*Role of Audit in Preventing Bank Fraud – MBA FM Batch 2021-2023

PROJECT REPORT

ON

“ Role of Audit in Preventing Bank Fraud”

SUBMITTED

To

CENTRE FOR ONLINE LEARNING

Dr. D.Y .PATIL VIDYAPEETH, PUNE

IN PARTIAL FULFILMENT OF DEGREE OF

MASTER OF BUSINESS ADMISTRATION

BY

Suhas Rajendra Pawar

PRN: 2105023065

BATCH 2021-2023

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Dr. D.Y. Patil Vidyapeeth’s

CENTRE FOR ONLINE LEARNING,
Sant Tukaram Nagar, Pune.

CERTIFICATE

This is to certify that Mr. Suhas Rajendra Pawar

PRN - 2105023065

has completed his/her internship at ICICI Bank, Ghodbunder Road Branch

starting from 21st April 2023 to 31st March 2023.

His / Her project work was a part of the MBA (ONLINE LEARNING)

The project is on Role of Audit in Preventing Bank Fraud

Which includes research as well as industry practices. He/ She was very sincere and
committed in all tasks.

Course Coordinator Director

_________________ ___________________

Date -

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COMPANY LETTER
(ICICI Bank, Ghodbunder Road Branch, Thane West)

To whomsoever it may concern

This is to certify that Mr. Suhas Rajendra Pawar

PRN - 2105023065

has completed his/her internship at ICICI Bank, Ghodbunder Road Branch

starting from 21st April 2023 to 31st March 2023.

His / Her project work was a part of the MBA (ONLINE LEARNING)

The project is on Role of Audit in Preventing Bank Fraud

Which includes research as well as industry practices. He/ She was very sincere and
committed in all tasks.

Signature & Seal of Industry Guide

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DECLARATION BY STUDENT

This is to declare that I have carried out this project work myself in part fulfillment of
the M.B.A Program of Centre for Online Learning of Dr. D.Y. Patil Vidyapeeth’s,
Pune – 411018

The work is original, has not been copied from anywhere else, and has not been
submitted to any other University / Institute for an award of any degree / diploma.

Date: - Signature: -

Place: Name:

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ACKNOWLEDGEMENT
(TO BE GIVEN BY THE SYUDENT)

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Table of content

Sr. Item Page No

No.
1 Title Page 1

2 Institute Certificate 2

3 Company Certificate 3

4 Declaration by Student 4

5 Acknowledgement 5

6 INDEX 6–7

7 Executive Summary 8

8 Chapter 1: Introduction 9 – 10

9 Chapter 2: Literature Review

10 Chapter 3: Research methodology

11 Chapter 4: Data Analysis

12 Chapter 5: Findings, suggestions,

recommendation

13 Chapter 6: Conclusion

14 Bibliography ( Books, Journals, research

work)

15 Reference ( Website, company paper)

16 Annexure ( A to C)

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17 A- Questionnaire

18 B- Scope for future study

19 C- Photograph, Drawings

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Executive Summary
(TO BE GIVEN BY THE SYUDENT)

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Chapter 1 : Introduction

The Indian banking sector has experienced significant growth and changes since

liberalization of economy in 1991. Though the banking industry is generally well

regulated and supervised, the sector suffers from its own set of challenges when it

comes to ethical practices, financial distress and corporate governance. In recent

years, instances of financial frauds have regularly been reported in India. Although

banking frauds in India have often been treated as cost of doing business, post

liberalization the frequency, complexity and cost of banking frauds have increased

manifold resulting in a very serious cause of concern for regulators, such as the

Reserve Bank of India (RBI).

Fraud vitiates every solemn proceeding and no right can be claimed by a

fraudster on the ground of technicalities. The definition of fraud as defined in the

Black's Law Dictionary, which is as under:

“Fraud” means:

(1) A knowing misrepresentation of the truth or concealment of a material fact to

induce another to act to his or her detriment. Fraud is usually a tort, but in

some cases (especially when the conduct is willful) it may be a crime.

(2) A misrepresentation made recklessly without belief in its truth to induce

another person to act.

(3) A tort arising from a knowing misrepresentation, concealment of material

fact, or reckless misrepresentation made to induce another to act to his or her

detriment.

