Chapter 7. Ethical Issues in Financial Management – Business Ethics and Corporate Governance


Ethical Issues in Financial Management


Corporate accounting and finance, which refers to the accounting practices and reporting through financial statements of public limited companies, is broadly categorized as:

  1. financial accounting; and
  2. financial management.

Financial accounting is the language of business. It is meant to measure, translate and sum up the impact of all business transactions into financial terms, in the form of statements. Such statements take the forms of balance sheet, income statement and cash flow statement and facilitate an organization to analyse and evaluate periodically whether its business is profitable and worth pursuing. Based on this financial input alone, the enterprise formulates its business strategies for enhancing its revenue, cost economies, overall efficiency and shareholder wealth. The process of accounting can thus be summed as the systematic recording, reporting, and analysis of financial transactions of a business.

Archaeologists have found evidence that the practice of accounting is as old as civilization. As a matter of fact, the history of accounting has been traced back to history of writing. The success of business in the earlier Italian renaissance is credited to the double entry book-keeping. Firms during the Industrial Revolution kept accurate records of their businesses by accounting for their regular transactions. This provided them a means by which they determined profitability of their businesses.1

We can broadly classify the process of accounting into two sub-branches:

  1. financial accounting; and
  2. management accounting.

Financial accounting is defined as reporting of the financial position and performance of a firm through financial statements issued to external users on a periodic basis. Financial statements, as stated earlier, typically include the balance sheet, profit and loss accounts and the cash flow statements followed by supporting documents. These documents are published by all the listed public limited companies and are required to be audited by external auditors for their accuracy and integrity.

The main characteristics of financial accounting are as follows:

  • The financial statements are meant primarily for external users such as investors, shareholders, analysts etc.
  • The financial statements must be prepared in compliance with the Generally Accepted Accounting Principles (GAAP).
  • The financial data provided must be accurate and timely.
  • These statements portray the company’s past performance.
  • The statements provide a picture of the business as a whole.
  • The financial statements stand by themselves.

Management accounting is the process of identifying, measuring, analysing, interpreting, and communicating information for the pursuit of an organization’s goals. Management accounting is also known as cost accounting. Management accounting involves budgeting, forecasting and analysing cost behaviour, cost management, financial control and decision making, ratio analysis and so on.

The main characteristics of management accounting are as follows:

  • The data involved in the process are meant solely for the use, understanding and analysis of internal users.
  • The preparation of reports etc. under this process is not subject to regulations or GAAP standards.
  • The relevance and flexibility of data are completely determined by the users of the data.
  • The use of management accounting techniques is to look into the future profitability and to make decisions based on existing data.
  • Management accounting draws heavily on finance, economics and quantitative methods for decision making and analysis.

The key difference between managerial and financial accounting is that managerial accounting information is aimed at helping managers within the organization to make decisions. In contrast, financial accounting is aimed at providing information to parties outside the organization.


Financial management encompasses the two core processes of resource management and finance operations. Resource management is the effcient and effective deployment of an organization’s resources when they are needed. Such resources may include financial resources, inventory, human skills, production resources, or Information Technology.

Financial operations involve the execution of the joint finance mission to provide financial advice and guidance, support of the procurement process, providing pay support, and providing disbursing support.2

Broadly speaking, financial management involves:

  • financial analysis and planning;
  • investment decisions;
  • financing and capital structure decisions; and
  • management of financial resources.

Role of Finance Manager

The finance manager heads the finance department. The finance manager has evolved, and today he or she wears many hats depending on the task at hand. Financial managers’ role involves the following activities:

  • providing and interpreting financial information;
  • business modelling and forecasting;
  • monitoring performance and efficiency;
  • analysing change, risk assessment;
  • strategic planning;
  • formulating long-term business plans;
  • pricing, competitor analysis;
  • developing complex financial models;
  • analysing financial implications of new or future ventures;
  • preparing accounts;
  • budgetary control;
  • monitoring cash flow; and
  • liaising with other team members across the organization.

In their roles as managers, gatekeepers, agents and promoters of organizations, these individuals are responsible to the shareholders of organizations. According to the Companies Act, the management is an agent for the owners of the firm. The shareholders or owners of the business provide compensation and/or incentives to the management, which has accepted to work in their (shareholders’) best interest. Shareholder wealth maximization is the main goal for most companies.

Since incentives of managers are tied in with the profitability of the businesses, there is scope for managers to involve in fraudulent activities to maximize their payments. Such malfeasance drains corporate resources causing millions of dollars worth of losses to shareholders and investors.


