Basics of

Fraud Management

1. Introduction to Fraud

Fraud in a bank may generally be characterized as an intentional act, misstatement, or omission designed to deceive banking customers, resulting in the victim suffering a loss or the perpetrator achieving a gain. Fraud is typically categorized as internal or external.

  1. Internal fraud occurs when a director, an employee, a former employee, or a third party engaged by the bank commits fraud, colludes to commit fraud, or otherwise enables or contributes to fraud.

  2. External fraud consists of first-party fraud and victim fraud. External fraud is committed by a person or entity that is not a bank employee, a former employee, or a third party engaged by the bank.

Fraud schemes are often ongoing crimes that can go undetected for months or even years and can be time consuming and costly to address. It is often difficult to fully understand and quantify the extent of the fraud and the harm caused. Measuring losses associated with fraud is often an inexact process. Typically, the true cost of fraud is greater than the direct financial loss, given the time and expense to investigate, loss of productivity, potential legal and compliance costs associated with remediation, and impact on a bank's reputation.

2. Why Commit Fraud?

The main reason that individual or group fraudster(s) would engage in fraud is that they want to make quick bucks and stay lavishly. One another reason is that they want to make their social status better as it is perceived in most countries that "respect comes from money and individuals with money are respected". The latest modern time drive which leads to committing fraud is pressure; pressure to pay bills or to maintain an addiction. Another reason which has popularized in the modern world to commit fraud is any opportunity where it is perceived that the risk of detection is low. Further, the accumulation of wealth is a long and tiring process, it takes lots of thinking, strategy building, convincing others, maintaining perseverance, etc. Fraudsters in pursuit of wealth creation see fraud as the best shortcut. Furthermore, the best shortcut for quick bucks is attempting fraud in a bank as banks have all money.

3. Why a Bank is Vulnerable to Fraud?

The bank is vulnerable to fraud for two reasons namely its loopholes and the internet. The internet is the favored mode for performing financial transactions in a bank. Whether transactions, online or on mobile or debit and credit card transactions, or on electronic channels such as ATMs, cross border payments made through swift all of the above require the internet. Consequently, banks are becoming increasingly vulnerable to cyber-attacks. Recent innovative financial services, such as mobile wallets, have also been targeted by fraudsters. Fraudsters adopt various methods such as bank spoofing, Vishing, Phishing, inserting Malware into PCs and mobile phones, SIM card cloning, etc., to do fraud. Also, Fraudsters are daily devising new ways to exploit loopholes in technology systems to steal confidential data. Further, the mistakes that banks do to curb fraud happening are as given below:

1. Banks do not educate Customers: The bank's weakest links are their customers and most of the time banks do not find time to educate their customer's on how they and their accounts are susceptible to fraud. To curb this, banks should have a mechanism to educate customers on “What steps should bank customers take not to fall prey to the fraudsters”.

2. Banks Fight Fraud in Silo’s: Each of the banks has loopholes and somehow these loopholes are exposed to fraudsters who they take advantage of. But, when the incident actually happens, it is recorded only in that particular bank’s learning book and not shared across banks. There are even banks that try to hide such information as they think it is a reputational loss. The fraudster applies the same logic to other banks and takes further advantage. There is no common forum created by banking organizations where these events should get recorded and all banks should have access to these records in common. To curb these, banks have no choice but to create a forum or at least a mechanism to share information.

3. Fraud gets identified but, banks do not want to invest to further safeguard: Banks are well-informed on the techniques used by fraudsters and they only tighten security to that extent. But banks do not want to invest time and money investigating the patterns of fraud that have happened or can happen. To curb these banks should invest to understand the patterns of fraud.

4. Banks Focus on Fraud to the degree of monetary transactions only: Fraudsters continually learn and are always a step ahead of banks. They are well aware that banks’ concentration is on monetary transactions and have less traction on processes and procedures which lead to monetary transactions. Hence, fraudsters try to find loopholes here (processes and procedures) and then enter the main arena (of monetary transactions) to play a better game. To curb this, Banks should have practice recording unusual activities.

