Liability of banks in Fraudulent Transactions
The continuous presence of fraudulent activities in Banking Institutions is not a foreign concept. Banking frauds in India only prove that financial flexibility catalysts the trend of shallow markets to grow and spread speculation and tends to deteriorate the growth of the market in a peculiar way from which recovery seems extremely difficult. Revaluation of the fraudulent Acts, evidence of insider trading activities, and an ensuing fiasco of innocent investor interests have led to a staunch decline in Indian banking services. This paper will also discuss different types of fraud and remedial measures. It also deals with different kinds of preventive and detective mechanisms required for the investigation of fraud.
The banking system has a very significant role to play in shaping a resilient Indian economy. A financial institution has an important role that is indispensable in modern society. It provides a driving strength to the economic development and forms the main core of the Banking sector as per the needs of an advanced economy. Conventional banking practices as followed have undergone an immense paradigm shift altogether over time. Corrupt acts in banks due to lack of transparency, accountability, inefficiency, and lack of supervision depleted the goodwill and reputation of the banking business. In the colonial era, during the 1770s maximum profit earning disproportionately was given priority even at the cost of exploiting the social and economic rights of the citizens without any scrutinizing. Even quite after independence, the banking industry was adversely affected due to internal and external factors like Zamindari practice; insecurities due to poverty, crime rates, natural calamities, wars, etc. But, the Indian Government understood the significance of banking sector reforms; hence they have undergone a drastic transformation, especially after nationalization. Post-nationalization in the years 1969 and 1980, there was the widespread adoption of socialistic attitudes, improved efficiency, effective delivery, and depository services coupled with transparency.
This transitional shift came along with the liberalization and globalization of the Indian economy in 1991. Radical changes were brought throughout the banking sector giving humongous opportunities to the private sector to stimulate the growth of the financial sector. The incumbent government at that period also contributed via the Narasimhan Committee to boost stability, through the inclusion of prudential norms, direct lending practices, internal assessments, balance sheets, and auditing of banking institutions for bringing transparency, direct control of the banks by RBI, etc.
While the functioning & instrumentality of banking institutions have become more essential for exponential growth, several minor and major discrepancies including banking frauds have also increased simultaneously, and over time, fraudsters are becoming more experienced, insightful, and resourceful. The very manifestation and existence of frauds in the banks is not a frequent evident phenomenon, in fact, its transgression into mainstream society, wrongdoings and forgery is as old as writing itself.
The conceptual notions of fraud are not specifically defined under the Indian Penal Code, 1860. Though Indian Penal Code includes and mentions meagre punishment, which leads to the perpetration and execution of fraudulent activities through various means. Further, Section 17 of the Indian Contract Act, of 1872 provides an inclusive definition of fraud. It fines it as, a kind of agreement in which one party is inducing the other with a deceitful intention to suggest certain facts which are not true but make the other belief to be true. It is a kind of arrangement in a legal relationship wherein a deliberate non-disclosure of facts exists by adopting chicanery & tricks. There is definitively an element of dishonest advantage and an increased level of disproportionate profit in every case of fraudulent activity. This phenomenon of financial fraud is a matter of grave concern in global markets. Often, it is difficult to establish criminal liability in the case of financial fraud because of the lack of specific definitions and provisions in law irrespective of the fact that banking and non-banking financial institutions suffer huge monetary losses either in collusion with bank personnel or with employees of other financial institutions. The persistent and exacerbating rise of monetary losses takes the shape of unfettered commercial disadvantage resulting in many complicated cases of scams. However, there is no doubt about the fact that financial fraud is a very vulnerable issue that needs to be tackled with due care & diligence and with effective scrutiny since it affects goodwill, reputation, and public faith in the overall market structure. Social & economic dependence of customers and investors exists on the sustainability & stability factor of any financial institution. Public faith and confidence are the sole basis for the growth of the banking business in banking institutions. Consistent market frustrations and collapses, unexposed and undetected frauds which go unnoticed deteriorate financial institutions to such a level that it hampers the basic doctrine of good corporate governance.
