Fraud is a major economic crime being perpetrated in our banking industry today. Indeed, banking fraud is an international phenomenon which has become pervasive as fraudsters become more sophisticated and daring in their approaches. This nefarious activity could lead and had actually led to crisis in and collapse of many financial institutions worldwide. The demise of the Bank of Credit and Commerce International (BCCI) London is a recent example
For one thing, frauds result in huge financial losses to banks and their customers, the depletion of shareholders’ finds and banks’ capital base as well as loss of confidence in banks. For another, the incidence of frauds and forgeries could, in extreme cases, lead to the closure of some banks as had happened in some parts of the world. Many of the distressed banks in Nigeria today had suffered a great deal from frauds and insider credit abuse.
The subject is of fraud therefore of special concern to the monetary and supervisory authorities who are concerned about the safety of individual banks and the soundness of the banking system. Specifically, the NDIC is charged with the responsibility of protecting depositors. Accordingly, section 39 and 40 of the NDIC Decree No. 22 of 1988 require the insured banks in Nigeria to render to the Corporation, monthly returns on frauds, forgeries outright theft occurring during such month and to notify the Corporation of any staff dismissed.
Fraud means an act of dishonesty, deceit and imposture. According to Kirkpatrick (1985), a person who pretends to be something that he is not is a fraud, a snare, a deceptive trick, a cheat and a swindler. By extension fraud includes embezzlement, theft or any attempt to steal or unlawfully obtain misuse or harm the assets of the bank (Hank Administration Institute, 1989 Fraud can be committed by employees, customers or others, operating independently or in conjunction with others inside or outside the bank.
The purpose of this paper is to increase, through the use of effective internal control, the awareness and capability of bank managers to detect prevent frauds that can be perpetrated against their banks. The rest of paper is divided into four parts. The second part examines the causes extent of frauds in Nigeria while part three highlights the nature and different types of bank frauds. In part four the internal control system as a basis for preventing and detecting frauds is examined, and finally the summary and conclusion is in part five.
14.2 Causes and Extent of Frauds
In order to be able to propose remedies for eliminating frauds in banks it is useful to identify the most common causes of bank frauds. Also, an indication of the extent of frauds perpetrated in the conventional banks – commercial and merchant – is necessary in order to put community banks on the alert as they too are as prone to frauds as the orthodox banks. It is therefore expected that community bank managers understanding of the major causes and extent of frauds would stimulate them to consider ways and means of making the control measures more effective.
14.2.1 Major Causes of Frauds
The causes of frauds are usually grouped into two classes – the institutional and environmental/social factors. The institutional factors arc those traceable to the internal environment of the bank while the environment / social factors are those which result from the influence of the environment/society on the banking industry.
14.2.2 Institutional Causes of Frauds
Various authors and professionals in the industry are unanimous in their identification of institutional causes of frauds. These are:
(1) Volume of Work
The amount of work done by bank officials could be so heavy that frauds could easily pass undetected by such officials.
(ii) Number of Staff
Where an official supervises a large number of staff; there is a high likelihood that fraud could go undetected.
(iii) Nature of Services
Frauds may be caused where documents of value and liquid assets are exposed to an indiscipline staff or unauthorized persons, for example, customers.
(iv) Banking Experience of Staff
All things being equal, frauds in banks occur with higher frequency among staff with little experience and knowledge of banking practice. The more the experience and knowledge of a staff, the less the likelihood that frauds would pass such staff undetected unless with his active support. Where professionally qualified bankers are involved in frauds, they are more likely to swindle larger sums of money than the less, qualified staff
(v) Inadequate/Lack of Staff Training
This could affect the morally weak as well as the morally robust staff in various ways. Lack of knowledge of the forms and ways of dealing with fraudulent practices in banks could affect an otherwise honest staff in apprehending and avoiding the wiles of bank fraudsters.
(vi) Poor Management
Banks with poor management record higher incidence of all sorts of frauds than those with effective management. Poor management gives rise to ineffective and poor control system and indiscipline among staff thus creating an environment for frauds to flourish.
(vii) Staff Negligence
In certain cases, staff negligence could give rise to the perpetration of frauds in banks. Negligence itself is a product of several factors, including poor supervision, lack of technical knowledge, apathy, pressure, etc.