Professor John Boatright of Business Ethics and Management School at Loyola University, Chicago, talks about how the theory of ethics in finance can be developed around three broad themes:

  1. in financial markets;
  2. in financial services industry (including banking and insurance); and
  3. by financial people in the organizations.3

Ethical Issues in Financial Markets

Professor Boatright mentions the level playing field established in financial markets; a set of rules and code of conduct which sets expectations in which the market dynamics work. However, the playing field is often influenced and moved in one way or the other based on information dissemination and resources.4

On 11 September 2008, the Supreme Court upheld the ruling of the Securities Appellate Tribunal’s judgement that refused to set aside the penalty imposed by SEBI on Rajiv B Gandhi, his wife and sister for insider trading, in violation of Regulations 3 and 4 of the Securities and Exchange Board of India (Insider Trading) Regulations 1992, read with Section 15G of the Act. ‘SEBI while holding Gandhi, his wife Sandhya Gandhi and sister Amishi Gandhi guilty of insider trading in the script of Wockhardt on the basis of unpublished price-sensitive information and the same was not available to the investors in general.’5

It was the contention of SEBI that Gandhi, Wockhardt’s company secretary and CFO, has access to information regarding the financial position of the company. Being aware of the fact that the company’s results for the December 1998 quarter reflected its negative performance over the previous quarter, and knowing well that the share prices would crash once the results were publicized, the Gandhis sold their shares on 21 and 22 January before the board meeting took place and the market could react to the company’s financial results. It was also reported that his sister and wife had also purchased the shares of the company when the price had fallen after the board meeting.

Ethical Issues in Financial Services Industry

In a broad sense, financial services would include services rendered by all financial institutions that are engaged in some form of borrowing and lending. In this wide sense, it would include financial intermediaries such as commercial banks, hire purchase finance companies, insurance companies, pension funds and investment trusts. But in our analysis of frauds committed in the financial services sector, we will concentrate on commercial banks and the insurance industry because of their overriding importance in the Indian economy as large providers of finance to the different sectors of the economy.


Legal authorities define fraud as a crime that ‘involves the use of dishonest or deceitful conduct in order to obtain some unjust advantage over someone else’.6 This definition of fraud implies that the fraudster commits a crime through deception using dishonest means with an intention to cheat other persons or institutions, to make them part with something of their own. It is assumed that the fraudster knows that his or her act is false or is without belief in its truth; and knowing it, he/she induces others to act upon the matter, which will deprive them of their possessions. These frauds are seen in various segments of industry such as:

  1. Financial services sector, that is, fraud in credit cards, cheques and other types of identity-related services; and
  2. Insurance sector, that is, internal fraud committed by employees against the insurer, fraud by policy holder and claims fraud, and fraud committed by intermediaries such as independent brokers/agents.

There are other types of fraud such as those relating to telecommunication, securities and the computer. Here, we will deal with the first two in the financial sector.

Available statistics shows that losses incurred by banks due to frauds are far larger than losses arising out of robbery, dacoity, burglary and theft—all put together.7 The use of high-tech instruments such as the computer has increased the quality and extent of fraud to an enormous degree.

A study of bank frauds brings to light several types of frauds, with or without the connivance of bank employees. Authorities on the subject identify four elements responsible for the commission of bank frauds.8

  1. Active involvement of the staff—both supervisory and clerical—either independent of external elements or in connivance with them.
  2. Failure on the part of the bank staff to follow scrupulously, the instructions and guidelines laid down by regulators like the Reserve Bank of India (RBI).
  3. External elements perpetrating frauds on banks by forgeries or manipulations of cheques, drafts and other negotiable instruments.
  4. Collusion among businessmen, top bank executives, civil servants and politicians in power to flout rules and regulations, and to throw banking norms to the winds.

Types of Bank Frauds

Unauthorized extension of credit facilities such as cash credit, pledging hypothecation of goods against bills or book debts, pledging of spurious goods, hypothecating goods to more than one bank, inflating the value of goods, removing goods with the connivance of bank employees, pledging of goods belonging to a third party, and accepting obsolete and inadequate stocks are all done with a view to cheating banks for illegal gratification. Apart from frauds committed by outsiders on banks or their clients, banks themselves resort to unethical practices, against the guidelines provided by the RBI. For instance, the National Consumer Disputes Redressal Commission at New Delhi has recently issued a notice to the RBI and 88 commercial banks, including foreign banks operating in the country, for delaying the crediting of cheques. This was based on a complaint that the banks in the country are allegedly earning nearly INR 6,210 million in interest everyday due to delays in crediting cheques sent for clearance. According to the complaint, a gross violation of the rights of millions of consumers was taking place in the banking industry. It was pointed out that there was a huge time gap between when the cheque of a bank’s customer was paid by the drawee bank, and when the bank actually credited its customer’s account, and a still further time gap if we consider when funds were made available for withdrawal. The complainant said that in the financial year 2005–06 nearly 1,300 million cheques were cleared by the 88 banks operating in India through their branches across the country amounting to about INR 113.4 million. Even if it was assumed that the banks enjoyed the benefit of ‘fund float’ only on 50 per cent of the cheques deposited, the daily rate of interest would come to about INR 6,210 million a day at 4 per cent rate of interest. It was submitted that as per the RBI guidelines, a local cheque was to be credited on the third working day from the date of acceptance of cheques at the counters; that an outstation cheque drawn on a bank in any of the four metropolitan cities was to be credited within seven days, and that this procedure was not being followed. It was contended that such a delay was not permissible under the RBI guidelines, as well as the Banker’s Code framed by the Banking Code and Standards Board of India from time to-time.9