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(4) Unconscionable dealing; esp., in contract law, the unconscientious use of the

power arising out of the parties’ relative positions and resulting in an

unconscionable bargain.”

Colloquially, the terms “fraud” and “scam” are used interchangeably to refer to

any kind of financial wrongdoing. Legally speaking, fraud usually refers to a

broader and more serious crime, with scams representing one type of fraud.

A scam is a fraudulent scheme generally involving money and some sort of

business transaction. Scams come in various forms. Maybe you have experienced

someone telling you would win a prize if you revealed your credit card details or

asking you to donate money to a charity that did not exist. Scams reach us in various

ways, via telephone, email, or even in person.

Fraud implies a deception. It is a breach of confidence or trust. Fraud is a serious

crime and a violation of civil law. The motivations for fraud can be many. These

include monetary gain, discrediting an opponent or adversary. It can be to gain

prestige as well as a financial advantage.

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 Fraud as Defined In Section 17 of Indian Contract Act, 1872

“Fraud” means and includes any of the following acts committed by a party to a

contract, or with his connivance, or by his agent, with intent to deceive another party

thereto or his agent, or to induce him to enter into the contract:

1. the suggestion, as a fact, of that which is not true, by one who does not believe

it to be true;

2. the active concealment of a fact by one having knowledge or belief of the fact;

3. a promise made without any intention of performing it;

4. any other act fitted to deceive;

5. any such act or omission as the law specially declares to be fraudulent.

In order to amount to Fraud, an act must be confined to acts committed by a party to

contract with an intention to deceive another party or his agent or to induce him to

enter into a contact. Fraud, which vitiates the contract, must have a nexus with the

acts of the parties entering into the contract.

This definition highlights the precondition to prove the intention of the person who

has committed Fraud. If that person has willingly committed a Fraud, then he will be

punished. Here the person means himself or his agent. The acts which include fraud

are wrong suggestions or concealment of facts or false promises or any fraudulent

act to deceive others.

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 Fraud under the Companies Act, 2013

The Companies Act, 2013 focuses on the issues related to corporate Fraud, as is

visible, it may continue in the future too. As per Section 447, Fraud in relation to

affairs of a company or a body corporate, includes any act, omission, concealment of

any fact or abuse of position committed by any person or any other person with the

connivance in any manner, with intent to deceive, to gain undue advantage from, or to

injure the interests of, the company or its shareholders or its creditors or any other

person, whether or not there is any wrongful gain or wrongful loss;

(i) “wrongful gain” means the gain by unlawful means of property to which

the person gaining is not legally entitled;

(ii) “wrongful loss” means the loss by unlawful means of property to which

the person losing is legally entitled.

 Classification of Frauds

In order to have uniformity in reporting, frauds have been classified as under, based

mainly on the provisions of the Indian Penal Code:

 Misappropriation and criminal breach of trust.

 Fraudulent encashment through forged instruments, manipulation of books of

account or through fictitious accounts and conversion of property.

 Unauthorised credit facilities extended for reward or for illegal gratification.

 Cash Shortages

 Cheating and forgery

 Fraudulent transactions involving foreign exchange

 Any other type of fraud not coming under the specific heads as above

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In Recent past Pratip Chaudhuri, former State Bank of India chairman was

arrested by Rajasthan Police in Delhi in connection with an alleged loan scam.

The arrest was made on the basis of a protest petition filed by former directors of

Hotel Gaudavan before the Chief Judicial Magistrate (CJM) Jaisalmer. A hotel

project, ‘Garh Rajwada’, was financed by SBI in 2007. The case is related to

properties owned by Godawan Group, which took a Rs. 24-crore loan from SBI in

2008 to construct a hotel. In 2010, the key promoter passed away, following

which the project turned into a non-performing asset (NPA). The charges against

Chaudhuri include properties worth Rs. 200 crore being sold for Rs. 25 crores

after the bank seized them for defaulting on the loan

Flow of Events

In 2008,
In 2008,Rajasthan-based
Rajasthan- In 2010, the term loan In July 2013, SBI had
Hotel Gaudavan Pvt. Ltd.
based Hotel Gaudavan invoked the SARFESI
declared as NPA
took
Pvt. loan
Ltd. for loan
took Rs. 23.5
for Act under the Debt
crore
Rs. 23.5 crore Recovery Tribunal.