(viii) Recruitment System
Poor recruitment system, where cognate experience, relevant technical knowledge, competence, character and other qualities are sacrificed at the altar of non factors such as connections and nepotism, constitute important facilitators of frauds in banks.
(iv) Poor Security Arrangement for Documents
In banks where security arrangements for valuable documents are weak, poor and vulnerable, it is easy for fraudsters to have their way without detection.
(x) Use of Sophisticated Accounting Machines
Where sophisticated accounting machines are in use and are manned by inadequately trained staff, errors could arise and thus lead to the production of unreliable records. In the hands of dishonest staff, sophisticated accounting machines could be employed to deliberately omit entries, substitute improper calculation and posting, manipulate documents, substitute fictitious’ documents and alter genuine ones. All of these are different ways of perpetrating frauds.
Management practices, when negative to the aspiration and developmental needs of staff, could result in the generality of staff being frustrated. Frustration in turn breeds fraudulent practices in banks.
(xii) Inadequate Infrastructure
Poor communications system, power failure which result in a backlog of unbalanced posting, congested office space, etc also encourage the perpetration of bank frauds.
(xiii) Delays in Operational Procedures
Delays in operational procedures create opportunities for hatching frauds in banks, thus making prevention and early detection difficult.
(xiv) Lapses in the Management Control System of Corporate Customers.
This is a clause example where frauds could be externally hatched and executed. Fraudulent staff in both the banks and in the employment of the corporate customers could collude to take undue advantage of the lapses observed iii the management control system of corporate customers.
(xv) Negligence of Customers
Traditionally, it is the negligence on the part of customers that provides ample opportunities to bank staff to perpetrate frauds. Negligence of customers takes various forms, including errors that might have been genuine but which are open to abuse, distortions and defalcations by unscrupulous staff both within and outside the bank in the employment of customers.
14.2 Environmental Causes
These have been identified as follows:
(i) Personality Profile of Fraudsters
Most individuals with inordinate ambitions and without qualms are prone to committing frauds. Such individuals arc bent on making money by hook or by crook Such people dismiss morality as an unnecessary prerequisite for virtuous life. To them, the end justifies the means; they arc usually unscrupulous and opportunistic.
(ii) Societal Values
The value system in any society is the set of rule that prescribes what is right or wrong within that society Where th6 possession of wealth determines the reputation ascribed to a person, that society is bound to witness unnecessary competition for the acquisition of wealth. This, no doubt, will lead to some people using dubious means to get rich overnight. It can be argued that the main cause of frauds in banks in Nigeria is traceable to the general dishonesty in the society where morality is thrown to the dogs. Misplacement of societal values, the unquestioning attitude of the society towards unusual sources of wealth, the rising societal expectations from bank staff and the subsequent desire by such staff to live up to such expectations, are also contributory factors to frauds in the country.
(iii) Slow and Tortuous Legal Process
Delays in the prosecution for fraud cases have a way of frustrating the parties to the case. A frustrated party can abandon the case midway, leading to miscarriage of justice. The delays can be in form of:
· late reporting of cases to the police;
· lack of specialised manpower for the investigation of fraud;
· lawyers and prosecution witnesses absenting themselves from courts; and
· undue delay in investigating and charging of cases to court.
All these make fraudsters have the feeling that they are above the law and as such can get away with any act of illegality.
(iv) Lack of Effective Deterrent/Punishment
Although this may be considered a moot point, it is argued in some quarters that lack of effective deterrent such as heavy punishment could be a factor contributing to the unabaung perpetration of frauds in banks.
(v) Fear of Negative Publicity
Many banks fail to report fraud cases to the appropriate authorities as they believe that doing so will give unnecessary negative publicity to their banks. This attitude encourages individuals with inordinate ambitions to defraud the banks. They reason correctly that the banks may not prosecute.
It is very sad to note that some bank staff, whose appointments have been terminated or those retired on ground of frauds stilt manage to secure appointments in other banks.
