!

CHAPTER 1
!

INTRODUCTION
1. Introduction to banking frauds

Bank fraud 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 applies to actions that employ a scheme or artifice, as
opposed to bank robbery or theft. For this reason, bank fraud is sometimes considered a
white-collar crime.
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.
The criminal offense of bank fraud is deliberately engaging in a secret scheme or deception
intended to defraud a bank or financial institution, to obtain money or property owned by the
bank or financial institution. Bank fraud is considered to be a white collar crime. In the United
States, a criminal charge of bank fraud generally applies when an individual knowingly
executes, or attempts to execute, at act in order to defraud a financial institution, or to
receive money, assets, credits, securities, or property from a bank or financial institution
using false information, pretenses, or insincere, promises. 

 !2

1.1 concept and definitions of Banking froude

Financial institutions are playing vital role for the development of Indian economy,
particularly banks. Banks are those financial institutions those are registered under
banking regulation Act 1949 to render various financial services to its customers such
as receiving of savings and paying it on customers demand. In this ways banks acted as an
intermediary in channelization of saving of the nation for the industrial purposes.
Frauds means dishonest act or behaviour through which one person gains an advantage
over another which results in the loss of the victim directly or indirectly. Now a day’s frauds
relating to banks are playing game in the dream of the public. Rs. 9000 Crores fraud
and money laundering case by Vijay Malya, business tycoon of India and the Diamond
star Nirav Modi’s Punjab National Bank scam of Rs. 13,000 Crores encourages us to
understand the concept of banking frauds and its impact on Indian economy. Banks
are performing its activities with public savings. Offences relating to banking activities are
not confined to banks but have a harmful impact on their customers and society at large.
The data used for the study purpose are collected from secondary sources such as
from published journals, bulletins and working papers on banking frauds by different
authors. In conclude some recommendations have been made to minimize the banking
frauds in future course of action in commercial banks providing services in India.
 !3

1.2 banking frauds historical background



Rebecca Bundhun

February 24, 2018

India has been rocked by a number of bank frauds over the years. Here are the ones that
have made headlines.




Kingfisher's Vijaya Mallya



The Kingfisher tycoon Vijay Mallya is accused in India of fraud and money laundering to the
tune of 90 billion rupees. He fled to the UK and there are efforts underway to get him
extradited. Widely considered to be India’s answer to Richard Branson, the flamboyant
Indian entrepreneur built up his inherited empire, United Breweries Group, the prized assets
of which were its beverages division and Kingfisher Airlines, and lived a lavish lifestyle,
buying Formula One and cricket teams, islands and vintage cars. But the collapse of
Kingfisher Airlines, which stopped flying in 2012 and had amassed US$1 billion in debt, left
him in trouble. State Bank of India has called for him to be jailed as the country’s largest
lender tries to recover money it is owed.

 !4



Rotomac founder Vikram Kothari



Vikram Kothari, the founder and chairman of Rotomac Pens, based in Uttar Pradesh in north
India, has been accused of a 36 billion rupees loan default, on loans taken from a
consortium of seven Indian banks. The industrialist and his son Rahul Kothari were arrested
by the Central Bureau of Investigation in Delhi last week following a day of questioning. The
scandal emerged following the break out of news of the $1.8 billion fraud linked to the
jeweller Nirav Modi and after state-run lender Bank of Baroda filed a complaint with the
authorities. Properties have been raided in connection with the case. Vikram Kothari denies
any wrongdoing.

 !5

Jatin Mehta of Winsome Diamond




A Gujarat-based diamond merchant Jatin Mehta is considered to be one of India's biggest
defaulters. He owns a company called Winsome Diamonds and is accused of owing more
than 65 billion rupees to a consortium of Indian banks, including Punjab National Bank,
which took the biggest hit. He fled India in 2016 and now resides in St Kitts and Nevis in the
Caribbean. This case had similarities to the Nirav Modi scandal. Letters of credit were issued
on the behalf of Indian lenders to raise money from international bullion banks, but these
loans were never paid, leaving the Indian banks exposed.
 !6

1.3 banking crisis : in indian companies

The Punjab National Bank (PNB) scam has, at least momentarily, shocked the nation. Some
headlines suggest this is the biggest banking fraud since Independence. Just a few days
earlier, Bank of Baroda was in the news, but far less prominently, for very similar fraudulent
activity in South Africa. 