4. Who is a "Responsible Person" in a Bank?

The fraud Prevention Cell (FPC) is responsible for fraud detection and prevention in a bank. But most banks do not have a separate department for fraud as it is not recognized by banks as a separate function. If FPC is not available in a bank, the responsibility lies with the Audit Committee of a bank. The main reason that most banks have audit committees responsible for fraud management as they best understand misappropriation, embezzlement, insider trading, and such things. Also, some banks can have responsibility delegated to the Risk team as per their belief system and the kind of people working in the risk department. In the changing regulatory environment slowly, banks are moving the fraud management to the responsibility of the compliance department. Whichever department in a bank is focused on fraud control and management and whoever heads it, the ultimate responsibility lies in the collective responsibility of each of the employees in a bank. Each employee is a fraud warrior and is expected to report or whistle blow fraud when the employee is aware of such incident. Hence, to conclude each employee of the bank is a "Responsible Person".

5. Types of Frauds

Some of the types of Frauds are:

a. Advance fee fraud: Advance fee fraud is when fraudsters target victims to make advance or upfront payments for availing of financial services from a bank. Example, a fraudster will call the target customer who is in need of a loan and make the target believe that the fraudster is actually a bank employee and can help. The fraudster uses good banking jargon to convince the target. Once the target is convinced, the target is told that before he/she receives a loan, he/she must pay an upfront fee to cover insurance for the loan. Once this fee is paid, the victim does not hear from the fraudster again and the loan is never received. Fraud has been committed and the money has been lost.

b. Debt Elimination Fraud: For an up-front fee, the organizers of these schemes create phony legal documents based on the type of a banking customer’s loan. Banking Customers present these documents to their bank, in an attempt to satisfy the elimination of debts. The documents used in these frauds include fake financial instruments that claim to eliminate the borrower's loan(s) obligation. For example, the literature may selectively cite passages of government publications, statements by politicians, constitutional provisions, court decisions, various statutes, and private newsletters to support claims and to ultimately conclude that a specific government agency supports these debt elimination programs. The bank borrowers usually pay substantial up-front fees and commissions based on the total amount of the loan that can be forgiven. However, these customers do not understand the risk of foreclosure or other legal action from the bank side.

c. Nigerian Fraud: This fraud combines identify theft and advance fee fraud (also called Section 419 schemes named for the violation of Section 419 of the Nigerian Criminal Code). Fraudsters pose as assistants to a foreign government official needing assistance to move money from their country. The banking account holders contacted are asked for payments for money transfer fees. Documents are created to explain these costs, along with guarantees that these fees paid in advance will be reimbursed and appropriate commissions will be paid once the funds are released successfully. Banking customers are also asked to provide personal and banking information to facilitate the transfer of monies which lead to identity theft.

d. Cashier's Check:

There are people who are selling merchandise through classified ads on the internet, newspapers, flyers, etc. The fraudster sends a check or draft that is well above the amount of the merchandise to the seller. The fraudster then says that the additional amount has been sent across for shipping and handling charges. By the time the check comes back as fraudulent, sellers have shipped the merchandise and sent back the excess funds too to the fraudster. In some cases, fraudsters may try to cancel the order and request that the victims return the full amount of the funds, including the excess for shipping.

e. Fictitious/Unauthorized Banking: Fraudsters create fake banks to lead a banking customer into believing they are working with a trustworthy bank in an online or mobile transaction. Fraudsters would wait for a bank customer to log in to their bank account online. Then, they would immediately change what the customer was viewing on the main page to a message advising of an upgraded security system that required a quick training session. That training would include requiring the customer to “practice” making a transfer to another account. The customer would be advised that no money would be transferred, nor would any account be debited. The consumer would then go through the process, only to find out at a later time that money had actually been transferred to a fictitious bank account.

f. High yield investment fraud: High yield investment fraud, also called prime bank fraud, involves issuing or trading prime bank, prime European bank, or prime world bank financial instruments that do not, in fact, exist. Fraudulent individuals or companies promise their victims huge profits with little risk if they invest in these instruments. Promoters use fake documents that appear legitimate and often claim to have special access to investment programs that ordinarily are available only to top financiers in the world's financial centers. Fraudsters claim to have secret or insider knowledge to share with a select few and use that premise to cloak their operations in secrecy.

g. Identity Theft: Identity theft a serious crime where a fraudster uses a banking customer's personal information, such as name, Social Security number, or credit card number, to commit fraud or other crimes.

h. Phishing: Fraudsters send an email or pop-up messages that might alert a banking customer to a problem with their account or state that they have a refund waiting. Post the customer provide all the details including details of cards, pins, and security questions, the fraudster easily uses this information to loot customers’ account.