14.2.4 Extent of Bank Frauds
In view of the reasons identified above, the magnitude of the loss arising from bank frauds is on the increase. It is appropriate to have a feel of the extent of loss through bank frauds in Nigeria, to enable us appreciate the havoc this cankerworm is wrecking on our economy. The actual amount involved and actual/expected loss in bank frauds should be multiples of the reported figures in Table 14.1, as many banks failed to render the required returns on frauds. The sum of N2.2 billion was involved in bank frauds in the three years, 1991-1993, out of which commercial banks accounted for about 94.1 per cent (see Table 14.1). The actual/expected loss to the banking system within the same period totaled about N0.3 billion, with commercial banks accounting for about 95.7 per cent thereof It is obvious from the above analysis that the bulk of bank frauds are being perpetrated in the commercial banks probably because of their large branch network and the low quality of employees when compared with the merchant banking subsector. Bank staff involved in frauds were either terminated, dismissed or retired. Table 14.2 shows the status and number of staff involved in frauds between 1991 and 1993.
A total of 5 17 bank staff were dismissed, retired or had their appointments terminated because of their involvement in frauds and forgeries during 1993 as against 436 in 1992 (see Table 14.2). In 1991, 514 members of staff of the affected banks were involved in fraudulent activities. The amount involved per staff during the 3 -years period (1991 – 1993) are NO.8 million, NO.9 million and N2. 7 million, respectively, as computed.
14.3 Nature and Types of Banks Frauds
Frauds in banks vary widely in nature, character and method of perpetration. There are three broad categories of bank fraud perpetrators: internal, external and mixed. Internal perpetrators of frauds are members of staff while external perpetrators are persons not connected with the bank. Mixed involvement involves outsiders colluding with bank staff. It is useful for bank management to identify the category under which various frauds in their banks fall A clear knowledge of this will help in the determination of the best solution.
The most common form of classification employed by banks is on the basis of method used. Under the approach, the list of fraudulent methods is almost inexhaustible as new methods are devised with time. It is worthwhile for community banks management to be familiar with a comprehensive list of all methods used in committing fraud even though some of them may not be directly applicable to their banks now. The most important and common types of fraud highlighted by the Bank Administration Institute in Fraud Prevention and Detection (1989) Series are discussed here.
14.3.1 Advance fee Fraud (“419”)
This may involve an agent approaching a bank, a company or an individual with an offer to access large funds at below market interest rates usually on a long term basis. The purported source of such funds is not specially identified as the only way to have access to it is through the agent who must receive a fee or commission “in advance.” As soon as the agent collects the fee, he disappears, and the loan never comes through. Any bank desperate for funds, especially the distressed banks and banks needing huge funds to bid for foreign exchange, can easily fall victim to this type of fraud. When the deal fails and the fees paid in advance are lost, these victims are not likely to report the losses to the authorities. Advance fee fraud can be very dangerous, especially those that are international in nature as banks can suffer substantial losses and find recovery and legal redress quite difficult.
14.3.2 Cheque Kiting
Kiting is defined by the US Comptroller of the Currency’s Policy Guidelines for National Bank Directors as “a method where a depositor utilises the time required for cheques to clear to obtain an unauthorised loan without any interest charge.” Cheque kiting involves the unathorised use by depositors of uncollected funds in their accounts. Uncollected funds are cheque lodgments accepted by a bank for which it cannot fully guarantee collectability until the institution on which such cheque is drawn has determined that funds are available to cover the item. The goals of the cheque kiter may be to use these uncollected funds interest-free for a short time to overcome a temporary cash shortage or to withdraw the funds permanently for personal use. Competition among banks in an era of deregulation encourages banks to make funds available before actual collection of customers’ cheques in order to attract customers, especially business accounts.
14.3.3 Account Opening Fraud
This involves the deposit and subsequent cashing of fraudulent cheques.
It usually starts with a person not known to the bank asking to open a transaction account such as current or savings account with false identification but unknown to the bank. The person opens the account with a small initial deposit of cash or cheque. Generally, within a few days, the person will deposit a number of bad cheques and obtain cash in return, either by cashing the fraudulent items outright or by withdrawing cash as soon as funds are available. The bad cheques may be large overdrafts drawn o n other banks or drawn on bank accounts that are closed or never existed; stolen, counterfeited, forged or otherwise fraudulent; or non-existent empty envelopes deposited in Automated Teller Machine (ATM).