Bank frauds and bank crises have been an integral part of Indian financial history. It is not for
nothing that in 1913, John Maynard Keynes after surveying the state of banking in the
country, wrote in Indian Currency and Finance, “In a country so dangerous for banking as
India, (it) should be conducted on the safest possible principles". His warnings have proven
prophetic. 



In fact, scams in Indian banking far predate Keynes’s warnings. The year 2017 was the
150th anniversary of the failure of the Presidency Bank of Bombay (PBB). The bank had
been started by the East India Company in 1840. It was stable and run prudently till the
mid-1860s. This was the period when the British started relying extensively on Bombay
cotton markets, as supplies from the US had declined due to the civil war. Thus, lots of
cotton companies and banks began to spring up in Bombay catering to a booming demand
for capital.



If one reads into the details of the PBB scam as given in Amiya Kumar Bagchi’s history of
State Bank of India, the scam is not all that different from the recent events at PNB. The
main difference is that while PBB failed, hopefully neither PNB nor Bank of Baroda is
headed in that direction.



Even before PBB, there were several bank failures in Calcutta. Several banking
organizations mushroomed in the early 18th century, as economic activity concentrated in
Calcutta. However, again, the same problems surfaced—overextended balance sheets,
accounting fraud, et cetera. At the time bankers in Calcutta blamed the fact that banks had
unlimited liability. Subsequently, in 1861, British authorities allowed banks to have limited
liability, only for the PBB collapse to show that accounting regulations and reforms can only
do so much for prudent 



The entrepreneurial response was overwhelming. By 1913, there were 451 banking
companies (accoring to Bakhtiar Dadabhoy's Barons of Banking). No prizes for guessing
what happened next. Following runs, prominent banks such as Indian Specie Bank and
People’s Bank of India collapsed. The case of Indian Specie Bank is interesting—it had
forwarded large loans to a prominent pearl merchant. When the merchant’s business
collapsed, so did the bank. In December 1913 one newspaper, The Colonist, said that if the
bank’s management had released balance sheets, the fraud could have been detected well
in advance of the collapse. A refrain that is all too common to this day.

 !7



Most of the banking failures in the 1910s took place in Punjab. In 1913-14, out of 54 closed
banks, 28 were from Punjab and 11 from Bombay. The location of failures then shifted
significantly towards southern India and West Bengal. The period of 1913-66 sees nearly
1800 banks failing—25% in Kerala, 21% in West Bengal and 20% in Madras. 





For a while these collapses were blamed on the lack of a central bank. Indeed, nearly 350
banks all over India closed between 1913 and 1934. In 1934 India finally got its own central
bank. Sure this central bank could now stem the rot in Indian banking? 



Hardly. Banks continued to fail at an alarming rate. Between 1935 and 1947, nearly 900
banks failed followed by 665 banks in the period from 1947 to nationalization in 1969. So
much so, in 1950 an elderly citizen from West Bengal wrote to prime minister Jawaharlal
Nehru complaining that small depositors who lost their deposits in these banks "scheduled
and affiliated [sic] by the Reserve Bank" had come to the conclusion that the central bank
was "only meant for the Big Pandas who ... only know how to squeeze" the poor and who
were "sleeping with oil in their noses" (RBI History 1951-67). 



Sentiments about banking mismanagement, then, have changed very little.





Though, to be fair, even at the time of the Reserve Bank of India's inception, there was a
feeling that the RBI Act did not give the central bank enough powers to regulate the sector. It
was felt that additional separate legislation was needed. This feeling was strengthened
following the failure of Travancore and Quilon Bank in 1938. It was only much later, in 1949,
that the Banking Regulation Act was enacted which gave RBI additional regulatory powers.
The statutory liquidity ratio was introduced to build reserves for safety (which later became a
tool for financial repression). 