6. Governance Systems In a Bank for Fraud Prevention

Strong governance is of paramount importance to control the bank's exposure to fraud, and a strong corporate culture against fraud is crucial regardless of a bank's size or complexity. The tone at the top sets the foundation on which the bank operates. The board and senior management have a responsibility to lead by example and demonstrate that the bank is serious about promoting ethical behavior to deter and prevent fraud. The board-adopted code of ethics (or code of conduct) should encourage the timely communication and escalation of suspected fraud through the appropriate oversight channel. The board is ultimately responsible for oversight but may delegate fraud risk management-related duties to specific committees (for example, the audit committee or operational risk management committee). The board also may delegate anti-fraud responsibilities to specific executives and managers, including those in charge of managing risks and controls. Roles and responsibilities should be clearly defined. The board should hold management accountable for effective fraud risk management and alignment of anti-fraud efforts with the bank's strategy, objectives, risk appetite, and operational plans. While not all fraud can be avoided, an active board can foster an environment in which fraud is more likely to be prevented, deterred, and promptly detected.

7.Fraud Controls in a Bank

a. Preventive controls designed to deter frauds in a bank are:

  • Strong internal controls to prevent fictitious account opening.

  • Real-time transaction analytic reports to Managers and Sr. Managers.

  • Maker-Checker should be available for all processes especially related to the posting of monetary transactions such as cheques, wire transfers, ACH, etc.

  • Robust information security programs.

  • Educate customers on fraud risks.

  • Fraud risk training to employees and contractors.

  • Policies and processes should have fraud programs.

  • fraud trend awareness to the board of directors, staff, vendors, and vendor employees.

  • Background checks for new employees and for existing employees from time to time.

  • Appropriate System controls designed to prevent fraudulent transactions

  • Restricting manual overrides, or deploying new financial system enhancements.

  • Mandatory leaves of minimum of 10 days to employees and contractors.

  • Robust KYC processes to identify and verify account controllers (Authorized Signatories) and entity controllers (beneficial owners and entity controllers like directors).

  • Strong KYE (Know Your Employee) processes.

b. Detective controls to respond to a fraud attempt:

  • Report on manual overrides.

  • Report on exceptions in processes.

  • Ethics and whistle-blower hotline report.

  • Employee exit interview report.

  • Inventory with action owners of unusual activities reported.

  • Transaction monitoring reports eligible for SAR.

  • Fee Waiver Reports.

  • System access controls.

  • Suspense and omnibus reconciliation reports.

  • Special Interest Rates given to customers report.

  • Charges written off report.

  • Loans eligible to become bad debts report.

  • Complaints from customer report.

  • Analysis of civil and criminal subpoenas received by the bank.

8. Fraud Detections in Banks After a Compliant is Received

A bank is only responsible to investigate whether a fraud claim from the customer was actually a consumer fraud or not. Further investigation is the job of law enforcement or Police. Investigators in a bank will try to look for transaction history, the regular pattern of the customer, check on location data, IP addresses, and other elements to prove whether or not the actual customer of the bank was involved in these transactions or not. Sometimes, cardholder claims that the merchant defrauded them in some way, in such cases, the bank may put out an inquiry for more information. With merchants carrying the ultimate liability for the cost of chargebacks, banks aren’t really incentivized to investigate fraud in great depth or push back too hard against their customers’ claims. This might not be fair, but it highlights how important it is for merchants to take charge of their own defense when it comes to fraud and chargebacks. Bank investigators nowadays are smarter to uncover friendly frauds (friendly fraud, is when a cardholder disputes a transaction and receives a chargeback based on false claims). Lastly, when a bank is unable to deduce anything, they may notify law enforcement agencies or the cybersecurity cell of the Police for further action at their end.

