Lack of holistic compliance

Borrowing a quote from Charles Dickens in his Tale of Two Cities, the Indian banking industry witnessed the best of times as well as the worst of times; wisdom and foolishness; light and darkness, spring of hope and winter of despair; banks had everything as well as nothing.

But one thing that seems to always be on the rise is bank fraud.

Deloitte recently came out with its third survey. Started in 2012 and conducted every three years, the survey indicated that banks seem to have learned very little from their past experience in tackling frauds. Deviation or not paying adequate attention to due diligence or action not being initiated when red flags are raised in certain accounts result in bank frauds.

While risks are inherent to the banking sector, dealing with risks associated with fraud is on no bank's wish list. But the fact remains – frauds are on the rise (and will continue to rise). Banks appear to be underestimating their ability to prevent frauds and this may impact the nature of anti-fraud compliance programs being developed, according to the Deloitte India Banking Fraud Survey, Edition III.

About 84 per cent of respondents pointed to a substantial rise in fraud incidents. They identified the top four types of frauds experienced by them as follows: fraudulent documentation, cybercrime, overvaluation/non-existence of collateral and syphoning/diversion of funds, the survey released recently said.

"The kind of frauds being highlighted here, perhaps indicate the ineffectiveness of existing controls to prevent such occurrences. Considering how none of these frauds are new for banks (cybercrime being the exception, given the dynamics of evolving technologies), it is important to know why they remain prevalent. What investments are banks making towards fraud risk management? Are these investments geared to holistically address fraud?" asked KV Karthik, Partner, Forensic, Financial Advisory, Deloitte India.

Despite issues identified across previous surveys, the root cause responsible for the increase in fraud incidents appears to have not been adequately addressed. Some of the key reasons identified by respondents towards an increase in fraud incidents include the use of new technology/digital channels that have made fraud detection difficult, lack of tools to identify potential red flags and business pressures to meet targets.

Respondents appear to have a strong fraud risk management (FRM) policy on paper with a focus on elements like strategy, reporting structure, fraud investigative cell, whistleblower hotline, employee background check and customer screening. However, what seems to be missing is the use of technology tools, intelligence gathering, conducting regular fraud risk assessments, fraud awareness training and workshops, vendor due diligence and social network analysis.

According to Karthik, deviation in the process of due diligence, lack of forensic tools and not taking immediate action whenever a red flag is raised in an account are some of the major reasons for bank frauds getting perpetuated.

Asserting that banks are guilty of underestimating the problem and missing the wood for trees, Karthik said that the increasing use of artificial intelligence will be helpful in data analytics to check frauds.

There are set rules for carrying out due diligence before a loan is granted by banks. Also, there is a proper procedure to deal with the situation when a red flag is raised. For example, when a company opens an account claiming it has a Rs 100 crore turnover but the account finds transactions of only Rs 50 crore, there is a red flag and the account needs to be investigated – but that does not happen. Likewise, if a person does not fulfil all the requirements prescribed in due diligence then loans should not be granted. Yet, loans are granted after deviating from the due diligence process, Karthik said, nurturing frauds as a result.

Karthik was not sure if adoption of blockchain technology by the banking system would help in preventing Nirav Modi-type frauds. According to former RBI Deputy Governor Usha Thorat, blockchain technology can prevent such frauds. Thorat feels that blockchain is a very solid system as every transaction and its execution are recorded; besides it cannot be reversed.

Former chief economic advisor Shankar Acharya says, lending exuberance to the power sector without due diligence during UPA II resulted in huge NPAs in PSBs.

Gajendra Haldea, a former advisor in Planning Commission, said that corruption in banking is huge. Frauds in Indian banks are triggered by sub-prime lending to power and highways. PSBs had lent Rs 6 lakh crore to the power sector and about Rs 3 lakh crore to highways. Gold plating of costs apparently due to widespread corruption in the banking system is the root cause of the mess.

Pronab Sen considers bank frauds to be a legacy issue as it got into a lending pattern for which they were not designed. Now that the banking code is

in place, companies will hereafter be careful before taking loans.

(The views expressed are strictly personal)