The fraud that takes place in banks is a kind of manoeuvring action by using deceptive methods to obtain illegal money & financial assets which were owned or kept in possession by a financial institution. Currently, the misappropriation can be done in many ways, sometimes differences also arise concerning factors like the presence of certain unauthorized methods and complications due to the issue of jurisdiction. There are possibilities, wherein fraudulent actions have resulted in a higher degree of serious offenses like theft, dacoity, burglary, and robbery in a professional manner. It can either be a part either organized crime or white-collar crime, also in certain situations actions were done in a more strategic and pre-concerted manner. It is quite obvious that enterprises dealing with a huge amount of financial assets are very vulnerable to fraud and it becomes more common in the case of enterprises or persons who are heavily indebted to the banks at a large scale. Thus, it is clear that the cases of banking fraud are also escalating very abruptly.
While looking closely, though there are many advantages of nationalization of banks it has resulted in an increase of multiple branches in various parts of the country without any effective supervision and control. Unfortunately, corruption has also increased in banking sectors due to reduced efficiency in providing services and undesired political interference & monopoly. The banking sector also has a deficient number of experienced & trained banking personnel for handling complicated cases. The government was overburdened with multiple tasks especially after taking the responsibility of looking into priority sector lending which is a major tool to boost the agricultural and industrial economy in the country. So, prudent supervision was not possible due to a lack of specific legislation and guidelines.
Uncertainty and speculation in financial markets play a very crucial role in the growth of the business of financial institutions. But fraudulent acts in Indian banks can increase the extent of financial flexibility to such a level that it leads to uncertainty with the unreasonably high risk involved in doing business, resulting in the disintegration of financial markets. Sometimes, banking fraudulent acts along with insider trading and continuing downfall of investors’ interests have generated unmanageable slumps in Indian banks. Disproportionate movement in the market gains and lows along with manipulative tactics leaves a weak position against which offenders, exploit it for doing fraudulent activities. Multiple dimensions of fraud occurred in banking activities like manipulative practices adopted in the utility of cheques, fraudulent deposits where illegal transfer of money takes place and misrepresentation concerning movable assets in the case of hypothecation frauds, the high extent of default with deliberate intention in the case of loan frauds.
There are mainly three aspects by which bank frauds are engendered & organized namely, conspiring with active collusion among banking staffs either in involvement with internal or external factors, wilful misconduct, and dereliction of duties of bank staff to follow guidelines as formulated by Reserve Bank of India. Further, extrinsic factors also contribute – proliferating frauds by doing mischievous acts like forgery, illegal alteration of cheques or misappropriation of drafts; non-observance of Know your customers (KYC) Norms. There is a consistent presence of financial pressure to exploit business opportunities among banking & non-banking financial institutions. Related factors like consistent economic downturns and an intense cutthroat commercial atmosphere have compelled banking companies to overlook the security issue, thereby deviating from normal existing processes. With the only objective to achieve maximum profit, all possible kind of anti-competitive measures has been adopted to get their highly expected business targets by flouting the bank norms.
2. Adverse Effects of Fraud
There are various instances of fraudulent acts happening in banks consistently that are not investigated and inconspicuous and often go unreported. Monetary loss and damage to the reputation and goodwill of the bank are the most direct impact of fraud. Serious aberration and non-application have resulted in fraud and have raised questions over the tenability & utility of secured technological capabilities of the financial institutions and their traditional method of protection. Frauds related to Internet banking, and mobile banking, ATMs bring down the morale of customers resulting in a lack of trust &reliability in these services. Fraudulent activities tend to subvert the profit & overall efficiency of banking services. It corrodes productivity and adversely affects the interests of investors resulting in an unexpected increase in operational & capital risk for the bank. It has become a great impediment to the growth of the banking business while bringing instability in the liquidity and mismanagement of capital adequacy norms. Even the process of lending has resulted in default and has become so serious that it has overburdened the securitization companies.
3. Recommendation by A K Ghosh Committee
The Reserve Bank of India concerned with the meteoric rise of instances of banking fraud, organized and set up a high-level committee to introspect the situation of fraudulent, deceptive activities and related malpractices in banks under the chairmanship of A K Ghosh
There are specific objectives of the committee to ensure transparency in banking services namely,
- Securing assets without any legal objection
- Complete coherence to existing policies and procedures without any dereliction.
