processes like:
• Data mining
• Patterns recognition
• Machine learning and prediction to implement proactive rules
In fact, these unsupervised methods do not require samples of fraudulent transactions, so they turn
out useful in all that scenarios where there is no a prior knowledge of classes of transactions or
when we want to extend these categories in order to recognise previously undiscovered frauds, not
yet present in historical databases.
Importance of human interaction

65
 Often in this scenarios we can encounter the Fraud Analytics concept, that is commonly conceived
as a combination of automated analytics technologies and analytics techniques with human
interaction. In fact, we cannot get rid of domain experts users’ interaction mainly for two reason:
• Problem of high number of false positives: not all the transactions detected as fraudulent are
actually frauds. Generally, detection systems based on the best algorithms result in too many
false positives, even though they are able to identify a high percentage of the actual fraudulent
transaction (till 99 %). Thus, all the results must be validated in order to exclude the false
positives from the first result.
• High computing time complexity of the algorithms, above all in prediction scenarios: when
algorithm time complexity is exponential, monolithic execution is not a good approach, because
it could require a lot of time for big inputs. Thus a progressive approach is adopted, consisting in
decreasing computational requested time by combining specific resolution models and
automated calculation with human interaction, said designer.
Intermediate results are proposed to the designer during the computation, thus he decides which
way the analysis has to take in a progressive manner. In this way whole execution branches can be
omitted, achieving a good gain in terms of the performance. For both these two aims a visual tool is
needed, Arcade Analytics turns out very appropriate for these tasks thanks to the features already
shown and the expressive power of the graph model.
How Graph perspective can help
Graph perspective can be very useful in fraud detection use case, because as already said most
of the computation relies on patterns recognition. Then we can use these patterns to find out
and retrieve all the unusual behaviours we are looking for, without needing to write complex
join queries.
Specifically Arcade offers support to different graph querying languages based on:
• the pattern matching approach: Cypher query language proposed by Neo4j and the MATCH
statement of the Orient DB SQL query language are fully supported in Arcade nowadays. This
is the winning approach when we can rely on several patterns to detect frauds.
• the graph traversal approach, that makes very simple walk the graph to explore information
of actual interest. Gremlin is a good example of these kind of languages. Moreover, one of the
most attractive features of Arcade Analytics is that it allows users to query data from a
relational database to easily visualise the data therein as a graph and explore the
connections inside it without any migration and through few simple steps.

66
 Now let’s have a look to a very common pattern recognised as potential fraudulent activity that is
often missed by traditional fraud detection systems, and in what way Arcade Analytics can help us in
the analysis of all the instances matching this specific schema

The following can be a simple example:

John Smith opens a new credit card account, maxes out his credit line, defaults and then disappears
without leave any trace.
In this scenario Mr. Smith used his own credentials, with minor variations in his contact data, to
deliberately defraud the credit card company.
But we can also encounter group of two or more people organised into a fraud ring, where there is
a subset of legitimate contact information, like telephone numbers and addresses. This data is
combined to create several synthetic identities that will be used by the ring members to open
fraudulent accounts. Thus this new accounts have access to credit lines, credit cards, overdraft
protection, personal loans, etc.
The accounts are used normally, with regular purchases and timely payments, and for this reason
banks increase the revolving credit lines over time, due to the observed responsible credit
behaviour.
One day the accounts coordinate their activity, maxing out all of their credit lines and
disappearing.

67
Then this ring schema can be detected as suspicious behaviour and if recognised and validated in
time can avoid big losses.
Here is a sample graph instance in Arcade matching this ring pattern:

This pattern can be looked for in the data through a specific query, loaded in Arcade
Analytics and deeply investigated by human experts in order to prevent this kind of fraud.

Chapter: 5

68
Conclusion and Recommendations:

It is observed that PSBs fare better than PVBs in terms of total number of bank frauds. However, the
total amount involved is much higher in PSBs as compared to the private sector. This can be
attributed to large size of loans which PSBs offer to customers. Credit related frauds have the
maximum impact in all the banking frauds in India because of the high amount involved and the
cumbersome process of fraud detection followed by CVC. The frauds may be primarily due to lack of
adequate supervision of top management, faulty incentive mechanism in place for employees;
collusion between the staff, corporate borrowers and third party agencies; weak regulatory system;
lack of appropriate tools and technologies in place to detect early warning signals of a fraud; lack of
awareness of bank employees and customers; and lack of coordination among different banks across
India and abroad. The delays in legal procedures for reporting, and various loopholes in system have
been considered some of the major reasons of frauds and NPAs.