Frauds in deposit accounts are opening of bogus accounts, forged signatures of introducers and collecting through such accounts stolen or forged cheques or bank drafts. Frauds are also committed in the area of granting overdraft facility in the current accounts of customers. A large number of frauds has been and is being committed through bank draft, mail transfers and telegraph transfers.

In recent times, several bank frauds have come to light in the use of credit cards and also in the extension of home loans. The same property is pledged to more than one bank by using original look-alike mother documents made possible by colour photocopies. For instance, a Chennai-based fraudster was arrested in September 2006 on charges of cheating 22 nationalized banks during 2000—04 of INR 15 million by pledging just one immovable property as collateral at INR 4 million. Acting on a complaint from a nationalized bank, the City Crime Branch (CCB) police found that he had taken loans ranging between INR 0.5 million and INR 1.2 million.10

Phishing is the tactic of using e-mail to solicit sensitive information from users. It is a recent form of cyber attack in which attackers make Internet users divulge sensitive information about their bank accounts and personal details.

Some inherent weaknesses in Web browsers and the Internet make users susceptible to phishing attacks. Fraudsters use e-mails to persuade users to part with sensitive information like password for Web sites, financial information, etc. In a typical attack, a user receives an e-mail message from the attacker with the address and logo or image of a bank or financial institution, making him or her believe that the message has come from these institutions; and the fraudster tries to convince the user to part with personal information and uses them for wrongful purposes. For instance, the user receives a mail regarding bank account verification. Generally, the entire e-mail message is sent as an image pointing to the ‘phish’ URL. When the user clicks the hyper link provided in the e-mail, it opens the genuine bank Web site in the background, with a popup window in the foreground asking for the bank account details. There have also been instances where the scam-mers/attackers embed a Web link in the e-mail message. The link may look like the actual bank site but actually it connects to the phisher’s Web site, where an exact replica of the bank site is created to fraudulently extract the personal information from the user. The solution to this problem lies in training the end-users not to reveal any sensitive information.

How to Avoid Phishing Scams/Attacks11

To avoid phishing scams, end-users need to be suspicious of e-mails, especially when they call for urgent requests for personal information about one’s financials. Better still, they should not react to such e-mails. Users should also be careful to verify the sender’s credentials before they enter into any transaction on the basis of the message they receive by e-mail. One should avoid using links in suspicious-looking e-mails to open Web sites. It should be ensured that a secure and updated Web site is used while submitting sensitive financial information, including details of credit card for online purchases. It would be safe if one checks one’s bank statements to check for authenticity of transactions.


Prevention of Money Laundering Act 2002

For a long time, especially after the adoption of the licensing policy, restrictive imports and import substitution, rationing of foreign exchange and the severely punitive Foreign Exchange Regulation Act (FERA), there was a large degree of smuggling and money laundering in the country. Half-hearted attempts by the government at different times did not yield any tangible result in curbing this menace, and this caused huge losses to the exchequer. Prevention of Money Laundering Act 2002 is a comprehensive legislation to curb the evil of money laundering.

Reporting of Cash and Suspicious Transactions   Section 12 of the Prevention of Money Laundering Act (PMLA) casts certain obligations on the banking companies with regard to preservation and reporting of customer account information. Under this section of the PMLA, each bank has to furnish information of transactions to the Director of the Financial Intelligence Unit of India (FlU-IND) within the prescribed time, where the ‘Principal Officer’ has reasons to believe that a transaction or a series of transactions are integrally connected so as to defeat the provisions of this section.

The information should contain the nature of transactions, the amount of transaction and the currency in which it was denominated, the date on which the transaction was conducted and the parties to the transaction. For this purpose, branches shall have to maintain a register containing information on the following types of transactions:

  1. all cash transactions of the value of more than INR l million or its equivalent in foreign currency;
  2. all series of cash transactions integrally connected to each other, which have been valued below INR 1 million or its equivalent in foreign currency where such series of transactions have taken place within a month, and the aggregate value of such transactions exceeds INR 1 million;
  3. all cash transactions where forged or counterfeit currency notes or bank notes have been used as genuine, and where any forgery of a valuable security has taken place; and
  4. all suspicious transactions whether or not made in cash.

