Banking Frauds : Classification and Reporting – RBI

Introduction:

The Risk of fraud in today’s scenario could be in any sector but the majority of it is found that where ever  “Money “ is involved, the chances of its misuse are more. Seen the financial sector, maybe Banking, Insurance, and Stock Market are more prone to fraud considering the fact that one way or the other or say directly or indirectly, money in cash or non-cash form is involved.

There could be various ways and methodologies which a fraud perpetrator may adopt to get an undue advantage or unfavorable benefit and thus would try to cheat /defraud in many ways.

The basic premise of fraud considered in this article is the “Banking Sector”, which is the major contributor to India’s domestic financial structure.

In India, the Apex Bank, Reserve Bank of India, regulates all Commercial Banks, and Primary (Urban) Co-operative Banks and thus requires the following from them:

1. Banks are primarily responsible for preventing fraud that’s why called preventers and not detectors of fraud.
2. To focus on major prone areas and put controls in place.
3. To implement internal controls and guidelines on fraud prevention
4. To report and share the instances of fraud, the objective is to avoid any such further instances with some other Bank

To note, the 9^th Global Fraud Survey Report on Fraud Risk in Emerging Markets conducted by Ernst and Young also focus on Robust Internal Control Mechanisms parity with Anti-Fraud Measures.

In addition, note that timely reporting of fraud to RBI in the prescribed format is also mandatory otherwise penalties to the Bank as per provisions of the Banking Regulations Act,1949. Section 49A, of the Banking Regulations Act 1949, Powers RBI to impose penalties on the Bank for Non-Reporting of Fraud on time to the Regulator.

Fraud Classification and Reporting-two major aspects:

RBI has laid down policy norms on “Fraud-Classification and Reporting”. The master circular on frauds is issued by RBI after making revisions to the old circular. The latest circular is RBI 86/2006, DBS FrMC BC No 6/23.04.001/2006-07 dated July 25, 2006, for all Commercial banks(excluding RRBs), and Financial Institutions and for Primary (Urban) Co-operative banks RBI 94/2006 DBS CO FrMC BC No 7/23.04.001/2006-07 dated July 27, 2006.

The article focuses on Guidelines relating to Fraud Classification and Reporting in the case of all Commercial banks(excluding RRBs), and Financial Institutions along with a comparison of guidelines for Primary (Urban) Cooperative banks.

Fraud Classification:

Noted that the classification of fraud is made for the sake of uniformity and is based on the provisions of the Indian Penal Code (IPC).

Category A-Broad Classification

1. Misappropriation/Criminal breach of Trust
2. Fraudulent encashment through forged instrument/manipulation of books of accounts or through fictitious account/conversion of property
3. Unauthorized credit facilities extended for reward/for illegal gratification
4. Negligence and cash shortage(to be only reported if cheating/fraud is suspected/proved)
5. Cheating/forgery
6. Ir-regularities on foreign exchange transactions(to be only reported if cheating/fraud is suspected/proved)
7. Other frauds

Category B-Cases of Cash Shortages

1. Shortage of cash up to Rs 1000/-, if reported same day by the person handling cash and where no suspicion arises need not be reported
2. Ant shortage of cash more than Rs 1000/-, if detected by management/inspecting officer, to be reported

Category C-Cases of Forged Instruments

1. For the sake of uniformity & avoid duplication, where fraud happened involving forged instruments, then the same needs to be reported by paying Banker and not by Collecting Banker.
2. In case of collection of in-genuine instruments and thereby encashment of money by the fraudulent person(who is not the true owner), then the collecting banker who is defrauded has to file the fraud report with RBI.

Category D-Cases of Theft, Burglary, Dacoity, and Robbery

Separately elaborated in this Article

Fraud Reporting:

1. Fraud involving Rs 1 Lac and above
2. Fraud committed by unscrupulous borrowers
3. Fraud involving Rs 100 Lacs and above
4. Cases of Attempted/Suspected Fraud

The below table summarises Reporting requirements to RBI along with Format, time, and Authority to whom the same is to be reported.

Broadly Reporting of fraud can be classified as Cases of Actual Fraud and Cases of Attempted/Suspected Fraud.

Notes:

1. Attempted Fraud cases need not be included in other returns to be submitted.
2. Frauds committed by unscrupulous borrowers would include fraudulent discounting of instruments, kite flying, fraudulent removal/disposal of hypothecated stock/inflating value of stock in stock statements for drawing excess bank finance, diversion of funds outside the borrowing limits, etc.

Updating RBI and Board on Fraud Outstanding:

 In addition to timely reporting of frauds to RBI, also required quarterly and Annual updates from RBI and Board about the Fraud Outstanding as of date.