- Clarity concerning accounts and related records and documents
- Systematic delegation of duties and obligations of staff towards customers, investors, and other stakeholders
- Timely detection and tracking down of frauds and malpractices
The committee emphasized the responsibility of banks to take the obligation of safeguarding cash and other valuables. It should reflect a dual authority on the part of the bank. Rotation of staff for better functioning of the bank with proper division of financial and administrative powers is required. Further, banks need to formulate safety measures against theft of cash and fraud in case of guarantees. A sincere and ardent responsibility is expected from banks to obtain a maximum level of scrutiny and surveillance in credit, investment sectors, and balance sheets. So far as the portfolio inspection is concerned, approval of the Reserve Bank of India is mandatory. Specific procedural formalities should be followed by a vigilance officer in specific cases who must refer to the chief vigilance commission where there is a presence of the vigilance factor. The committee also raised few warnings, as shrewd customers can take undue advantage in cases where bank staffs are relatively careless in obliging their well-established duties and safety measures.
4. Raise of frauds in the Modern era
The phase of change from traditional banking practice (mainly on paper) to modern practice has brought radical and significant changes in the efficiency of banking services. The greatest advantage of this transformation is that banking services are working efficiently and expeditiously without any discrepancy. At present, almost all branches of the banks have been computerized to introduce paperless services wherever feasible. But the extent of increasing cyber-crimes is alarming and a matter of grave concern. There are a few kinds of fraud that are quite dangerous and one must be aware of them.
- Spy software: This is a kind of activity wherein, fraudsters decode passwords and enter into the system for misappropriate data for malicious interests and obtain access to money illegally.
- Hacking:This is another sinister type of fraudulent mechanism adopted by criminals to access the information in computer systems in an unauthorized manner by a purloining password. This act is done not only for monetary gains but also to cause irreparable damage to the system of the other person.
- Wiretapping: This is a kind of unscrupulous act, whereby fraudsters record signals and steal the password to withdraw money. This act is possible by tapping the wires of an ATM when a customer uses the same to withdraw cash.
There is specific legislation that deals which penalties for fraudulent acts related to computer systems. Section 43 of the Information Technology Act, 2008 provides compensation up to 10 lakhs to the aggrieved person. It is applicable in the case of unauthorized access to copy and download certain sensitive information.
Though online banking is very efficient due to fewer complications, speedy process, and reduced costs, there is always a serious apprehension related to security and the level of risks, which are involved. There are some deceiving tactics adopted by cybercriminals who entice their customers by asking them to visit their websites and click something to download or to read and accordingly they get trapped. They introduce themselves to offer profit-making investment schemes for customers so that customers get interested and follow the same, and steal all sensitive information stored in the computer system of the customer. There is also another way for fraudsters to get personal and financial details like credit card information, passwords, etc from customers by allowing them to engage in any kind of online trading through unsecured websites. It can be done either through phishing or identity theft.
Credit or debit card frauds take place in a systematic manner by which the card is used by fraudsters so that they can withdraw money illegally. Duplication of the credit card is the most common method used by a fraudster. Theft of the card and disclosure of sensitive information like (Personal Identification Number (PIN) number to another are also part of credit/debit card fraud.
5. Legal Concepts relating to Bank Frauds
As commonly known, forgery is a crime where the accused person creates a false record or credential with a specific intent to cause harm or injury. A document must be in existence where contents of the same should be explained & interpreted well through words, marks, and figures so that it can be used for illegal purpose. However, It is not relevant though where such marks, figures, or letters were made. The most important element of forgery is the presence of deceit, impropriety, and criminality. Though it is not always mandatory for the offense of forgery the document has to be in writing or it has a signature as a part of the formal procedure. Any record or document can lead to fabrication even by simply expunging signatures or any particular figure.
It is important to understand different conceptual nuances of intention to remove ambiguities. There is a difference between two particular acts which involve the intention to do fraudulent manipulation and the intention to get wrongful gain for oneself in addition to the wrongful loss to another. For example, If a person gets a disproportionate gain by an action at the cost of another person’s loss, then it is only considered a dishonest act. Whereas, a fraudulent act always involves an intention to deceive to obtain an illegal advantage.
Whenever the question of interpretation of the offense of forgery comes, it is a must that the act should be completed to defraud, though actual damage or harm may not be necessary. It is also not required for the fraudster to have a certain relative power to defraud or a certain circumstantial chance to do the same. Any kind of previous engagement or relationship between people committing forgery and aggrieved persons is also not essential.
Therefore, whenever a person claims his authority or title over a forged document, it is pertinent to introspect & verify the documentation. Since forgery of signatures is one of the most common frauds occurring on daily basis in a commercial transaction. Verification of the same can be done in this regard either with the help of expert opinion or someone who is acquainted with handwriting & signature by comparing the same with any previous existing record. It is expected that bankers exercise due care & diligence meticulously while performing their duties.