In 2013 Mr. Chaudhuri retired In March 2014, SBI In March 2017,v Alchemist,
In Marc h 20 14 ,SB Is ol d
th el oa nt ot he
Al che m ist AR C .

and took over the directorship sold the loan to the approached the National
of Delhi headquartered Company Law Tribunal
Alchemist ARC.
(NCLT) for resolution under
Alchemist ARC.
a court-driven process

The NCLT finally disposed

of the case in December
2017 & ARC sold hotel to
JFC Finance.

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The State Bank of India (SBI) sold over 15 loan accounts of defaulters at a

discount of 65-67 per cent under the chairmanship of Pratip Chaudhuri, who is

currently under arrest in a Rs. 23.5-crore loan case. The 68-year-old Chaudhuri is

charged in connection with one such nonperforming asset (NPA) sale to an asset

reconstruction company (ARC), which happened after his retirement

Bank frauds in India Number of bank fraud cases across India between from

financial year 2009 to 2021

Source: https://www.statista.com/statistics/1012729/india-number-of-bank-fraud-cases

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In the last decade, Public Sector Banks (PSBs) in India have lost thousand crores

on account of various banking frauds. Indian banking system has remained

plagued with growth in NPAs during recent years, which resulted in a vicious

cycle affecting its sustainability. In May, 2021 the RBI has published its annual

report 2020-21 which disclosed that in the last three years 22,864 banking frauds

have been reported involving a gargantuan amount of over INR 3.95 trillion.

Some of the frauds in last three years are ICICI Bank-Videocon bribery for loan

scam in 2020, Punjab and Maharashtra Co-operative Bank crisis in 2019 or Nirav

Modi and Gitanjali Gems-Punjab National Bank scam in 2018. After

investigations it is revealed the involvement of not only mid-level employees, but

also of the senior most management of the banks.

Fraud Cases - Bank Group-wise

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The root cause of weak corporate governance at highest level is directly linked to

the very process of appointment of highest level of officials and poor

compensation structure of highest level functionaries. There is a serious issue in

terms of pay structure in higher echelons of PSBs, which is markedly lower than

their counterparts in PVBs. The only good factor in PSBs is prestige of a post that

a person holds. The inability to hire competent professionals and expertise from

market (lateral hiring) due to existing recruitment policy, flight of officials to

greener pastures and private or foreign banks, poor compensation structure,

unionization challenges as well as lack of adequate training in contemporary fraud

prevention techniques are key HR issues, which indirectly contribute to bank

frauds. At times, senior management themselves may like to cover-up some cases

to meet their short term targets and goals, and create a good picture for the

shareholders. In fraud cases, within the banks, with suspected involvement of

senior management, there is significant resistance while prosecuting officers in

level 4 or above. Most of the officers retire before they can be booked for a fraud.

Once retired, pension regulations apply to them making them immune to any

financial penalty.

 The Basel III

The context of the disclosures by Banks are

Basel III is an internationally agreed
set of measures developed by the
required under Annex 18 – Pillar 3 disclosure Basel Committee on Banking
Supervision in response to the
requirements of the Reserve Bank of India financial crisis of 2007-09. The
measures aim to strengthen the
regulation, supervision and risk
(‘the RBI’) Master Circular – Basel III Capital management of banks.

Regulations dated 1st July 2015. The Bank has implemented the requirements laid

down by RBI for Pillar 3 disclosure, covering both the qualitative and quantitative
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items. The information provided has been reviewed by senior management and is

in accordance with the guidelines prescribed by the RBI. Central Fraud Registry

(CFR) A Central Fraud Registry (CFR) based on the Fraud Monitoring Returns,

filed by the banks and the select FIs, including the updates thereof, has been made

available, for which banks have been given access through user-ids and password.

CFR is a web-based and searchable database. The practice of issuing paper based

Caution Advice (CA) has since been discontinued. However CAs on frauds

including attempted frauds having systemic implication will be issued as and

when required. Banks are advised to make full use of the CAs/CFR for timely

identification, control, reporting and mitigation of fraud risk. Banks are also

advised to put in place proper systems and procedure to ensure that the

information available in CA/CFR is made use as a part of the credit risk

governance and fraud risk management.