This article investigated the occurrence of corporate fraud in Brazilian banking institutions in the
period between January 2001 and December 2012 using detection variables extracted from agency
theory and the economics of crime, grouped according to the dimensions of the Cressey fraud
triangle: pressure, opportunity, and rationalization. From agency theory, variables were identified
that enabled the measurement of the pressure and opportunity dimensions pertaining to the
instruments for monitoring manager actions, such as remuneration incentives and corporate
governance. From the economics of crime, technical and empirical studies were used that enabled
the identification of variables for measuring the pressure and rationalization dimensions, such as
indicators of pressure for company performance and manager demographic characteristics, with
age, educational level, training in the area of business, and gender standing out.

The study confirmed the general hypothesis of the Cressey fraud triangle, in which breaking financial
trust is conditioned by the simultaneous existence of the three dimensions of the fraud triangle:
pressure, opportunity, and rationalization.

This article is relevant in that it fills a gap in the literature in the area by carrying out a differentiated
analysis of frauds, contemplating all those that occur in the context of an institution and not being
limited to only those of an accounting nature. Likewise, this study enabled the measurement of the
probability of occurrence of corporate fraud by dissociating fraudulent banking institutions from
those that only showed indications of corporate fraud, this situation not being found in neither the
Brazilian or international empirical studies used.

Besides the theoretical relevance presented in the previous paragraph, it is worth highlighting that
the variables used in constituting the factors, with statistical significance, can be treated as
indicators of possible occurrences of corporate frauds. Moreover, identifying these variables will
enable both regulatory bodies and investors to analyse the possibilities of fraud occurring, whether
for the regulatory bodies to curb it or for investor decisions with regards to maintaining or carrying
out new investments.

This research also contributes with an investigation of new debates and studies in the Brazilian
academic field on corporate frauds in the country, since besides being few in number these have
different scopes to those of this study.

There were limitations for carrying out the study, especially during the data gathering process, due
to the existence of few institutions that presented the totality of their data series for the period

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analysed, mainly impacting on the obtainment of information on manager demographic
characteristics. Another limitation was the temporal range of the data, covering January 2001 to
December 2012, due to the fact that via Circular Letter n. 3,630 of 2013 ( CB, 2013) the CB relieved
banking institutions of presenting QFI from January 2013 onwards. The decision made obtaining the
quarterly data from 2013 onwards unviable. This is added to the limitations of the research from
using punitive administrative proceedings as proxies for the occurrence of corporate fraud; in future
studies, judicial proceedings could be used for this purpose.

It bears mentioning that the models that use accounting variables can cause the problem of variable
endogeneity, which requires specific treatment. In linear panel data models, the endogeneity of the
regressors can be controlled using the generalized moments method (GMM) technique. However,
controlling the endogeneity of the regressors in non-linear panel data models, especially in
multinomial logit and probity cases, is something that is still being developed and is not yet available
in the literature. For this reason, this problem was not considered in this article, representing a
technical-scientific limitation to be addressed at some point the future.

For future studies, we propose an in-depth analysis of other measures of manager remuneration
incentives, such as share bonuses, and their effect on the probability of corporate fraud occurring.
We also suggest replicating this study for other activity sectors, such as non-financial publicly-traded
companies.

The frauds might be principally because of absence of sufficient supervision of best administration,
broken motivating force component set up for workers, intrigue between the staff, corporate
borrowers and outsider offices, frail administrative framework, absence of suitable instruments and
advances set up to identify early cautioning signs of a fake, absence of attention to bank
representatives and clients; and absence of coordination among various banks crosswise over India
and abroad. The brains of officers can't be perused amid the season of enlistment. Mentality of
some private and some open division bank representatives should be to deliberately cheat the
association. What the associations can do is to build up and recheck frameworks which should raise
the auspicious alarm on deviations. Web based managing an account is the new pattern and it is
digging in for the long haul. Banks must understand that the clients who utilize web based keeping
money administrations is a capable gathering fit for propelling searing assaults utilizing the web-
based social networking, which can hopelessly discolour the notoriety of banks. Banks would need to
continually screen the typology of the fake exercises in such exchanges and routinely survey and
refresh the current security highlights to avoid simple control by programmers, skimmers, phishes,
and so forth. Banks have generally made arrangements for versatility against physical assaults and
catastrophic events; digital flexibility can be dealt with similarly. Banks ought to consider their
general digital flexibility capacities over a few measurements.

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 Recommendation:

5 Tips to Reduce Banking Fraud

• Multi-Factor Authentication. The best approach is to start with a multi-factor authentication/multi-

layered security structure. ...
• Banks: Monitor Transactions. ...

