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Financial Frauds Risks and Prevention (Speech delivered by Shri R. Gandhi Deputy Governor at 2nd National Conference on Financial Frauds Risks & Preventions organized by ASSOCHAM on June 26 2015 at New Delhi)

Dated:- 29-6-2015 - Ladies and Gentlemen, it s a great pleasure for me to be amidst all of you this morning to inaugurate the conference on Financial Frauds - Risks and prevention. Introduction 2. There are three things in the world that deserve no mercy - hypocrisy, fraud, and tyranny - Frederick William Robertson There is no universally accepted definition for the term fraud . The laws in many countries do not define fraud; it actually needs no definition; it is as old as falsehood and as vers .....

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es like cheating, concealment, forgery, counterfeiting, mis-appropriation, breach of trust and falsification of accounts involve elements of fraud in their commission. 4. Can frauds be wished away? Obviously, we can t wish them away. We can only be consciously on our vigil to ward off frauds and initiate exemplary action on the perpetrators of fraud which will serve as deterrents to intending fraudsters. 5. Banks and financial institutions are easy prey to fraudsters. As long as banks and financ .....

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. Of these, the deposit related frauds which used to be big in number though not in size, have been on the wane, thanks to the improvements in cheque and payment processing, usage of technology and tightening the provisions of the Negotiable Instruments Act. The advances related frauds continue to be the major concern for banks, especially because of their size and far reaching implications to their financial soundness and integrity. A special variety of frauds, which are increasing in number an .....

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, the users of bank services or by their own staff, their outsourced agencies, their vendors, their agents like assayers, valuers, auditors, etc. Root Cause of Financial Frauds 8. Financial frauds, more specifically the advances related frauds, occur because of breach of contract and trust. It could be because of the pledged or mortgaged assets are compromised or divested off; or the documents are forged; or the funds availed are diverted or siphoned off; or the documentary credits like the lett .....

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nding, being risk averse, losing confidence in documentary credit, excessive collateralisation or documentation, demands on personal guarantees, collapse of need based lending systems like MPBF, Tandon and Chore Committee norms, etc. These are in addition to the bankers' efforts to recoup the losses through higher interest rates and charges. The Three KY Principles 11. When banks are faced with frauds, their financials are expected to bear the immediate impact. Because of this implication, a .....

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Ys. The First KY - Know Your Customer (KYC) 12. When one thinks of KYC norms frequently the emphasis is on the different type of documents to be obtained from an account holder which will establish that KYC norms have been followed. In a scenario where many frauds are committed by submitting forged and fabricated documents, such an emphasis is too narrow and will result in us missing the wood for the trees. 13. A bank, apart from obtaining the relevant documents, should make an effort to know th .....

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and do discreet investigations on the suppliers / buyers to check if they are in the same line of business or are bogus entities. Such timely checks help identify frauds at an early stage. 14. Banks need to invest in data analytics and also intelligence gathering to make fraud detection as near to real time as possible. Data analytics solutions can crunch huge data and give us the patterns, that too in a visual, easily understandable format. 15. Another strong trend in the future would be the pr .....

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happening. 16. On a bank level, each bank should segment its customers based on their risk profile and transaction patterns and develop appropriate response systems for exceptional patterns noticed and fortify systemic level controls. 17. But one word of caution though. I don t think banks can sit back after investing in a software or establishing a fraud risk management system. The business landscape is generally dynamic and with ingenious fraudsters we are dealing with people who always change .....

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e bad apples do escape or become rotten. Banks have to take extra care to have continuous vigil on their staff. Background checking for antecedents, checks and balances, periodic rotations, vigilance assessments, internal audits, etc. techniques will have to be employed to know the employees better and as preventive measures. The Third KY - Know Your Partner 19. Modern day banking necessitates that a bank join hands with partners, agents, vendors. Outsourcing peripheral and several operational a .....

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easures that banks should adopt. One set of instructions relate to information sharing. The importance that the Reserve Bank had always attached to is information sharing among banks, which has been again reinforced and made an integral part of the monitoring of potential frauds. 21. To facilitate this, banks have been advised to assign Unique Customer Identity Numbers (UCIN). Database on credit information, centralized registry for recording security interests Central Registry of Securitisation .....

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rtain deterrent action against them. The new framework to deal with Frauds 23. Recently, we had constituted an Internal Working Group that went into the causes for delays in detecting frauds, suggest ways to compress the time between occurrence of fraud and detection and also to remove any other impediments that may prevent deterrent actions taking place. The Group after wide consultations had recommended for a new framework to deal with frauds. The study revealed that there were a lot of delays .....

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a fraudster to enjoy banking facilities with impunity and ensnare more bankers and other innocent individuals in his net. The money trail gets cold and prospects of recovery becomes dim as each day passes. This scenario calls for a focussed response from the regulators, bankers and other stakeholders. 24. The best way to prevent frauds especially, loan frauds is to tone up the appraisal process. A good appraisal can weed out many undesirable or flawed proposals that may eventually turn out to be .....

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s operations will go and whether there is inherent resilience in the promoters and the project to face rough weather and come out unscathed. 25. While diligent appraisal is a major factor in eliminating dodgy borrowers, subsequent monitoring also plays a vital role in identifying potential frauds. In many cases we find that the discovery that stocks have been clandestinely sold, diversion to related parties and siphoning off of funds have taken place and documents provided had been fabricated, .....

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g Red Flagged Accounts based on Early Warning Signals has been put in place. A red flagged account is one where a suspicion of fraudulent activity is thrown up by the presence of one or more Early Warning signals. The presence of these signals should trigger a detailed investigation into the RFA. 27. As one of the major problems in fraud risk management was time delays in dealing with a fraud, we have prescribed time limits within which certain actions like investigating for fraud should be comp .....

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a major part is played by the deterrent actions and punishments that are meted out to the fraudsters. Towards this end henceforth the fraudster borrowers will not be able to avail bank finance for five years after full repayment of the dues. This is of course in addition to the criminal complaints to be filed with police or CBI. This is expected to build in a disincentive for any borrower to consider committing a fraud on banks. 28. As I mentioned earlier, containing frauds means focussed action .....

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nks. However the aspects of continuous monitoring and timely action on the basis of any early warning signals apply equally well to other types of fraud like deposit frauds, cyber fraud, etc. 30. It is here that I am sure that adhering to the KYC norms and real time transaction monitoring, transaction analysis, centralized databases, etc. rigours will come in handy for banks. Fraud risk and governance 31. It is when we think of the dynamic nature of frauds landscape that we need to pay attention .....

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bust anti-fraud machinery. They should have a deep understanding of the institution s strengths and weaknesses and be able to steer the institution in the right direction. For this they need to retain their common sense in the face of an information overload. As a famous saying goes, you can find out if a man is clever by his answers, but you can find out if a man is wise by his questions (Naguib Mahfouz). As another saying goes, the wise man doesn't give the right answers, he poses the righ .....

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