 Reporting of frauds to Reserve Bank of India

Banks need to furnish Fraud Monitoring Return (FMR) in individual fraud

cases, irrespective of the amount involved, to RBI electronically using FMR

Application in XBRL System supplied to them within three weeks from the date of

detection.

A monthly certificate, (mentioning that soft copy of all the FMRs have been

submitted to RBI) is to be submitted by the bank to CFMC, Bengaluru with a copy to

the respective SSM of the bank, within seven days from the end of the month.

Fraud reports should also be submitted in cases where central investigating

agencies have initiated criminal proceedings suo moto and/or where the Reserve Bank

has directed that such cases be reported as frauds.

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Banks may also report frauds perpetrated in their subsidiaries and

affiliates/joint ventures in FMR format in hard copy only. In case the subsidiary/

affiliate/joint venture of the bank is an entity which is regulated by Reserve Bank of

India and is independently required to report the cases of fraud to RBI in terms of

guidelines applicable to that subsidiary/affiliate/joint venture, the parent bank need

not furnish the hard copy of the FMR statement in respect of fraud cases detected at

such subsidiary/affiliate/joint venture.

Banks (other than foreign banks) having overseas branches/offices should report all

frauds perpetrated at such branches/offices also to RBI.

In addition to the FMR, banks are required to furnish a Flash Report (FR) for frauds

involving amounts of ₹50 million and above within a week of such frauds coming to

the notice of the bank’s head office. The FR is to be furnished in the form of a DO

letter addressed to the PCGM / CGM-in-Charge, DBS, RBI, Central Office, Mumbai

with a copy to CFMC, Bengaluru. The FR inter alia, should include amount involved,

nature of fraud, modus operandi in brief, name of the branch/ office, names of parties

involved, their constitution, names of proprietors / partners and directors, names of

officials involved and lodging of complaint with police/CBI.

Further, banks are also required to furnish developments in the fraud case through the

FMR Update Application supplied to them in XBRL system.

It is observed while scrutinizing FMR returns from the banks, that certain vital fields

in the returns are left blank. As the complete particulars on frauds perpetrated in the

banks are vital for monitoring and supervisory purposes and dissemination of

information through Caution Advice / Central Fraud Registry (CFR), banks should

ensure that the data furnished are complete/accurate and up-to-date. Incidentally, if no

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data is to be provided in respect of any of the items, or if details of any of the items

are not available at the time of reporting of FMR return, the bank may indicate as “no

particulars to be reported” or “details not available at present” etc. In such a situation,

the banks have to collect the data and report the details invariably through FMR

Update Application.

Central Fraud Monitoring Cell (CFMC), Department of Banking Supervision, Central

Office located at Bengaluru will have a Record of officers of all banks/Financial

Institutions (FI) responsible for reporting of Frauds etc. All banks/Financial

Institutions should furnish to Department of Banking Supervision, Central Fraud

Monitoring Cell, Bengaluru any changes in the names of officials that will be

necessary for inclusion in the Record.

 Early Detection and Reporting

At present the detection of frauds takes an unusually long time. Banks tend to

report an account as fraud only when they exhaust the chances of further recovery.

Among other things, delays in reporting of frauds also delays the alerting of other

banks about the modus operandi through Caution Advice / CFR by RBI that may

result in similar frauds being perpetrated elsewhere. More importantly, it delays

action against the unscrupulous borrowers by the law enforcement agencies which

impact the recoverability aspects to a great degree and also increases the loss arising

out of the fraud.

The most effective way of preventing frauds in loan accounts is for banks to have a

robust appraisal and an effective credit monitoring mechanism during the entire life-

cycle of the loan account. Any weakness that may have escaped attention at the

appraisal stage can often be mitigated in case the post disbursement monitoring

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remains effective. In order to strengthen the monitoring processes, based on an

analysis of the collective experience of the banks, inclusion of the following checks /

investigations during the different stages of the loan lifecycle should be carried out:

Pre-sanction: As part of the credit process, the checks being applied during the stage

of pre-sanction may consist of the Risk Management Group (RMG) or any other

appropriate group of the bank collecting independent information and market

intelligence on the potential borrowers from the public domain on their track record,

involvement in legal disputes, raids conducted on their businesses, if any, strictures

passed against them by Government agencies, validation of submitted

information/data from other sources like the ROC, gleaning from the defaulters list of

RBI/other Government agencies, etc., which could be used as an input by the

sanctioning authority. Banks shall keep the record of such pre-sanction checks as part

of the sanction documentation.