• Businesses: Reconcile Corporate Accounts Daily. ...

• Employ Dual, Triple Controls. ...

• Raise Fraud Awareness.

1. Multi-Factor Authentication
The best approach is to start with a multi-factor authentication/multi-layered security structure. This
is what Romeo is seeing from the institutions that are successfully thwarting fraud. "Remember,
there is no one silver bullet that will solve this problem, so if you put all your hope in a single
solution, you'll get compromised, and the intruder will have everything."

This multi-layered approach from a software perspective, combined with old-fashioned outof-band
phone calls to the customer to confirm a questionable transaction, can cut the institution's
headaches and the business' fraud losses.

In the old days, Romeo says, calendars were put in place for all set transactions for all accounts,
whether they were large corporates or small businesses. "If they had a weekly payroll, that only
went out once a week, and then all of a sudden we saw something going out every day -- that would
be a red flag; we would question it," he says.

2. Banks: Monitor Transactions

In his days in bank operations, Romeo says, the bank used to set up daily limits on each user. "We
used to set these limits on our mainframe processor in the bank, along with file limits and batch
limits, so if there were something added, or out of the ordinary, we would spot it." Another thing to
watch for is a whole lot of activity right under $9,000. "Because the fraudsters know they won't draw
suspicion of a bank if they fly under $10,000 mark."

3. Businesses: Reconcile Corporate Accounts Daily

For businesses, Romeo recommends reconcilement of banking accounts and transactions on a daily
basis -- either at end of day or at least at the beginning. "This will help catch any transactions you
didn't make, and the sooner you bring it to your bank's attention, the better chance to retrieve the
money, with the bank doing a recall or reversal of the transaction. The longer you wait, the less likely
it is that you'll see that money recovered."

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4. Employ Dual, Triple Controls
Dual controls at the corporate side are, at the very least, tables take. Romeo suggests even triple
controls, where one person creates the transaction, a second person approves it, and then a third
person actually sends the transaction.

"If you don't have the people, then set up the ACH transactions with the institution, an out of band
confirmation, whether it is a phone call to confirm that you've sent it, and confirmation of the
correct information was received," he notes. This can be done live or through an automated voice
response system. Usually, only one person would have the password and ID to call the bank, which
would be totally separate from the person's computer.

5. Raise Fraud Awareness

Finally, Romeo says, continuous education of business customers is important. At the national level,
this problem of corporate account takeover has gotten real attention. But real solutions won't come
until financial institutions and their corporate accounts alike realize the real risks they face - and
simple solutions they can implement to help mitigate those risks.

With over 11 million identity fraud victims in the United States annually, anyone with a bank account
must take the proper precautions. Fortunately, guarding yourself from fraudsters requires a minimal
time investment and a little common sense. Here are 20 easy ways to secure your bank accounts and
avoid identity theft.

Check your account activity regularly. This may be the single most effective strategy you can employ
to secure your finances. Balancing a check book is advised, though the technique is becoming
outdated with the advent of online banking. At the very least, you should log in and view your
account activity multiple times every week to make sure there are no unexpected transactions.
Report any discrepancies to your financial institution immediately.

Keep your PIN and passwords secret. These are the keys to your money. Guard them with vigilance.
Do not give them out to anyone, and never write them down on paper, in an email or in a text
message. These can all be easily intercepted.

Use a strong password for online banking. Do not use your birthday, your spouse’s name, your kid’s
name, your social security number, your address or anything so painfully obvious. Always use a
capital letter or two along with a few numbers. An example of a bad password would be “Sarah”. An
example of a good password would be “12MarinersRevenge56.” And please, never set the word
“password” as your password.

Change passwords periodically. Get a new password every few months or so. That way, if you’ve
had to give someone else your password or for some reason made a physical record of it, you will
reset your chances of being hacked.

Do not give out account info over the phone. Your bank will not call requesting your account
numbers, PINs or passwords. They already have this information. You should be automatically
suspicious of unexpected calls. If you have any doubts about the caller, hang up and call your bank
directly.

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Do not give out account info through email. Again, your bank will not email you requesting your
account numbers, PINs or passwords. Never send this information through email.

Don’t click links embedded in emails. It is easy for scammers to rig convincing emails. If you get an
email from your bank, don’t click on the links. They could lead you anywhere.

Instead, type in the bank’s web address in your browser and navigate from there.

