Int. Journal of Business Science and Applied Management, Volume 4, Issue 3, 2009

A study to investigate the reasons for bank frauds and the

implementation of preventive security controls in Indian banking

industry

Ashu Khanna

Department of Management studies, Kanya Gurukul Mahavidyalaya

2nd Campus, Gurukul Kangri University, 47, Sewak Ashram Road, Dehradun, India

Tel: 00919412173247

Email: binduarora17@rediff.con

Abstract

This paper examines the issue of frauds from the perspective of banking industry. The study seeks to evaluate the

various causes that are responsible for banks frauds. It aims to examine the extent to which bank employees

practices framed by Reserve bank of India to prevent frauds are followed) are the main reasons for bank frauds.

The banks should take the rising graph of bank frauds seriously and need to ensure that there is no laxity in

internal control mechanism.

Keywords: bank frauds, preventive measures, internal control, compliance, and security controls

Int. Journal of Business Science and Applied Management / Business-and-Management.org

rise in bank frauds calls for tightening of security mechanism. A strong system of internal control is the most

effective way of fraud prevention. The banks should increase their efforts to raise the level of security awareness

in their organizations to combat frauds.

2 RESEARCH OBJECTIVES

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 the factors that influence the degree of compliance.

inadequate rewards; inadequate internal controls; no separation of duties or audit trails; ambiguity in job roles,

duties, responsibilities, and areas of accountability; failure to counsel and take administrative action when

performance levels or personal behaviour fall below acceptable levels; inadequate operational review; lack of

timely or periodic review, inspections, and follow-up to assure compliance with company goals, priorities,

policies, procedures, and governmental regulations and failure to monitor and enforce policies on honesty and

loyalty.

Beirstaker, Brody, Pacini (2005) proposed numerous fraud protection and detection techniques. These

various techniques include fraud policies, telephone hotlines, employee reference checks, fraud vulnerability

reviews, vendor contract reviews and sanctions, analytical reviews (financial ratio analysis), password protection,

firewalls, digital analysis and other forms of software technology, and discovery sampling.

fundamental principles of good internal control be established and used.

 To detect and investigate fraud, organizations must ensure the existence of strong internal audit

departments with sufficient resources to pursue the increased responsibilities faced by internal

auditors.

Barnes (1995) has pointed out that the quality training to bankers helps not only in developing job related

skill but also maximizes the performance potential of bankers and provides them the sound knowledge and

understanding of banking practices and principles. Imparting training is of paramount importance in this regard.

To Commercial Angels‟ Newsletter (2001), the best way of preventing fraud was to understand why it

happened. Fraudster generally identifies loopholes in control procedures and then assess whether their potential

to prevent frauds.

Ashu Khanna and Bindu Arora

Ganesh and Raghurama (2008), believe that training improves the capabilities of employees by enhancing

their skills, knowledge and commitment towards their work In the survey conducted by them, about 80 executive

from Corporation Bank and Karnataka Bank Ltd of India, were requested to rate their subordinates in terms of

development of their skills before and after they underwent certain commonly delivered training programs.

Responses revealed that for the seventeen skills identified there was improvement in the skills statistically. The

paired t-test was applied individually for the seventeen skills, and all these skills have shown statistical

significance. The seventeen skills include analytical skill, human resource skill, marketing skill, communication

skill, accounting skill, credit appraisal skill, cash management skill, time management skill, inter-branch

reconciliation skill, conceptual skill, information technology related skill, technical skill, role identification skill,

substance abuse. Business today is very competitive, and employees often stressed. As a result, they have a

feeling of being overworked, underpaid, and unappreciated. If employees are also struggling with serious

personal problems, their motivation to commit fraud is very high. Adding to the situation of poor internal

controls, the readily available computer technology also assists in the crime, and the opportunity to commit fraud

becomes a reality.

Harris and William (2004) examined the reasons for loan frauds in banks and emphasised on due diligence

program. This is a proactive approach, with each business line within the institution establishing policies and

procedures for conducting due diligence investigations for both new and existing customers .They indicated that

lack of an effective internal audit staff at the company, frequent turnover of management or directors,

appointment of unqualified persons in key audit or finance posts, customer‟s reluctance to provide requested

percent of the 910 cases are classified under the internal control risks that include: lack of regular independent

checks in performance, inadequate organizational control methods, inadequate methods of communicating or

enforcing the assignment of authority and responsibility; and unauthorized access and physical control of assets,

records, computer programs, or data.