It is also important to understand the meaning and concept of cheating in the context of criminal law. Any dishonest act with the presence of deception to get property or to do an act can be termed as cheating. So, bank staff can prevent the offense of cheating or cheating by impersonation by proper identification of the concerned person (for quashing the possibility of fictitious or anonymous customers) and so far as the authenticity of documents is concerned, it is essential to scrutinize the legitimacy and veracity of documents either related to a place of residence, business or nature of security. Bank employees hold a very responsible task in performing their jobs. Their service depends on the principle of trust and confidence. They need to perform their job according to instructions or directions of their superior authority and by the procedure established by terms of employment and recommendation as banking norms given by the Reserve Bank of India.
Where a banker misuses or misappropriates the security lodged with a bank for a loan provided to the customer even before the expiry of the term of the loan or before the existence of default, it will result in a criminal breach of trust because a criminal breach of trust involves a dishonest action wherein one uses the assets entrusted to him or her improperly and inappropriately violating the directions of law prescribing the procedure, and thereby resulting into disproportionate loss of another. Therefore, it is necessary to assess the overall functioning of the bank. Periodic inspection of actions and vigilance over particular issues should be taken into serious consideration. The extent of vigilance & precautionary principle that needs to be followed is quite different in platforms where suspicious transactions and vicarious liability exist.
Every bank needs to be accountable for every activity and transaction to the superior bank. It is one of the foremost duties of banks to prepare annual reports on a timely basis and to prepare balance sheets without any discrepancy & ambiguity. Rendering true accounts indeed require a meticulous approach, But if bank employees fabricate certain important data and make a false entry in the record with a will to damage or deceive, those actions attract falsification of accounts.
In situations wherein, accurate diligence is required starting from the application form to the procedure as to how accounts are maintained, there are certain relevant legal provisions from sections 489A to 489E in the Indian Penal Code,1860 which relate to the utility of counterfeiting currency notes and related matters. The objective of these provisions is to provide security for the careful and judicial use of currency notes without the presence of any duplicity, forgery, and fictitious content. Therefore, it is clear that fraudulent activities in banks are not only incessant but an unfolding threat to the nation’s financial markets. The vigilance mechanism that has evolved in every step of every banking transaction is the need of the hour. An audacious approach is also important for stimulating the growth of the anti-fraud program for meticulous monitoring of every action.
The following two precautionary principles like control measures related to fraud & detection of fraud can be utilized simultaneously to identify the problem on a timely basis. The two possible categories of procedural techniques which are related to the vigilance system are:
Preventive method: It is important to understand the obligations and different roles of employees in any transaction. Proper assessment of risk is required to check suspicious transactions, which may result in fraud. This practice of assessment requires internal inspection and proper auditing of bank activities to ensure transparency.
The Banking Ombudsman Scheme of 2006 was introduced with the same purpose to hear complaints and redress consumer grievances as well as to resolve any disputes related to a deficiency in banking service.
Detective method: This is a conventional practice followed to check up on any minor or major discrepancies occurring during banking transactions. The role of supervisors (to engage in active surveillance), auditors, or any external agency (collection of sensitive information through the Intelligence Bureau) are important in fulfilling this task. The investigation includes checking into previous business affairs of customers (history of any consistent minor or major discrepancy), financial background of the customer, nature of commercial transaction dealing with third parties, particular tasks done by committed forensic experts or tools, etc.
It has now become imperative for the Reserve Bank of India to provide financial as well as administrative support for the creation of a fraud-monitoring cell in every branch of public or private sector banks. It will help in reducing the time gap in an investigation initiated at an internal level in banks and the reports to be made as soon as possible so that police can take over the matter. There are certain matters involving the highest degree of fraud, which can face administrative or jurisdictional complications to determine the investigation. These cases should be taken seriously by the Crime Bureau of Investigation (CBI) without any kind of financial or undue political pressure.
6. Liabilities of Banks
In the year 2020, The National Consumer Disputes Redressal Commission (NCDRC), the Hon’ble Presiding Member, Mr. C Viswanath dismissed the revision petition that had been filed under Section 21 (b) of the Consumer Protection Act of 1986 by HDFC Bank (Petitioners) and held that the bank will be liable to pay to its customers in case of any unauthorized transactions. Thus, the banks must compensate their account holders in case of fraudulent transactions in the absence of any evidence to substantiate its stand that, the fault was on the part of the account holder and in this digital era, the possibility that the credit card was hacked or forged cannot be ruled out.