Types of Reports and Their Periodicity   The following types of main reports are to be prepared by branches:

  1. Cash Transaction Report (CTR)
  2. Counterfeit Currency Report (CCR)
  3. Suspicious Transaction Report (STR)

All reports should be submitted by branches to Circle Offices, which shall be retransmitted by Circle Offices to Head Office along with the comments/observations of the Circle Heads.

The Cash Transaction Reports (CTRs) shall be submitted on a fortnightly basis by branches to their Circle Offices. For the first fortnight ending 15th of the month the report shall be sent before 20th and for the second fortnight the report is to be sent before 5th of next month. While preparing CTRs, individual transactions below INR 50,000 may not be included.

The Suspicious Transaction Report (STR) should be furnished by branches and Circle Offices on a daily basis where any transaction, whether cash or non-cash or a series of transactions integrally connected are of suspicious nature. The branch manager should record his or her reasons in the register for treating any transaction or a series of transactions as suspicious.

The Counterfeit Currency Report (CCR) shall be submitted as and when any transactions related to deposit of counterfeit currency notes or defrauding the bank by forged high value securities, etc. takes place.

Reporting to the RBI   The primary responsibility of reporting transactions as per the guidelines of RBI lies with the Principal Officer of the bank. On receipt of data/details from Circle Offices, the officer designate of the Head Office (who has been nominated by the Principal Officer for monitoring this assignment) should enter the details in a register and place the reports with the Principal Officer for his or her comments and/or approval along with the supporting documents.

Only those items approved by the Principal Officer shall be forwarded to the FlU-IND. Where the Principal Officer requires in-depth enquiries on the events/transactions, he/she may order for the same through his or her own sources or seek clarification or further documents from the Circle Head or Branch Head.

The Principal Officer is the ultimate authority of the bank to decide as to whether a transaction is to be reported or not.

Other Guidelines Under the Act   The other guidelines under the Act are as follows:

  1. The Branch Managers and the Circle Heads are personally responsible for the timely submission of CTRs and STRs to Circle Offices and Head Office, respectively.
  2. Utmost confidentiality should be maintained in submitting the CTRs and STRs to the controlling offices. The reports may be transmitted by speed/registered post, fax or e-mail.
  3. Circle Offices should ensure that the reports for all the branches are filed in one mode, that is, electronic or manual.
  4. The summary of CTRs and the individual Suspicious Transaction Report should be signed by the Circle Heads only. In case a confirmation is needed on the report, he/she may arrange for verifying the details before recommending for further transmission by the Principal Officer at the Head Office.
  5. The Principal Officer is the ultimate authority to decide on the reporting of transactions to the FlU-IND.

Compliance to Anti-money Laundering Standards   The RBI has directed that monitoring of all transactions of the bank has to be strictly done as per the Anti-money Laundering Standards prescribed.

The Banking Ombudsman Scheme 2006

RBI has introduced the Banking Ombudsman Scheme 2006 with the objective of addressing and resolving complaints related to bank services. Box 7.1 details the Banking Ombudsman Scheme 2006 of the RBI.


The scheme is introduced with the object of enabling resolution of complaints relating to certain services rendered by banks and to facilitate the satisfaction or settlement of such complaints. The Reserve Bank may appoint one or more of its officers in the rank of Chief General Manager or General Manager to be known as Banking Ombudsmen to carry out the functions entrusted to them by or under the Scheme.

The appointment of Banking Ombudsman may be made for a period not exceeding three years at a time.

Banking Ombudsman’s Jurisdiction, Powers and Duties

  1. The Reserve Bank shall specify the territorial limits to which the authority of each Banking Ombudsman appointed under Clause 4 of the Scheme shall extend.

  2. The Banking Ombudsman shall receive and consider complaints relating to the deficiencies in banking or other services filed on the grounds mentioned in clause 8, and facilitate their satisfaction or settlement by agreement or through conciliation and mediation between the bank concerned and the aggrieved parties, or by passing an award in accordance with the scheme.

  3. The Banking Ombudsman shall exercise general powers of superintendence and control over his Once and shall be responsible for the conduct of business thereat.

  4. The Office of the Banking Ombudsman shall draw up an annual budget for itself in consultation with the Reserve Bank of India and shall exercise the powers of expenditure within the approved budget on the lines of the Reserve Bank of India Expenditure Rules, 2005.

  5. The Banking Ombudsman shall send to the Reserve Bank Governor a report as on 30 June every year, containing a general review of the activities of his Office during the preceding financial year and shall furnish such other information as the Reserve Bank may direct, and the Reserve Bank may, if it considers necessary in the public interest so to do, publish the report and the information received from the Banking Ombudsman in such consolidated form or otherwise as it deems fit.