Bhasin (2007) examined the reasons for cheques frauds, the magnitude of frauds in Indian banks, and the

manner, in which the expertise of internal auditors can be integrated, in order to detect and prevent frauds in

banks. He emphasized that though the head of the branch holds the responsibility for ensuring adherence to

prescribed systems and procedures, the bank's internal auditors also occupy a special position in the detection

and prevention of frauds. In addition to considering the common types of fraud „signals', auditors can take

several „proactive' steps to combat frauds. Checking frauds requires training, account screening, signature

Unscrupulous constituents commit frauds by taking advantage of the laxity on the part of the officials in

observance of time-tested safeguards established by Reserve Bank of India (RBI). The RBI has set up an

investigation cell in its central office. Ace investigator of high and vast experience mans it. The bank team goes

deep into the root cause of bank frauds and suggests exhaustive preventive measures. The RBI carries out

detailed studies and researches in the commission of bank frauds and recommends innovations to prevent frauds.

The authors have further suggested that the need of the hour is not another piece of complex high-powered body

of RBI, but analysis and concerted application of controls by bank management and their operational staff.

Smith (1995) offered a typology of individuals who embezzle. He indicated that embezzlers are

“opportunist‟s type”, who quickly detects the lack of weakness in internal control and seizes the opportunity to

use the deficiency to his benefit. To deter embezzlement he recommended the following measures:-

Int. Journal of Business Science and Applied Management / Business-and-Management.org

Willson (2006) examined the causes that led to the breakdown of Barring bank, in his case study: “the

collapse of Barring Banks”. The collapse resulted due to the failures in management, financial and operational

controls of Baring Banks. The failures that were evident include the following areas:-

Ashu Khanna and Bindu Arora

The results show that compliance level is lowest in administration of chequebook and passbook. The bank

employees do not seem to exercise due diligence in administration of passbooks and chequebooks. The highest

compliance is in internal checks; this shows that the managers are vigilant in this regard. The managers give

second highest importance to loans and advances while officers give equal importance to loan and advances and

deposit account. But one thing is evident that there is no 100 percent compliance in any of the heads. A little

Int. Journal of Business Science and Applied Management / Business-and-Management.org

The compliance level of officers is highest in internal and inter branch account, followed by loans and

advances, draft section, deposit account and is lowest in administration of cheque book and passbooks.

There is a significant difference in compliance level of employees of various banks (result of hypothesis

testing given in Table 7). This can be due to their difference in organization culture, training status and attitude

towards RBI procedure.

Moreover there is a significant relationship between the level of compliance and attitude towards RBI‟s

procedure (result of hypothesis testing, given in Table 7). Thus a favourable attitude towards RBI‟s procedure

leads to a high degree of compliance level. The procedures and instructions prescribed by RBI if fully complied

with can greatly reduce the incidences of frauds. But the study revealed that very low percent age of respondents

respondents also feel that they are overburdened and hence are not able to follow procedures strictly. Since the

attitude is based on the perception of bank employees towards adequacy of staff, it can be inferred that if there is

adequate staff the compliance will be more.

Table 4: Frequency distribution of the responses of bank employees on the basis of their attitude towards

RBI procedures

properly. Through training this information is disseminated and they feel the need to comply with them despite

of work overload. The findings also show that the managers are more trained than officers and clerks. 47.83%

managers are trained while only 22.73% officers and 4.43% clerks are trained in this regard. The compliance

level of the managers is higher than that of officers (result of hypothesis testing given in Table 7). This can be

due to the fact that managers are more trained and their attitude towards RBI‟s procedures is more favourable

than that of officers and clerks. Moreover their awareness level is high and they have increased level of

responsibility.

Table 5: Percentage distribution of managers and officers according to their of level of compliance

percentage form

awareness level of employees about various types of frauds that perpetrate in the banks is very low. From the

result of hypothesis testing it is clear that training does have an impact on the awareness level of employees)

result of hypothesis testing given in Table 7). The awareness level is very low in the clerks and officers only

4.12% of clerks and 5.45% of officers belong to high category of awareness level. Managers did fare a little

better; around 15.22% of managers belong to high category of awareness level. As evident from the following

Table 62.89% of clerks 49.09% of officers and 47.83% of managers belong to low category of awareness level.