Disbursement: Checks by RMG during the disbursement stage, shall among others,

focus on the adherence to the terms and conditions of sanction, rationale for allowing

dilution of these terms and conditions, level at which such dilutions were allowed, etc.

The dilutions should strictly conform to the broad framework laid down by the Board

in this regard. As a matter of good practice, the sanctioning authority may specify

certain terms and conditions as ‘core’ which should not be diluted. The RMG may

immediately flag the non-adherence of core stipulations to the sanctioning authority.

Annual Review: While the continuous monitoring of an account through the tracking

of Early Warning Signals is important, banks also need to be vigilant from the fraud

perspective at the time of annual review of accounts. Among other things, the aspects

of diversion of funds in an account, adequacy of stock vis-a-vis stock statements,

stress in group accounts, etc., must also be commented upon at the time of review.

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Besides, the RMG should have capability to track market developments relating to the

major clients of the bank and provide inputs to the credit officers. This would involve

collecting information from the grapevine, following up stock market movements,

subscribing to a press clipping service, monitoring databases on a continuous basis

and not confining the exercise only to the borrowing entity but to the group as a

whole.

Early Warning Signals (EWS)

Some Early Warning Signals (EWS) which should alert the bank officials about some

wrongdoings in the loan accounts which may turn out to be fraudulent are as under:

 Undisputed payment to the statutory bodies as declared in the Annual report.

 Bouncing of high value cheques

 Frequent change in the scope of the project to be undertaken by the borrower

 Foreign bills remaining outstanding with the bank for a long time and tendency

for bills to remain overdue.

 Delay observed in payment of outstanding dues.

 Frequent invocation of BGs and devolvement of LCs.

 Under insured or over insured inventory.

 Invoices devoid of TAN and other details.

 Dispute on title of collateral securities.

 Funds coming from other banks to liquidate the outstanding loan amount unless in

normal course.

 In merchanting trade, import leg not revealed to the bank.

 Request received from the borrower to postpone the inspection of the godown for

flimsy reasons.

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 Funding of the interest by sanctioning additional facilities.

 Exclusive collateral charged to a number of lenders without NOC of existing

charge holders.

 Concealment of certain vital documents like master agreement, insurance

coverage

 Floating front / associate companies by investing borrowed money

 Critical issues highlighted in the stock audit report.

 Liabilities appearing in ROC search report, not reported by the borrower in its

annual report

 Frequent request for general purpose loans.

 Frequent ad hoc sanctions.

 Not routing of sales proceeds through consortium I member bank/ lenders to the

company.

 LCs issued for local trade I related party transactions without underlying trade

transaction

 High value RTGS payment to unrelated parties.

 Heavy cash withdrawal in loan accounts.

 Non production of original bills for verification upon request.

 Significant movements in inventory, disproportionately differing vis-a-vis change

in the turnover.

 Significant movements in receivables, disproportionately differing vis-à-vis

change in the turnover and/or increase in ageing of the receivables

 Disproportionate change in other current assets

 Significant increase in working capital borrowing as percentage of turnover

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 Increase in Fixed Assets, without corresponding increase in long term sources

(when project is implemented).

 Increase in borrowings, despite huge cash and cash equivalents in the borrower's

balance sheet

 Frequent change in accounting period and/or accounting policies

 Costing of the project which is in wide variance with standard cost of installation

of the project

 Claims not acknowledged as debt high

 Substantial increase in unbilled revenue year after year.

 Large number of transactions with inter-connected companies and large

outstanding from such companies

 Substantial related party transactions

 Material discrepancies in the annual report

 Significant inconsistencies within the annual report (between various sections)

 Poor disclosure of materially adverse information and no qualification by the

statutory auditors

 Raid by Income tax /sales tax/ central excise duty officials

 Significant reduction in the stake of promoter /director or increase in the

encumbered shares of promoter/director

 Resignation of the key personnel and frequent changes in the management.

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Source: https://www.statista.com/statistics/1012729/india-number-of-bank-fraud-

cases

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