Use anti-virus protection software, firewalls and spyware blockers. By acquiring these basic
computer protection tools, you significantly reduce your vulnerability to cyber-attacks and fraud
attempts. Make sure to also keep your computer updated with the most recent security patches.

Don’t use public computers for online banking. This is never a good idea. Even if you’re careful to
make sure no one sees your screen and you remember to log out completely, an expert scam artist
can find ways to record your activity. You should also avoid conducting transactions using public Wi-
Fi.

Check for secure connections. When visiting your bank’s website or conducting an online
transaction, check your browser to verify a secure connection. If the web address starts with “https,”
you should have a secure connection.

Report lost cards immediately. Act fast and prevent fraud before it can happen. Don’t procrastinate.
As soon as you realize your card is missing, call the bank and have them send you a new one.

Be aware of your surroundings at ATMs. Keep an eye on the people around you. Make sure no one
is standing too close. Use the curved mirror to watch activity behind. It is absolutely imperative you
keep your PIN secret and close your transaction completely before walking away from the machine.
If there is anything at all suspicious, quit your transaction and walk away immediately.

Watch out for skimmers. Skimmers are interesting little devices that can be placed over ATM card
slots in order to steal your account information. They can be installed and uninstalled in a matter of
seconds. If the card slot looks peculiar, don’t use it.

Take your receipt. At the ATM, wait for your receipt to print and take it with you. Do not toss it in a
trashcan. The information could be used to access your accounts.

Shred documents and old checks. Anything with account information should be destroyed beyond
recognition. You don’t want sensitive documents to end up in the wrong dumpster.

Minimize check writing. Checks display a lot of personal information, including your phone number,
address, bank, account number and signature. Whenever possible, use a card or pay in cash.

Write checks in permanent blue ink. This makes it more difficult for fraudsters to alter the written
information.

Do not leave blank space on your check. You don’t want to give anyone the opportunity to tack
another zero on the end.

Make sure checks can’t be seen through envelopes. This is an invitation for fraud. Use security
envelopes or place your check between sheets of heavy paper.

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Use secure mailboxes only. When mailing checks, the mailbox at the end of your driveway can
hardly be considered safe. Anyone can come along and snatch your outgoing mail in a matter of
seconds. If you’re sending money through the Postal Service, use a secure box or take it to the office
directly.

Case study: Using anomaly detection for check kiting

Check kiting is where a scammer takes advantage of the float to withdraw non-existent funds in a
bank account. There are a number of possible indicators for kiting including a large number of check
deposits, accounts with large proportion of uncleared cash by the paying bank and deposits through
multiple bank branches.

It is a multi-million-dollar problem that can be difficult to detect especially with accounts with
normal check writing and depositing activities. However, financial institutions of any size can use
their data and anomaly-detection models to find transactions that may be indicative of check kiting.

The first step is to create the “ground truth”. This is where we create a baseline, or the model that
establishes what is expected, or normal behaviour for an institution’s client base.

To create the ground truth, the system takes in all the supporting transactions and starts grouping
them by characteristics. Any anomalies are isolated for review – are they “normal”, are these cases
of “Not Sufficient Funds (NSF)” or are they “suspicious or provide indications of fraud”?

The process does take several iterations but once you have identified the valid and NSF transactions,
the system can quickly help fraud departments identify the transactions that are potential cases of
check kiting.

Strategies
Technology is only part of the solution for reducing bank fraud. Evolving policies and procedures
have to be in place to reduce the risk. Here are some strategies to address some of the various types
of fraud.

Preventing bust out fraud

• Implement a five business day clearing period
• Identify check payments versus electronic payments and frequency of deposits by customers

Preventing account takeover fraud

• Alert when there is an account level change (authorized user, address, phone number, card
request)

• Alert when there are changes in spending pattern Preventing identity fraud

• Verify identification
• Screen new customers against sanctions lists
• Review consumer alerts
• Review discrepancies between information from bureau and application

• Validate KYC (know your customer) information

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 • Call to verify employer Preventing lost/stolen fraud

• Detect spending pattern changes (low to high volume)

• Look at small monetary value transactions that could be indication of credit card testing

• Look for aggressive transactions at unattended merchants (gas stations, or Pay Pass)
Preventing internal fraud
• Prohibit emails from being sent outside the bank with card or customer information
• Review activities of top performers to look for irregular practices
• Follow-up with inconsistencies in employee resumes
Preventing bank fraud is deliberate activity that requires continuous update of technology, policies
and procedures. On the technology side, AI-based models are no longer something just for tier 1
institutions and allow smaller organizations to enhance their existing rulesbased internal controls
and identify previously undetected and evolving fraud schemes.

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