9. Effective Internal Controls in Banks for Fraud Prevention

  • The audit department in a bank should appropriately audit the key controls of every process and evaluate the potential for the occurrence of fraud. Also, recommend areas where reviews of procedures are required.

  • Review all bank accounts at least annually. Consolidate or eliminate bank accounts that are not frequently utilized.

  • Require two-party authorizations (initiation and release) on all transactions including wires and ACH files.

  • Frequent reconciliations of Suspense and Omnibus accounts.

  • Determine that appropriate controls are present while employees access the banking systems from remote sites.

  • Ensure proper segregation of duties among staff initiating, authorizing, and signing off payments and reconciling bank statements.

  • Remove individuals from bank transaction authority immediately upon resignation or termination.

  • Ensure that controls exist for the storage and destruction of all documents that contain accounts and other related information.

10. Types of Bank Frauds

Bank Fraud can happen within a bank by employees or within a bank by external fraudsters or to a banking a customer. Let us check on a few:

1. Cooking the Books:

Cooking the books mean manipulating financial records in order to deceive. Companies do manipulate financial data to inflate a company's revenue and deflate its expenses in order to pump up its earnings or profit. Once this is done, the company is ready to negotiate for more loans from banks. Banks are ready to loan as the books look lucrative to them. Ultimately when the truth of inflated books is revealed, the company puts up an “Insolvency” board. The banks recover so much that they often put it as collateral while providing the loans and other unsecured loans usually are written off as bad debts.

2. Demand Draft Fraud:

Demand draft fraud, or the unauthorized debiting of a consumer’s checking account, is a growing problem. Currently, it is the favorite method of fraudulent actors for taking consumers’ money through fraudulent telemarketing and other scams. How do these fraudulent actors steal consumers’ money through demand drafts? Many fraudulent actors persuade consumers, either over the telephone or through the mail, to divulge their checking account numbers by telling them that their bank account numbers are needed to verify prizes or to deposit prize money directly into consumers’ bank accounts. In other cases, fraudulent actors tell consumers that only a small amount will be withdrawn, but in fact, withdraw huge amounts of money from the consumer’s checking account. As a further insult, the unauthorized demand draft may generate significant overdraft charges to the consumer if the consumer does not have the additional money in the first instance or has written subsequent checks. Little do consumers know that once they give fraudulent actors access to their bank account information, their money will disappear. Once a consumer provides his or her checking account number, a fraudulent actor can generate a document that looks exactly like the checks in the consumer’s checkbook imprinted with the consumer’s name, address, phone number, and, most importantly, the account numbers and the numbers necessary to route the draft through the banks’ check clearing system. The only difference is that in place of the consumer’s signature, there is a notation such as “pre-approved” or “signature on file.” The fraudulent actor deposits this draft the same as any conventional check, and in most cases, it clears in exactly the same way as a conventional check; the lack of a handwritten signature is not a problem in processing it.

3. Bill Discounting:

Bill discounting is a genuine business where the seller’s bank funds the seller before the invoices (Bills) are realized to be paid by the buyer on a future due date of settlement. The bank does this business to profit from the margin and fees it receives. It is called bill discounting as seller is settled by its bank with discounted bill and not the full amount as per the agreement. At the time of maturity of the bill, the seller’s bank will duly present the bill and collect the dues from the buyer. Fraudsters take advantage of this concept by incorporating a genuine company and doing a legitimate business. To give the illusion of being a sincere customer, the company regularly and repeatedly uses the bank to get payment from one or more of its customers. These payments are always made, as the customers are part of the fraud. After the fraudster has gained the bank's trust, the company requests that the bank to pay its bills up front. Many banks will agree, but this facility is not provided upfront as expected by the company. So again, business continues as normal. As the bank gets more confidence in such arrangement, it will start trusting the fraudsters company more and are now willing to pay large amounts of bill claims by the company. Eventually, when the outstanding balance between the bank and the company is sufficiently large, the company and its customers disappear. There is no one on the street now where a bank can collect the bills from. The fraud is done.

