Management of Financial Institutions

Banking Fraud & Misleading Activities:Rogue Traders, Uninsured Deposits

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Management of Financial Institutions - MGT 604
Lecture # 42
Banking Fraud & Misleading Activities
Bank fraud is a federal crime in many countries, defined as planning to obtain property or
money from any federally insured financial institution. It is sometimes considered a white-
collar crime.
Rogue Traders
A rogue trader is a highly placed insider nominally authorized to invest sizeable funds on
behalf of the bank; this trader secretly makes progressively more aggressive and risky
investments using the bank's money, when one investment goes bad, the rogue trader
engages in further market speculation in the hope of a quick profit which would hide or
cover the loss. Unfortunately, when one investment loss is piled onto another, the costs to
the bank can reach into the hundreds of millions of dollars; there have even been cases in
which a bank goes out of business due to market investment losses.
Fraudulent Loans
One way to remove money from a bank is to take out a loan, a practice bankers would be
more than willing to encourage if they know that the money will be repaid in full with
interest. A fraudulent loan, however, is one in which the borrower is a business entity
controlled by a dishonest bank officer or an accomplice; the "borrower" then declares
bankruptcy or vanishes and the money is gone. The borrower may even be a non-existent
entity and the loan merely an artifice to conceal a theft of a large sum of money from the
Wire Fraud
Wire transfer networks such as the international SWIFT inter-bank fund transfer system are
tempting as targets as a transfer, once made, is difficult or impossible to reverse. As these
networks are used by banks to settle accounts with each other, rapid or overnight wire
transfer of large amounts of money is commonplace; while banks have put checks and
balances in place, there is the risk that insiders may attempt to use fraudulent or forged
documents which claim to request a bank depositor's money be wired to another bank, often
an offshore account in some distant foreign country.
Forged or Fraudulent Documents
Forged documents are often used to conceal other thefts; banks tend to count their money
meticulously so every penny must be accounted for. A document claiming that a sum of
money has been borrowed as a loan, withdrawn by an individual depositor or transferred or
invested can therefore be valuable to a thief who wishes to conceal the minor detail that the
bank's money has in fact been stolen and is now gone.
Uninsured Deposits
There are a number of cases each year where the bank itself turns out to be uninsured or not
licensed to operate at all. The objective is usually to solicit for deposits to this uninsured
"bank", although some may also sell stock representing ownership of the "bank".
Sometimes the names appear very official or very similar to those of legitimate banks. For
instance, the "Chase Trust Bank" of Washington DC appeared in 2002 with no license and
no affiliation to its seemingly apparent namesake; the real Chase Manhattan Bank is based
in New York. There is a very high risk of fraud when dealing with unknown or uninsured
The risk is greatest when dealing with offshore or Internet banks (as this allows selection of
countries with lax banking regulations), but not by any means limited to these institutions.
Theft of Identity
Management of Financial Institutions - MGT 604
Dishonest bank personnel have been known to disclose depositors' personal information for
use in theft of identity frauds. The perpetrators then use the information to obtain identity
cards and credit cards using the victim's name and personal information.
Demand Draft Fraud
Demand draft fraud is usually done by one or more dishonest bank employees. They remove
few DD leaves or DD books from stock and write them like a regular DD. Since they are
insiders, they know the coding, punching of a demand draft. These Demand drafts will be
issued payable at distant town/city without debiting an account.
Then it will be cashed at the payable branch. For the paying branch it is just another DD.
This kind of fraud will be discovered only when the head office does the branch-wise
reconciliation, which normally will take 6 months. By that time the money is unrecoverable.
Stolen Cheques
Some fraudsters obtain access to facilities handling large amounts of cheques, such as a
mailroom or post office or the offices of a tax authority (receiving many cheques) or a
corporate payroll or a social or veterans' benefit office (issuing many cheques).
A few cheques go missing; accounts are then opened under assumed names and the cheques
(often tampered or altered in some way) deposited so that the money can then be withdrawn
by thieves. Stolen blank cheque-books are also of value to forgers who then sign as if they
were the depositor.
Accounting Fraud
In order to hide serious financial problems, some businesses have been known to use
fraudulent bookkeeping to overstate sales and income, inflate the worth of the company's
assets, or state a profit when the company is operating at a loss. These tampered records are
then used to seek investment in the company's bond or security issues or to make fraudulent
loan applications in a final attempt to obtain more money to delay the inevitable collapse of
an unprofitable or mismanaged firm.
Stolen Credit or Debit Cards
Often, the first indication that a victim's wallet has been stolen is a 'phone call from a credit
card issuer asking if the person has gone on a spending spree; the simplest form of this theft
involves stealing the card itself and charging a number of high-ticket items to it in the first
few minutes or hours before it is reported as stolen. A variant of this is to copy just the
credit card numbers (instead of drawing attention by stealing the card itself) in order to use
the numbers in online frauds.