The Banking Ombudsman Scheme 2002 has been revised by the Reserve Bank of India and the new ‘Banking Ombudsman Scheme 2006’ has come into effect from 1 January 2006. The new Scheme has been expanded to include customer complaints on certain new areas such as Credit Card complaints, levying service charges without prior notice to the customer, non-adherence to fair practices code etc. The new Scheme also provides for online submission of complaints, changes in the appeal mechanism against the Awards issued by Banking Ombudsman along with a few administrative changes.

Salient features of the Scheme

The new scheme provides an institutional framework applicable to all Commercial Banks, Regional Rural Banks and Scheduled Primary Co-operative banks having business in India, with the object and purpose of (i) enabling resolution of complaints relating to certain services rendered by Banks; and (ii) to facilitate the satisfaction or settlement of such complaints. The role of the Banking Ombudsman as an arbitrator as envisaged in the 2002 scheme has been removed under the new scheme. However, the coverage of the scheme has been enhanced to include new areas of complaints.

The scheme covers complaints for deficiency in areas of service, mentioned in clause 8 of the scheme. For better understanding, the grounds on which complaint(s) can be made are enumerated here.

Grounds of Complaint

Clause 8 of the Scheme mentions the following as the grounds of complaint:

  1. A complaint on anyone of the following grounds alleging deficiency in banking or other services may be filed with the Banking Ombudsman having jurisdiction:

    1. non-payment or inordinate delay in the payment or collection of cheques, drafts, bills etc;
    2. non-acceptance without sufficient cause of small denomination notes tendered for any purpose and for charging of commission in respect thereof;
    3. non-acceptance, without sufficient cause, of coins tendered and for charging of commission in respect thereof;
    4. non-payment or delay in payment of inward remittances;
    5. failure to issue or delay in issue of drafts, pay orders or bankers cheques;
    6. non-adherence to prescribed working hours;
    7. failure to honour guarantee or letter of credit commitments;
    8. failure to provide or delay in providing a banking facility (other than loans and advances) promised in writing by a bank or its direct selling agents;
    9. delays, non-credit of proceeds to parties’ accounts, non-payment of deposit or non-observance of the Reserve Bank directives, if any, applicable to rate of interest on deposits in any savings, current or other account maintained with a bank;
    10. delays in receipt of export proceeds, handling of export bills, collection of bills, etc., for exporters provided the said complaints pertain to the bank’s operations in India;
    11. complaints from non-resident Indians having accounts in India in relation to their remittances from abroad, deposits and other bank-related matters;
    12. refusal to open deposit accounts without any valid reason for refusal;
    13. levying of charges without adequate prior notice to the customer;
    14. non-adherence by the bank or its subsidiaries to the instructions of Reserve Bank on ATM/Debit card operation or credit card operations;
    15. non-disbursement or delay in disbursement of pension (to the extent the grievance can be attributed to the action on the part of the bank concerned, but not with regard to its employees);
    16. refusal to accept or delay in accepting payment towards taxes as required by Reserve Bank/Government;
    17. refusal to issue or delay in issuing, or failure to service or delay in servicing or redemption of government securities;
    18. forced closure of deposit accounts without due notice or without sufficient reason;
    19. refusal to close or delay in closing the accounts;
    20. non-adherence to the fair practices code as adopted by the bank; and
    21. any other matter relating to the violation of the directives issued by the Reserve Bank in relation to banking or other services.
  2. A complaint, on any one of the following grounds alleging deficiency in banking service in respect of loans and advances may be filed with the Banking Ombudsman having jurisdiction:

    1. non-observance of the Reserve Bank directives on interest rates;
    2. delays in sanction, disbursement, or non-observance of prescribed time schedule for disposal of loan applications;
    3. non-acceptance of application for loans without furnishing valid reasons to the applicant; and
    4. non-observance of any other direction or instruction of the Reserve Bank as may be specified by the Reserve Bank for this purpose from time to time.
  3. The Banking Ombudsman may also deal with such other matter as may be specified by the Reserve Bank from time to time in this behalf.

Procedure for Filing a Complaint

Any person who has a grievance against a bank on any one or more of the grounds mentioned in Clause 8 of the Scheme may, himself or through his authorised representative (other than an advocate), make a complaint to the Banking Ombudsman within whose jurisdiction the branch or office of the bank complained against is located.

Settlement of Complaint by Agreement

  1. As soon as it may be practicable to do, the Banking Ombudsman shall send a copy of the complaint to the branch or office of the bank named in the complaint, under advice to the nodal officerand endeavour to promote a settlement of the complaint by agreement between the complainant and the bank through conciliation or mediation.

  2. For the purpose of promoting a settlement of the complaint, the Banking Ombudsman may follow such procedure as he may consider just and proper and he shall not be bound by any rules of evidence.