The Presiding Member C Viswanath held that, since the petitioner had failed to produce any reliable evidence to substantiate that the fraudulent transaction took place because of the account holder’s fault, Hence, the petitioner will be liable for the same and the bank cannot rely on arbitrary terms and conditions to circumvent from its liability towards customers and any such terms and conditions must conform with the directions issued by the Reserve Bank of India which is the sole authority for safekeeping of the banking systems and maintaining checks and balances in the same.
Reliance was placed by the Hon’ble NCDRC on the RBI circular dated 6th July 2017 dealing with Customer Protection – Limiting Liability of Customers in Unauthorized Electronic Banking Transactions wherein it was stated:-
“6. A consumer’s entitlement to zero liability shall arise where the unauthorized transaction occurs in the below-mentioned events:
- Contributory fraudor negligence or deficiency on the part of the bank (irrespective of whether or not the transaction was reported by the customer).
- Third-party breacheswherein the deficiency lies neither with the bank nor with the customer but lies elsewhere in the system in itself, and the customer notifies the bank within three working days of receiving the communication from the bank regarding the unauthorized transaction.”
The Hon’ble NCDRC also relied on the Punjab National Bank and Anr. V Leader Valves II. Here, The Hon’ble NCDRC while addressing the question of liability of a bank in case of unauthorized and fraudulent electronic banking transactions had observed as under:
“11. The first and foremost fundamental question that arises is whether the Bank is responsible for an unauthorized transfer occasioned by an act of malfeasance on the part of employees of the Bank or by an act of malfeasance by any other person (except the Complainant/account holder). The answer was, straight away, in the affirmative. If an account is maintained by the Bank, the Bank itself is entirely responsible for its safety and security. Any systemic failure, whether by malfeasance on the part of its functionaries or by any other person (except the consumer/account-holder), is its responsibility, and not on part of the consumer.”
The Reserve bank of India (RBI) on 6th July 2017, amid the national drive toward digital transactions and rising incidents of fraud, had notified the norms to fix the liability in cases, wherein a person loses money through an unauthorized electronic banking transaction like cyber attack on the bank or hacking of an account.
The time is propitious now that our banking and financial institutions to adopt a vigorous mechanism that specifically deals with fraud identification and its broad diagnosis, as this kind of system can easily be compatible with a complex fast growing market and it has become very necessary for the survival & growth of the banks. Assessment and high-risk management can prevent persistent financial loss and secure goodwill &bring positive prominence and credibility to the bank. It provides exhaustive &far-reaching security against all possible kinds of frauds from different avenues like online banking, ATMs, the utility of credit cards, etc. Since modern-day fraudsters are using novel technology to do mischievous acts for unauthorized transactions, it is time for banks to step up and play a vigilant role in the detection of fraud well before any determination of fraudulent transaction and thereby blocked it without any hindrance. However, this is possible only with the active involvement of fraud management technology. Though, it is unfortunate to note that only a few banks are serious about tackling the issue in a well-planned comprehensive manner. Banks need to set their priority as the prevention of fraud without wasting time.
However, on the same note, the order passed by the Hon’ble NCDRC in HDFC Bank and Anr v. Jesna Jose was indeed a welcome step and aligned with the RBI circular on the other hand, but, it makes the banks helpless in case the transaction is disputed by the account holder. It is therefore a clear mandate to exonerate an account holder as the circular presumes the innocence of the account holder and banks can only recover the amount when it can prove that the account holder was responsible for such a transaction.
It is quite saddening that, neither the circular passed by the RBI nor the order passed by the Hon’ble NCDRC forecloses the remedy of the bank to proceed against the fraudsters and also against customers or any other persons or entity involved. In today’s time with an increase in digital and net-banking transactions, the threat of fraud in online transactions and hacking are also advancing. Even in cases of unlawful gains by a few account holders by deceiving the banks or in cases of negligence on the part of the customer in protecting their details from fraudsters or hackers, there are no legal remedies available to the banks.
I believe it is high time to think not only about the customers but also about the banks otherwise in such a scenario where cybercrime is at its upsurge, some guidelines or rules must be made to protect the banks also. Also, Banks and financial institutions should not be selective in finding a solution only for particularly complicated issues related to credit cards or retail loans, etc. Their action plan & execution should be compatible with rules established as per existing banking norms. It is equally important to update their rules and standard banking practices for efficacy and better productivity in the competitive market.