14.3.4 Letters of Credit Fraud
Letters of credit generally arise out of international trade and commerce.
They stimulate trade across national borders by providing a vehicle for ensuring prompt payment by financially sound institutions. However, in some areas of the world, fraud has historically been a problem, especially in Nigeria, Iran and the Middle East. Most letters of credit fraud are perpetrated by beneficiaries to the credits using forged or fraudulent documents. In these cases, forged or fraudulent documents are presented to the confirming or issuing bank and payment is demanded against the credit. Whether or not the bank pays the beneficiary will depend upon whether the presented documents appear to comply with the terms of the credit. In most eases, if a credit transaction turns out to be fraudulent, it is the applicant who suffers the loss. In addition to fraudulent transactions, the letter of credit itself may be fraudulent. For example, an account officer or an employee of the documentary unit could create a phoney letter of credit application or enter a non-existent credit into the system using the name and credit capacity of an existing bank customer. However, to effect payment against a fraudulent letter of credit, the named beneficiary would probably have to be an accomplice in the scheme.
14.3.5 Money Transfer Fraud
Money transfer services are means of moving funds to or from a bank to a beneficiary account at any banking point worldwide in accordance with the instructions from the bank’s customers. Some common means of money transfer are mail, telephone, over-the-counter, electronic process and telex. Fraudulent money transfers may result from a request created solely for the purpose of committing a fraud or the alteration of a genuine funds transfer request. A genuine request can be altered by changing the beneficiary’s name or account number or changing the amount of the transfer. The fraud typically involves a non-repetitive, three person transaction. The perpetrator will obtain the particulars of the account (especially inactive large balance accounts) and names of bank personnel. This information is then used to alter legitimate money transfer or initiate a fraudulent transfer in favour of a third party, usually an accomplice.
14.3.6 Loans Fraud
Loans and other forms of credit extensions to business and individual customers constitute traditional functions of banks. In the process of credit extension, fraud may occur at any stage, from the first interaction between the customer and the bank to the final payment of the loan. Loan fraud occurs when credit is extended to a non-borrowing customer or to a borrowing customer who has exceeded his credit ceiling. The fraudulent aspect of this class is that there is intent to conceal it from the head office inspectorate staff on routine check to deceive them with plausible but falsified statements, documents, etc. Discounting of dud instruments also fall within this class of fraud. Some perpetrators of credit frauds go to the extent of applying credit facility approved for one customer to the credit of another who is often unrelated to the first customer. In other words, a credit facility for a customer ‘A’. yet to be drawn down is diverted for the use of customer ‘B’. In some cases, drafts and certified cheques sold against insufficient funds may be concealed in a suspense account instead of debiting the account of the purchaser.
Other categories of loan fraud include:
(i) Deceptive customer – false financial statements, pretence of credit worthiness and false guarantees;
(ii) False collateral – non-existent, over-valued, multiple-pledged, stolen, counterfeit;
(iii) Corrupt bank officer – improper loans to insiders, friends/relatives, improper loans benefiting hidden financial interest of officer, kickbacks to bank officers. embezzlement of loan proceeds or loan payments;
(iv) Improper use of loan proceeds other than stated business use – criminal enterprise, money laundering, e.t.c.
Loan frauds often inflict huge losses upon victim banks. Years of profit- making effort can be negated by a single loan fraud. Sometimes, the very survival of the bank is at risk. Fraud losses arising from loans are a significant factor in majority of bank failures worldwide. For all these reasons, prevention and detection of loan frauds must be a top priority concern for bankers.
Loans made through international offices have additional vulnerability to fraud Foreign and business customs can make recovery/collection efforts difficult or impossible if a loan goes bad due to fraud. The value of collateral must receive careful attention (it is probably one of the reasons that foreign guarantees are no longer allowed for naira denominated loans) as special attention must be given to unfamiliar foreign negotiable instruments used as collaterals.