Fraudulent Loan Applications
These take a number of forms varying from individuals using false information to hide a
credit history filled with financial problems and unpaid loans to corporations using
accounting fraud to overstate profits in order to make a risky loan appear to be a sound
investment for the bank.
Can We Avoid Cheque Fraud?
Management of Financial Institutions - MGT 604
1. Reconcile your account; Reconcile your cheque account promptly and regularly. If
you hold business accounts, consider opening a separate account specifically for
higher value cheques, so they can be easily monitored.
2. Signing of Cheques; Never sign blank cheques, only sign cheques after all details
have been completed.
3. Preparation; Cheques must be completed in a way that deters fraudulent alternation.
Ensure that a strong bold and consistent font is used and that no gaps are left in
completion of the payee name, amount in words and in figures. Use permanent
ballpoint or ink (preferably black) when filling out a cheque.
4. Ordering and maintaining cheques; If cheques are lost or stolen contact your bank
immediately and ask them to load a `Stop Payment'. Notify bank, if you have not
received an ordered cheque book.
Protect your credit / debit card
Save your personal identification number (PIN). Don't use the same PIN for different cards
or equipment, and don't choose your birth date or any other easily identifiable number that
might be on something else in your wallet. Check statements and call your credit card issuer
immediately if you see anything suspicious on your bill. You could help the company
uncover fraud--and save yourself from paying un-authorized charges. Keep track of when
new and reissued cards should arrive, and call the credit card issuer if they don't come on
time. Make sure your mailbox is secure, and that only you and the postal carrier have access
to it. When you use your credit card online, make sure you are using a secure website. Look
for a small key or lock symbol at the bottom right of your browser's window. Never give
your card number to strangers or telemarketers who call you on the phone. Don't give your
card number unless you initiated the call.
Table of Contents:
  1. Financial Environment & Role of Financial Institutions:FINANCIAL MARKETS &INSTITUTIONS
  2. FINANCIAL INSTITUTIONS:Non Banking Financial Companies
  3. CENTRAL BANK:Activities and responsibilities, Interest Rate Interventions
  4. POLICY INSTRUMENTS:Open Market Operations, Capital Requirements
  5. BALANCE OF TRADE:Balance of Payments Equilibrium, Public Policy and Financial Stability
  6. STATE BANK OF PAKISTAN:History, Regulation of Liquidity, Departments
  10. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Human Resources Department
  13. PAKISTAN ECONOMIC AID & DEBT:Macroeconomic Stability, Strengthening Institutions
  14. INCREASING FOREIGN DIRECT INVESTMENT:Industrial Sector, Managing the Debt
  15. ROLE OF COMMERCIAL BANKS:Services Typically Offered by Banks, Types of banks
  16. ROLE OF COMMERCIAL BANKS:Types of investment banks, The Management of the Banks
  17. ROLE OF COMMERCIAL BANKS:Public perceptions of banks, Capital adequacy, Liquidity
  19. ROLE OF COMMERCIAL BANKING:Private Deposit Insurance,
  20. BRANCH BANKING IN PAKISTAN:Remittances, Online Fund Transfer
  22. Mutual funds:Types of international mutual funds, Mutual funds vs. other investments
  23. Mutual Funds:Criticism of managed mutual funds, Money Market Fund
  24. Mutual Funds:Balanced Funds, Growth Funds, Specialized Funds, Measuring Risks
  25. Mutual Funds:Cost of Ownership, Redemption Fee, Reports to Shareholders
  26. Mutual Funds:Internet Fraud, The Pyramid Scheme, How to Avoid Investment Fraud
  27. Mutual Funds:Investing In International Mutual Funds, How to Pre-Select a Mutual Fund
  28. Role of Investment Banks:Recent evolution of the business, Possible conflicts of interest
  29. Letter of Credit:Elements of a Letter of Credit, Commercial Invoice, Tips for Exporters
  30. Letter of Credit and International Trade:Terminology, Risks in International Trade
  31. Foreign Exchange & Financial Institutions:Investment management firms, Exchange Traded Fund
  32. Foreign Exchange:Factors affecting currency trading, Economic conditions include
  33. Leasing Companies:Basic Purpose of Leasing, Technological Benefits
  34. The Leasing Sector in Pakistan and its Role in Capital Investment
  35. Role of Insurance Companies:Indemnification, Insurer’s business model
  36. Role of Insurance Companies:Life insurance and saving
  37. Role of financial Institutions in Agriculture Sector:What is “Revolving Credit Scheme”?
  38. Agriculture Sector and Financial Institutions of Pakistan:What is SMEs
  39. Can Government of Pakistan Lay a Pivotal Role in this Sector?:Business Environment
  40. Financial Crimes:Process of Money Laundering, Terrorist Financing
  41. DFIs & Risk Management:Managing Credit Risk, Managing Operational Risk
  42. Banking Fraud & Misleading Activities:Rogue Traders, Uninsured Deposits
  43. The Collapse of ENRON:Auditing Issues, Corporate Governance Issues, Corrective Actions
  44. Classic Financial Scandals:Corruption, Discovery, Black Wednesday