 !8



More importantly, both new and old banks were required to apply to RBI for a banking
licence. Old banks which could not fulfil new conditions were asked to merge or liquidate
their operations. However licensing was a double-edged sword, as RBI could not use it
aggressively to clean the system. After all banks are deeply interconnected. You cannot
restructure one without unsettling others down the line. For all its regulatory enthusiasm, RBI
had to walk a tightrope. 



In 1951, there were 566 banks of which 474 banks were unfit to be included in RBI’s Second
Schedule. In 1967, this figure was pared down to 91 banks of which just 20 banks were unfit.
These statistics are staggering but is perhaps still inadequate to fully convey the challenges
faced by India’s banking system till 1969.



After 1969, RBI became highly conservative and no new bank licences were issued till 1994.
This was also a period when banks were pushed aggressively towards financial inclusion
leading to an accumulation of bad loans starting from the 1980s. In 1994, 10 new banks
were licenced (of which only a few remain now). In the early 2000s, two more banks were
licenced followed by another two in 2014. Some special banks like local area banks,
payments banks and small finance banks have since been licensed. In all these new
beginnings, the process of consolidation has continued with the eight associate state banks
being merged with State Bank of India last year.

 !9

CHAPTER 2
2 RESEARCH METHODOLOGY RESEARCH METHODOLOGY
The study seeks to evaluate the extent of implementation of internal control mechanism. It
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 mechanism.
It also evaluates the factors that influence the degree of compliance.
 !10

2.1 RESEARCH HYPOTHESES 


RBI has developed many important guidelines for prevention of bank frauds. The security
controls prescribed by RBI if followed prescribed with 100 percent adherence can greatly
prevent frauds. The level of compliance of these security, controls were measured under six
heads: internal checks, deposit accounts, administration of 

cheque books and passbooks, loans and advances, drafts, internal accounts and inter
branch accounts. Some important questions were asked on the compliance of RBI‟s
procedures under the above said heads and their 

responses were evaluated.

 !11



In the current research the following research hypotheses were also investigated:

H1: There will be no significant difference in the compliance level of employees of various
banks

H2: There will be no significant relationship between training status of employees and their
level of compliance 

H3: There will be no significant relationship between attitude towards RBI procedure of the
employees and their compliance level 

H4: There will be no significant difference in compliance level between two categories of
employees at two different hierarchal levels

H5: There will be no significant difference in the attitude towards RBI procedure of
employees of various banks 

H6: There will be no significant relationship between training status of employees and their
awareness level toward type of bank frauds

H7: There will be no significant difference in the awareness level of various banks

H8: There will be no significant difference in awareness level among three categories of
employees at three different hierarchal levels

 !12

FRAUDS IN FINANCIAL INSTITUTIONS :: 


Understanding the types and modus operandi

Evolution of fraud 

1990–1999

• Hawala transactions

• Ponzi schemes

• Fake currency

• Cheque forgery

• Advancing loans without adequate due diligence

• Siphoning of investors’ money through fictitious companies

• Use of fictitious government securities

2000–2015

• Tax evasion and money laundering

• Black money stashed abroad

• Cybercrime

• Debit/credit card fraud

• Identity theft

• Fake demat accounts

• Benami accounts

• Collusive frauds emanating kickbacks to employee of financial institution

 !13



 !14



 !15

2.2:TRANSFORMATION THROUGH TECHNOLOGY :The 


advent of a new world of financial services

Policy and market trends

In August 2014, the government of India 

announced a planned investment of 1,330 

billion INR in the Digital India project that 

aims to provide universal mobile phone 

access, broadband access in 250,000 

villages and Wi-Fi hotspots in every city 

with a population of 1 million plus by the 

year 2020.

As per Celent’s banking practice study, 

total bank IT spending across North 

America, Europe and Asia-Pacific will 

grow to 196.7 billion USD in 2015, an 

increase of approximately 4.6% over 2014. 

The majority of the growth is expected 

to come from banks in the Asia-Pacific 

region: The spending of banks in this 

region is expected to grow by 5.6% in 

2015 to 70.3 billion USD. The IT spend by 

Indian banking and securities companies 

in 2015 will be 15% more than the 46,600 

crore INR spent in 2014.

 !16