14.3.7 Counterfeit Securities
Like counterfeiting of money, counterfeiting of commercial financial instruments is one of the older forms of crime. Modem photographic and printing equipment has greatly aided criminals in reproducing good quality forged instruments. The documents may be total counterfeits or may be genuine documents that are copied, forged or altered as to amount, payout date, payee or terms of payment. A common method is to present counterfeit stocks or bonds as collateral for loans. Other counterfeit items such as treasury notes, cashiers’ cheques, bankers acceptances, or certificates of deposit in counterfeit or altered forms, may be presented to a bank for redemption. The presenter would then draw out the proceeds and disappear before the financial instruments are found to be counterfeit.
14.3.8 Cheque Fraud
The use of cheques as a means of setting financial obligations is an essential feature of a modem economy. Cheque fraud is now common, involving millions of naira annually. Common types of cheques are personal, business, government, travellers’ certified, draft and counter cheques, with each having its own characteristics and vulnerabilities for fraudulent use The most common cheque frauds involve cheques that are stolen, forged, counterfeited or altered.
14.3.9 Money Laundering Fraud
This is a means to conceal the existence, source or use of illegally-obtained money by converting the cash into untraceable transactions in banks. The cash is disguised to make the income appear legitimate. Banks should be advised to avoid handling such funds.
143.10 Clearing Fraud
Most clearing frauds hinge on supervision of an instrument so that at the expiration of the clearing period applicable to the instrument the collecting bank will give value as though the paying bank had confirmed the instrument good for payment. Clearing cheques can also be substituted to enable the fraudster divert the fund to a wrong beneficiary.
Misrouting of clearing cheques can also assist fraudsters to complete a clearing fraud. In other words, a local clearing item can be routed to an up country branch. In the process of re-routing the instrument to the proper branch, the delay entailed will give the collecting bank the impression that the paying bank had paid the instrument.
14.3.11 Computer Fraud
Computer frauds can remain undetected for a long time and can take the form of corruption of the programme or application packages and even breaking into the system via a remote sensor. Diskettes can also be tampered with to gain access to unauthorised areas or even give credit to an account for which the funds were not originally intended.
14.3.12 Telex Fraud
Transfer of funds from one location to another can be effected through telex The message, though often coded, can be altered to enable the diversion of funds to an account not originally intended
14 . 4 Internal Control Systems for Prevention and
Detection of Frauds
The consequences of frauds in banks are very grave. Let it be emphasised that the classic rule of banking, “Know Your Customer” is the key to detecting and preventing frauds. To minimise the incidence of frauds in the industry, bank management have to institute a system of internal control, generally
defined as “the whole system of controls, financial and otherwise, established by the management to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard the assets and secure as far as possible the completeness and accuracy of the records.”
Management has the responsibility under the Companies and Allied Matters Decree (CAMD) 1990 to keep adequate account records. Management should therefore introduce appropriate controls to prevent, or at least, substantially reduce the incidence, not only of mistakes but also of irregularities and intentional errors, including frauds. The risk of frauds can be reduced by ensuring that key functions within each transaction cycle are always performed by separate individuals.
In particular, adequate segregation of duties should exist among:
· those with power to authorise a transaction and to commit the bank to execute it;
· those charged, with the duty recording such transactions in the banks’ books;
· those who have custody of assets and can determine their release. Internal management control systems can be classified in the underlisted ways:
14.4.1 Internal Checks
These are the operational controls which are built into the banking system to simplify the processing of entries in order to secure prompt services, to help in minimising errors and act as insurance against possible collusion.
14.4.2 Internal Audit or Inspection
This involves the review of operations and records undertaken within a business by specifically assigned staff. The roles of the inspectorate division are to serve as a watch-dog on bank funds and properties, to ensure that there is no improper application of funds, to ensure that expenditure and revenue are duly authorised and accounted for, to periodically inspect account books in order to ensure that transactions are properly recorded and books are regularly balanced, and to investigate malpractices like frauds, forgeries and theft of bank assets.
The internal audit of banks should be independent and be seen to be so by all members of staff In this regard, the internal auditor should have the authority to carry out such work as he considers necessary (with access to all relevant records) without first obtaining permission of any member of senior management.
For maximum effectiveness, the internal audit function of banks should have direct access and freedom to report to senior management, including the chief executive, the board of directors and where necessary, the board audit committee.