4. Check Frauds:

There are several types of check fraud. To start with a check alteration is a con where the fraudster alters the payee’s name, the cheque amount, or the date. The other types of check frauds are forgeries or imitated signatures on the check, counterfeit checks or fake checks, and remote checks where instead of a signature, there is a bogus statement that the account holder has authorized a check.

5. Letter of Undertaking:

A letter of undertaking (LOU) is a form of bank guarantee under which a bank can allow its customer to raise money from another home country's bank's foreign branch (located overseas) in the form of short-term credit. The LOU usually is issued to the extent of the collateral available in the home country branch. The fraudster can bribe bank officials in the home country and ask them to raise LOUs in his/her company’s name without collateral and raise short-term loans overseas. This can continue till the time Audit catches it in the branches at the home country.

6. Dupe Bank Employees:

Fraudsters impersonate employees of a bank and can dupe the victims on the pretext of providing higher loans on lower interest rates for an advance fee. Here fraudsters observe people in branches who are in dire need of a loan. They also engage banking employees to give them hints about such people. They then meet up with such victims, show them their fake Id cards and tell the customer that they are from the sales department and hence, they are not usually visible in branches. But they have contacts with Relationship managers who can manage greater loans for less interest and sometimes they convince the customers that they can get a loan without collateral. Certain Conman can divert the loan sanctioned on customer's name to their accounts too after getting the personal information of the customer.

11. Bank Fraud Investigation

The detection or investigation of fraud process in a bank is as given below:

1. Analysis of Data: Analysis of data consists of the following steps.

a. Fraud information collection:

Fraud can occur in many ways in a bank; it may involve one or more internal and external parties and may be executed by one person or involve a number of parties. Irrespective of how fraud is perpetrated, in most circumstances, fraud arises due to the opportunity to do fraud. The fraud investigation officer identifies potential fraud triggers and collects data accordingly. The fraud investigation officer also maintains a log of these triggers. The fraud trigger information or data are collected in the bank from various venues like hotlines, whistleblowers, reconciliation errors, unusual entries in suspense accounts, sometimes specific requests from regulators, conduct reports, escalations, unusual activity reports, suspicious activity reports, etc.

b. Cleansing of Data:

Data cleansing is the process of removing incorrect, corrupted, incorrectly formatted, duplicate, or incomplete data within a dataset. When combining multiple data sources, there are many opportunities for data to be duplicated or mislabeled. The objective of data cleaning is not simply about erasing information to make space for new data, but rather finding a way to maximize a data set’s accuracy without necessarily deleting information. In case a bank uses IT, models, for Fraud detection and investigation, data cleaning is to create data sets that are standardized and uniform to allow business intelligence and data analytics tools to easily access and find the right data for each query. The first important rule of a Data cleansing is that the removed data should be still available in separate files folders or cloud as you never know that those removed data might become an important clue in future investigations. The fraud analyst of a bank also is required to ensure that the data is rightly picked. Sometimes it so happens that the data is not available in the appropriate field those data are not deletable items but require to be put in the right place. The reason for data cleansing is so important as incorrect, inconsistent data can lead to false conclusions and misdirect the fraud analysts.

c. Hypothesis Creation:

In order to form hypotheses, a fraud analyst should collect as many observations from the cleansed data about a topic or problem as possible. Evaluate these observations and look for possible causes of the problem. Finally, fraud analysts create a list of possible explanations. After the fraud analyst has developed some possible hypotheses, the analyst thinks of ways that could confirm or disprove each hypothesis through judgment and experience, and available facts. All hypotheses accepted or ready for deletion should have meaningful explanations.

d. Plotting Hypothesis:

Hypotheses collected that are accepted are then represented into patterns using charts or trends to guide the interpretation of results. Data mining techniques offer a good solution to finding patterns in vast amounts of data. fraud analysts are guided by the results of data mining models to obtain a primary indication of where fraudulent behavior might situate.

d. Investigation Report:

At the completion of an investigation, the information gathered is assessed by the investigator, and a formal report is prepared. All recommendations within the report are supported by evidence. Reports are logical and provide a sound basis for decisions to be made on the merits of the case and on the balance of probabilities.