  3. The proceedings before the Banking Ombudsman shall be summary in nature.

Award by the Banking Ombudsman

  1. If a complaint is not settled by agreement within a period of one month from the date of receipt of the complaint or such further period as the Banking Ombudsman may allow the parties, he may, after affording the parties a reasonable opportunity to present their case, pass an Award or reject the complaint.

  2. The Banking Ombudsman shall take into account the evidence placed before him by the parties, the principles of banking law and practice, directions, instructions and guidelines issued by the Reserve Bank from time to time and such other factors which in his opinion are relevant to the complaint.

  3. The award shall state briefly the reasons for passing the award.

  4. The Award passed shall specify the amount, if any, to be paid by the bank to the complainant by way of compensation for the loss suffered by him and may contain any direction to the bank.

  5. Notwithstanding anything contained in sub-clause (4) of the scheme the Banking Ombudsman shall not have the power to pass an Award directing payment of an amount which is more than the actual loss suffered by the complainant as a direct consequence of the act of omission or commission of the bank, or ten lakh rupees whichever is lower.

  6. In the case of complaints arising out of credit card operations, the Banking Ombudsman shall, while determining the amount of compensation payable, take into account the loss of the complainant’s time, the expenses incurred by him/her, financial loss, harassment and mental anguish suffered by the complainant.

  7. A copy of the Award shall be sent to the complainant and the bank.

  8. An Award shall lapse and be of no effect unless the complainant furnishes to the bank concerned within a period of 30 days from the date of receipt of copy of the Award, a letter of acceptance of the Award in full and final settlement of his claim. Provided that no such acceptance may be furnished by the complainant if he has filed an appeal under sub. clause (1) of clause 14.

  9. The bank shall, unless it has preferred an appeal under sub. Clause (1) of clause 14, within one month from the date of receipt by it of the acceptance in writing of the Award by the complainant under sub-clause (8), comply with the Award and intimate compliance to the Banking Ombudsman.

Rejection of the Complaint

The Banking Ombudsman may reject a complaint at any stage if it appears to him that the complaint made is

  1. not on the grounds of complaint referred to in clause 8;

  2. beyond the pecuniary jurisdiction of Banking Ombudsman prescribed under clause 12 (5);

  3. frivolous, vexatious, mala fide;

  4. without any sufficient cause;

  5. that it is not pursued by the complainant with reasonable diligence;

  6. in the opinion of the Banking Ombudsman there is no loss or damage or inconvenience caused to the complainant; and

  7. requiring consideration of elaborate documentary and oral evidence and the proceedings before the Banking Ombudsman are not appropriate for adjudication of such complaint.

Source: Thorat, Usha (2005), “The Banking Ombudsman scheme 2006,” December 26, Reproduced with permission from RBI


Indian banking has seen phenomenal changes during the 20th century. Starting with the banking being concentrated in the hands of a few selected groups of business communities like the chettiars in the south, marwaris in the east, the Gujaratis in the west, the banking industry has moved from the limited area of operations to global operations through the process of social control, nationalization of banks and greater autonomy to the banks.

Over the last three decades, we have traversed quite some distance from micro-management of banks by capping call money rates, stipulating interest rates across the board and public humiliation of banks’ personnel who resisted direct lending in respect of non-bankable proposals.

In several sectors of Indian economy like oil, gas, telecommunication, metals and banking, public sector units compete with the private sector. The competition is becoming increasingly acute in the case of banking mainly due to the greater speed and degree of implementation of financial sector reforms I and II of the Narsimhan Committee compared to the slow pace of reforms in the other sectors. In respect of nationalized banks (including State Bank of India and its associates) who manage more than 70 per cent of the total bank business, the government has to play a dual role—(i) as the majority shareholder of the respective banks; and (ii) as the ultimate regulator and upholder of public interest leading to inherent conflict of interest.

As the owner, the government is very much interested in the ongoing profitable growth of banks by deploying the available resources based on general demand at market determined cost. As upholder of public interest, the government needs to make concessional credits to selected priority sectors to ensure continuous employment and productivity in the less developed areas. The dichotomy is best exemplified when the government is directing the public sector banks to grant agricultural loans at a concessional rate of 7–9 per cent which amount may not even cover the basic cost of resource mobilization. At the same time, government’s direction to banks to sanction 40 percent of total advances to the priority sector continues.

One of the basic principles of corporate democracy is that no shareholder enjoys special rights vis-à-vis other shareholders. In fact, while listing the new equity, stock exchanges endeavour to ensure that even private equity entities that typically have special rights relating to appointment of management personnel, maintenance of healthy financial parameters, buy back provisions etc. rescind such rights. Such being the case, the recent government directives on interest rates to public sector banks especially emanating from its role as majority shareholder prima facie at variance with the commercial judgement of the bank management and circumventing the interest rates signals emanating from the banking regulator, have to be seen in this light.

