Fraud as defined by RBI: “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."
History for making Banking system robust:
1999: GSA repealed as it became redundant after years of dilution.
1999: World Bank and IMF jointly launched Financial Sector Assessment Program (FSAP) to assess, diagnose and address potential financial vulnerabilities. India's FSAP was conducted in 2011.
Too big to fail concept: That government will bail out these banks in times of crisis to prevent disastrous impact which eventually led to highly risky financial objectives and financial crisis of 2008.
2010: Dodd Frank wall street reform and consumer protection Act. It gave birth to new agencies to help monitor and prevent fraudulent practices. Volcker rule under DFA banned banks from engaging in proprietary trading operations for profit.
Challenges in Indian Banking:
As per KC Chakrabarty report titled, “Frauds in the banking sector: Causes, Cures and Concerns” while most no. of frauds have been Attributed to private and foreign banks, public sector banks have made the highest contribution towards the amount involved.
Asset Quality (RBI circular)
Marginal Capitalisation. (RBI circular)
Good Governance. (Rajan)
Bank Autonomy (Rajan)
Whistleblower Policy of Banks (RBI circular)
Absence of Robust credit appraisal system(R. Gandhi)
Inefficient Supervision post credit disbursal (R. Gandhi)
Ineffective recovery mechanisms. (R. Gandhi)
All the above will be discussed in detail in the video to be uploaded on our youtube channel (click here)
Classification of Banking Frauds by RBI:
Other types of Bank Frauds that are being observed are :
Documentary credit (Line of Credit) related frauds.
Fraud Detection Procedure:
This is the reporting structure of Bank Frauds. The dotted lines depict optional reporting where as the bold lines are mandatorily followed in case of fraud. Also, the agency to whom complaint is to be lodged varies from case to case as shown in the table below.
Reasons for contrast between Public and Private sector Banks wrt Frauds and Non-Performing Assets:
Proportion of Loan advanced:
Stringent oversight of CVC:
Underreporting/Evergreening of loans by Private Banks:
Lack of due diligence across several public sector banks.
Wilful default is still not a criminal offence.
Lack of competent auditors in India. Also, auditors suffer from problems like staffing, training, low pay etc.
Weakness in selection procedure for top level management as documented by RBI results in weak governance.
Poor Compensation structure. The one day pay of MD of HDFC bank Aditya Puri in 2015-16 was more than the monthly salary of Arundhati Bhattacharya of SBI group.
Poor Law enforcement and Judicial delays.
Whistleblower policy doesn't guarantee adequate safety.
Independent specialised cadre:
On the lines of All India Services, a specialised cadre equipped with the best financial and legal know how to detect financial frauds.
Know your market:
Along with Know Your Customer and Know your vendor, banks also need to know the market so as to have improved lending and reduced defaults. This becomes more important in the light of recent Chinese market crash.
Internal Rating Agency:
Banks need to develop their own rating agency and the loan applications should be checked by both internal and external agencies.
Use of latest technology:
Data collection mechanisms of banks need to be updated and data analytics need to be employed in order to ensure effective implementation of the Red Flagged account (RFA) and early warning signals (EWS) framework as suggested by RBI.
Strong laws to prevent fraudulent financial reporting.
Transparent Hiring and Adequate compensation.
Financial literacy of both borrowers and staff need to be improved.
Better coordination between agencies such as CBDT, CVC and RBI.