The Various  Returns/Reports required can be categorized as under:

1. Quarterly Report on Fraud Outstanding
2. Quarterly Progress Report on Frauds
3. Reporting of fraud to the Board
4. Quarterly Reviews of Frauds by Board
5. Annual Review of Fraud by Board( Review Reports not to be sent to RBI)

The below chart shows the Quarterly review/Reporting requirements to RBI as well by the Board of the Bank.

Note:

In all Quarterly returns/reports to RBI, Bank which may not have any fraud outstanding shall submit NIL report.

Reporting of Frauds in Special Circumstances:

Considering that Banks are Custodians of public money, social evils may try to take undue advantage of public money by conducting activities like theft, dacoities, and robberies times, where crime is serious involvement of police/CBI is also entailed.

Under-reporting requirements of fraud in special circumstances may be classified as under:

1. Cases of Theft, Burglary, Dacoity, and Bank Robberies
2. Fraud Reporting to Police/CBI

Cases of Theft, Burglary, Dacoity, and Bank Robberies:

 All instances of  Theft, Burglary, Dacoity, and Bank Robberies are to be reported to the following Authorities immediately via telegram/Fax/E-mail.

1. Central Office of RBI, Department of Banking Supervision, Mumbai
2. Regional Office of RBI, Department of Banking Supervision(under whose jurisdiction Banks HO falls)
3. Regional Office of RBI, Department of Banking Supervision(under whose jurisdiction Banks affected Branch falls)
4. Security Advisor, RBI, Central Security Advisor, Mumbai
5. Ministry of Finance, Department of Economic Affairs, Banking Division, New Delhi

2. In all such cases a Quarterly Consolidated Statement in Format FMR 4 comprising all particulars of the quarter, is to be submitted within 15 days from the Quarter.
3. In all Quarterly returns/reports to RBI, the Bank which may not have any cases of             Theft, Burglary, Dacoity, and Bank Robberies shall submit an NIL report.

Fraud Reporting to Police/CBI

 The guidelines on reporting fraud to the Police/CBI are based on the category of Bank-Public sector or Private sector. The below comparative chart depicts the reporting requirements as under:

How to Close the Fraud Case with RBI

In relation to any fraud, Bank feels that no further action is required, and based on the criterion prescribed by RBI( as listed below), the details of the closure of cases could be forwarded to Fraud Monitoring Cell, RBI both Central Office and Regional Office.

Under the following circumstances, the Fraud case be presumed to be closed:

1. Case pending with CBI/Police/Court is finally disposed of.
2. Examination of staff accountability has been completed.
3. Amount of fraud recovered/written off.
4. Insurance claim where ever applicable, has been settled.
5. Bank reviewed the system and procedures, identified the causative factors, and plugged the lacunae and the fact of which has been certified by the appropriate authority(Board/Audit Committee of the Board).

As required by RBI, Banks should pursue vigorously with CBI/Police Authorities or Court the following cases for final disposal of the same.

1. Where Bank has completed action against staff
2. Any other cases

Formats prescribed by RBI with timeliness to file

RBI requires all banks to report instances of fraud in a standardized format and also within the time frame. It attracts strict penal action in case the frauds are not reported on time.

The below chart summarises the detailed format requirements along with the timeliness to file the same.

To note RBI has laid down policies of Fraud Reporting and Classification for not only Commercial Banks but also for Primary (Urban) co-operative Banks.

Though the reporting and classification norms in both cases would be similar, as the article primarily focussed on reporting requirements for  Commercial Banks and Financial Institutions, for the sake of clarity and understandability, a comparison has been made on the point of differences for both categories of Banks.

The below chart highlights the point of differences in reporting and classification of frauds:

Conclusion:

 Since Banks are dealing in monetary transactions, the chances of fraud are always on the higher side. The fraud could be possible in any field say Cash Counter, Clearing section, Account opening (Non-Adherence to KYC Norms), PIN/ATM Frauds, etc.

To avoid fraud, the basic mantra would be adherence to KYC Guidelines. RBI has prescribed the “Know Your Customer (KYC)” guidelines for Banks. All Banks before establishing relations with the customer should ensure that the profile/identity and entity of the customer is genuine. In the past it has been found that fake/dummy entities get their account opened in the bank by providing fudged documents and later misappropriation of funds could easily be channelized through such fake accounts.

It may also be noted that in addition to due diligence as required at the time of account opening, continues transaction monitoring is also required in order to plug the activities viz., Anti-money Laundering, Kite-flying, etc.

Banks need to ensure that all controls are in place from the stage of “prospective customer  turning into an existing customer.”

Abhishek R Sharma

Published in The CA Journal in Jan 2007 edition.