Fraud has been a persistent threat since ancient times. One of the earliest known cases dates back to Greece in 300 BC, where Hegestratos attempted to deceive shipload insurers by sinking his boat and keeping the cargo. While he drowned in the process, this highlights that fraud is not a new phenomenon. Today, with technological advancements, fraudsters have become more sophisticated and creative in their methods. Various banking frauds in India underscore the need for heightened vigilance in the financial sector.
Evolving Threats and Technological Advances: Techniques deployed by fraudsters have evolved significantly over the past decade. With easy access to technology, they are constantly developing innovative ways to commit fraud. This makes it crucial for financial institutions to stay ahead by implementing robust checks and being better prepared to combat such threats.
AML (Anti Money Laundering) & KYC (Know Your Customer): In the 1920s, the Mafia used laundromats as fronts for their criminal activities, giving rise to the term “money laundering.” Money laundering involves concealing the origin of illegally obtained funds through a complex system of banking transfers or commercial transactions, eventually returning the money to the launderer in an obscure manner. AML laws, regulations, and procedures are designed to prevent criminals from disguising illegal funds as legitimate income. The Prevention of Money Laundering Act (PMLA) 2002 in India mandates verification of clients, maintenance of records, and reporting of suspicious activities to the Financial Intelligence Unit.
KYC checks enable financial institutions to verify the identity of their customers to ensure they are not engaging with fictitious or proxy individuals. While KYC is essential, it is just the start to combat financial fraud. The process starts with AML checks and escalates to KYC checks, helping identify tax evaders, white-collar criminals, and loan defaulters.
Internal Due Diligence: To combat fraud in the financial sector, financial institutions must perform thorough internal checks on clients at multiple levels. This includes multi-layered checks on personal guarantees, up-to-date verification of assets, physical site visits by relationship managers, and cross-checking the utilization of funds for business needs. Documentation, financial records, credibility, and creditworthiness checks are essential components of internal due diligence. This should be supported by external due diligence with PEP, adverse media and other enhanced screening. These measures help financial institutions to not deal with fraudulent entities and can mitigate potential risks.
Constant Monitoring: Constant monitoring is crucial to mitigating fraud. Ongoing manual and automated monitoring, including requests for information, physical site visits, attrition pattern checks, sudden drops in share prices, and negative analyst reports, can help identify potential fraud risks as an early warning mechanism. Investigations by agencies like the Enforcement Directorate (ED), Central Bureau of Investigation (CBI), Serious Fraud Investigation Office (SFIO), and Securities and Exchange Board of India (SEBI) are essential in addressing large-scale financial frauds in India.
Mandatory Checks and Verifications: To prevent frauds, financial institutions must implement multiple pre-loan checks, automated checks, independent checks by external agencies, anti-collusion measures, and regular updating of documentation. These processes should be mandatory and followed without exception. By having stringent checks and verifications in place, financial institutions can create a strong defense against potential fraudsters.
Learning from the Past and Adapting to the Future: The history of fraud demonstrates that as long as there is value, there will be attempts to deceive and steal. This reality necessitates that financial institutions remain vigilant and proactive in their efforts to combat fraud. Learning from past incidents provides valuable insights into tactics used by fraudsters and help institutions develop more effective countermeasures.
Leveraging Technology for Fraud Prevention: With the rapid advancement of technology, financial institutions have access to sophisticated tools and systems that can aid in fraud prevention. Artificial intelligence and machine learning algorithms can analyze vast amounts of data to detect unusual patterns and behaviour indicative of fraudulent activities. These technologies can provide real-time alerts and enable financial institutions to respond swiftly.
The Role of Regulatory Bodies and Industry Collaboration: Regulatory bodies play a crucial role in establishing guidelines and standards for fraud prevention. Financial institutions must comply with these regulations to maintain the integrity of the financial system. Additionally, industry collaboration is essential in sharing information and best practices to combat fraud.
Given the potential of the Indian economy and the entry of AI tools, it becomes crucial to use a combination of automated validation and frequent manual verification to mitigate significant financial frauds in the future.