Several private sector banks have senior management personnel who have migrated from nationalized banks. This suggests that the inherent competence of senior management personnel of nationalized banks is comparable to that prevailing in the private banking. The government expects public sector banks to compete effectively with the private sector banks without providing the former with a level playing ground resulting in the latter enjoying special advantages in certain crucial areas of operations. Further, some of the policies followed by the government, instead of reducing the gap, has widened the same. A few examples are given below:

  1. tenure of CEOs;
  2. remuneration of CEOs; and
  3. accountability without autonomy.

Tenure of CEOs

For any organization to make reasonable progress on a continuous basis, the CEO needs to be at the helm of affairs at least for a minimum period of five years. In private sector banks some of the CEOs even continue for more than 10 years and their career prospects are entwined with the growth of the bank. But the CEOs of the several public sector banks have a smaller tenure—as low as one year. This is being done because there is no tenure for the post of secretaries in the government. It is perceived that the finance ministry and the government are running the affairs of these public sector banks, and hence the tenure of the CEO is immaterial for the growth of the bank. At the same time, the government exercises undue interventions on occasions in the matters of placement, promotions, business acquisitions and disposal, closure of branches and restructuring of balance sheets of the banks.

Remuneration of CEOs

It will be unbelievable for many people that the remuneration of the Chairman of the State Bank of India, the biggest bank in India, having more than 9,000 branches and controlling 20 percent of the banking business is abysmally low in comparison to the remuneration of some CEOs of the private sector banks (both old and newly started). The government is really interested in increasing the remuneration to a reasonable market level for all the bank executives of the public sector in tune with the market demands taking into consideration the special risks attendant with their role. But they find it difficult to implement the same as the proposals are not cleared by bureaucrats of the ministries, who forget the fact that they are sitting at the back instructing the CEOs to run the banks as desired by the government. But the commitment of huge resources for several large projects is done by the CEOs only.

Accountability and Autonomy

An official of the private sector bank is not subjected to vigilance at any point of time. He or she is outside the ambit of vigilance even if the advances sanctioned by him or her become irrecoverable. The final decision in regard to the employees is taken by the respective boards of the banks. But in the case of public sector banks, all employees above a particular level are subject to vigilance proceedings. Even genuine business losses incurred by the bank cannot be written off easily unless a clearance of the Central Vigilance Department is received about the official whose decision resulted in the loss, although the management is fully convinced of the bona fides of the official concerned.

Even if an official has performed exceptionally well during his or her entire career, a small loss to the bank on account of the factors beyond his or her control may lead to an unpleasant situation due to the interventions of the Central Vigilance Department. The management remains helpless on several occasions leading to de-motivation of the officials. In the above circumstances, to think that the same degree of corporate governance and ethical practices would be followed by the entire banking industry (i.e., both public sector and private sector) is a Utopian expectation. However, there are banks which indulge in practices that, even by modest values, are grossly unethical. A few such practices are described below:

  1. To show achievement of annual business targets, a few banks sanction loans towards end of the financial year which are then closed at the beginning of the next financial year by not charging/charging nominal interest to the obliging borrowers.
  2. As per RBI guidelines, no commission can be paid for obtaining deposits. In view of the competition faced, managers try to offer commission by way of gifts, etc. to the depositors the cost of such gifts being borne by the banks’s advance customers. They agree for this arrangement and in turn demand special financial benefits from the banks.
  3. It is really unfortunate that for retaining the public sector units’ existing deposits with them (without being snatched away by the private sector banks under some flimsy reason), the nationalized banks are driven to indulge in some unethical practices like offering large gifts and other pecuniary benefits to the concerned persons. Earlier, there was a government guideline in terms of a list of all public sector units that should bank only with the State Bank of India or its associates. Gradually this guideline has been relaxed/violated by permitting the different public sector units to open accounts with private sector banks also, although the entire gamut of services required by the public sector are fully taken care of by the State Bank of India group. Permission by the ministries is accorded to the public sector units to transfer to other private sector banks and the reasons for the switchover are obviously known to all.

How Do Other Countries Who Have Public Sector Units Manage Such Issues?

In Australia, following the partial privatization of the telecommunication company Telstra, ‘the Communications Minister has the power, under the Telstra Act, to give the management, after consultation with its board of directors, such written directions as appear to the Communications Minister to be necessary in the public interest’.12 In Britain, the government has constituted a 15-member body, called Share Holder Executive (SHE), drawn from a mix of commercial, financial and civil services background, headed by a senior investment banker. The SHE has direct responsibility for the shareholder interest of the government, to advice ministers on shareholder issues including the objective governance, appointments, remuneration, strategy and performance monitoring of these companies. The SHE is also the centre for corporate finance and governance, advising the department on shareholder-related management, corporate governance and financial issues as well as wider corporate finance and other industrial issues.