Ashu Khanna and Bindu Arora

This shows a proper system is not developed to abreast the bank employees of various frauds that perpetrate

in banks every now and then, or the reason could be that the circulars that are circulated among various banks by

among the awareness level of employees of various banks. This may be due to the reason that organization

culture; training status and communication process differ for different banks (result of hypothesis testing given in

Table 7).

Figure 1: Hypothesized Bank Fraud Reduction Model

Int. Journal of Business Science and Applied Management / Business-and-Management.org

*Critical value of chi-square at 5% level of significance at 4 degree of freedom is 9.49

*Critical value of chi-square at 5% level of significance at 16 degree of freedom is 26.3

*Critical value of chi-square at 5% level of significance is 1.96

time to scrutinize documents thoroughly. About two thirds of the respondents (approximately 68%) feel that

they do not have sufficient staff to carry out the work meticulously. The overburdened staff was given the highest

weight age as the reason responsible for bank frauds. The weight age given was 5.63. A banker may pass about

300 cheques a day (finding through questionnaire) in about three and a half hour. He scrutinizes the cheque, the

signature and money for each cheque in 40 seconds.

Table 8: Weighted average given by bank employees to the various reasons for perpetration of fraud on

ten point scale

Ashu Khanna and Bindu Arora

Among reasons responsible of bank frauds overburdened staff has taken the highest score followed by lack

of training, competition and corrupt officer in charge.

Dilution of system and non-adherence to procedures is also a significant reason for bank frauds. In tune with

the economic liberalization and reforms in the financial sectors, new private sector banks have entered the field

in a big way creating competition in the market. In the garb of existing quality customer service to meet

competition, time honoured system and procedures have been diluted. The employees have given 4.68 weight-

ages to the factor of competition that compels the officer in charge to compromise with the procedure.

Sometimes many decisions are made at the bank level. It appears that misconception has developed in the minds

of many staff/ officers that in the course of development of business and in providing good customer services

following are few illustrations.

There is improper checking of ledger / registered and subsidiary book daybooks, general ledger. Passbooks

are not updated promptly statements of accounts are not furnished to customers promptly. Out of the total

respondents who were asked whether the passbooks are updated promptly, more than half of the respondents

(approximately 58%) said that there is delay in updating them always or often. Books and accounts are not

balanced at periodic intervals and large arrears are kept pending in balancing of books. Slightly more than half of

the respondents (approximately 53.21%) say that inward and outward clearing is standing in their books. The

balance appearing, in passbooks are not verified with the balances in files respective ledger accounts periodically

or even on random basis.

There is unauthorized delegation at branches. The custody of security forms such as bank draft forms;

Allowing unauthorized access to member of the public / outsiders to the cash department, cash cabins, bank

records, ledgers and forms has been a factor in perpetration of frauds especially in institutional accounts.

Main cause of frauds in Deposit Accounts is because the best policy “know your customer” is not followed

properly. Current accounts are opened without proper introduction. Some questions were asked regarding the

formalities that should be followed when a new account is opened during introduction. The findings showed that

proper guidelines were not followed. Only 45.7% managers scrutiny withdrawal of large sum in general account

always, while in case of new account the percentage of managers who implement this practice is 69.6%. The

compliance percent age of managers is 82% and that of officers is 76% in deposit account. The banking business

is becoming impersonal, often the banker does not know the customer, he knows him only through his signature.

But even signatures are not given due importance. The customer should be encouraged to have long legible

Gross negligence can be seen in administration of chequebook and passbook. It is seen that the prompt

processing of passbooks is not done and they are kept lying unattended in many cases. Only 16.03% of

respondents stated that prompt processing is done in their branch and passbooks do not lie unattended.

Sometimes written request of the customer is not taken to whom loose cheques are issued; it is not always

ensured that the delivery and issuance of chequebooks are given to the account holder only. Sometimes the

specimen signature card is also not duly locked overnight. Signatures of dormant account are not always kept

separate from running account. Only two thirds of the respondents keep specimen signature of dormant account

separate from running account. (Refer to Appendix II)

Frauds are quiet common in internal accounts and inter branch account. This situation has accrued because

of low priority given by the branches to it. Around 24% of managers do not check their suspense account daily.