The concept of corporate governance and follow up of ethical practices in nationalized banks will show a high degree of visibility in future if the Indian government also adopts measures similar to what followed in Australia and the United Kingdom. Until such time these concepts will be more of an ornamental value and discussed and debated by the academicians and bureaucrats in different fora.

The RBI, the regulator of banks, with a view to arresting the increasing number of frauds and malpractices in the banking sector has published the ‘Reserve Bank of India Guidelines to Banks’ to enable commercial banks to be alert to the possibility of frauds (Box 7.2).

Further, the RBI with a view to making bank employees conscious of their responsibilities, and also to make them aware of the systems and procedures that are put in place to eliminate chances of frauds likely to be committed by outsiders, has suggested appropriate remedial measures in its ‘Reserve Bank of India Guidelines to Banks’. An excerpt of these guidelines is reproduced in Box 7.3.


The Reserve Bank of India has given guidelines in respect of frauds as given below. Preventive measures to be undertaken by banks in this regard are also mentioned.

Areas offraud preventive/curative measures

  1. Misappropriation and criminal breach of trust.

    1. Persons of doubtful integrity not to be posted in sensitive posts.
    2. ‘Watch List’ to be prepared for staff of doubtful integrity—the outgoing manager of a branch to handover the list to the incoming manager, who can then have idea about whom to be relied upon for confidential/sensitive work.
  2. Illegal/irregular manipulation of records, documents, withdrawal of money, etc.

    1. Cross-checking of transactions by staff other than the one effecting the transaction initially.
    2. Careful and continuous monitoring of the work done in sensitive areas, particularly deposits and advances.
  3. Forgery of documents/voucher/records.

    1. Keeping under safe custody to avoid fraudulent manipulations.
    2. Inspecting officers to cross check at random, particularly records relating to large value transactions.
    3. Documents related to loans taken ought to be vetted by the bank’s lawyers—more so in case of equitable mortgage.
  4. Falsification of financial documents.

    1. Reinforcements of instructions emanating from controlling offices regarding execution of documents, and the same have to be put into practice. Instructions are to be carried out within the laid down time frame and deviation must be followed up with appropriate action.
    2. All ledgers are to be periodically balanced by staff other than the concerned ledger-keeper and the same must be checked by supervisors.
  5. Unauthorized credit facilities extended for consideration.

    1. Inspection reports raised on branches must be meaningfully analysed at controlling offices and any lacunae pointed out therein should be taken up with the concerned branch, for removal of such shortcomings/infirmities within a definite time frame.
    2. Controlling offices must monitor and analyse the various statements sent to them relating to credits disbursed and deviation noticed are to be rectified within a reasonable time, keeping close watch on the procedures undertaken for rectification.
  6. Forgery in demand drafts and issuance of fake drafts.

    1. Blank demand draft books to be kept under dual custody.
    2. Meaningful scrutiny of draft leaves to be made before making payment therefore.
    3. When instance of fake/forged draft comes to notice, the incident is circulated among all branches/offices to exercise caution for obviating recurrence of such incidence.
    4. Master list of the previous notified stolen/fake security documents to be maintained at branch level.
  7. Cash shortage too frequently.

    1. Cash keys are to be kept under dual custody, properly recording movement of keys.
    2. Cash safes to be operated by both custodians together.
    3. No unauthorized persons are to be allowed in the cash strong room and cash department enclosures.
    4. Physical verification of cash to be invariably undertaken each day after the close of business hours.
  8. Irregularities in foreign guidelines

    1. Strict enforceability/observance of RB1 exchange transactions related to such transactions.
    2. Establishing, in a foolproof manner, the credentials of the prospective customer before embarking on banking transaction with him.
    3. Judicious approach to be undertaken while dealing with such matters.
  9. False letter of credit (L/C) submission.

    1. Confirmation to be called for from Issuing Bank immediately on submission of letter of credit by the party.
    2. Thorough scrutiny of the letter of credit to detect any onerous clause.
    3. Evaluating the terms/conditions to verify their practical enforceability or otherwise.
    4. L/C not to be opened for those who do not enjoy credit facilities.
    5. The customers’ ability to retire bills under L/C has to be considered and ensured.

Source: Banking division, (2003) “Reserve Bank of India Guidelines to Banks” Mumbai: Reserve Bank of India. Reprinted with permission from Reserve Bank of India.


Frauds usually occur due to

  1. the ignorance of staff members or clientele about system/procedure; and
  2. mala fides and deliberate irregular functioning of bank employees.

Thus, as preventive measures, the staff members should be made aware of the systems and procedures, and when frauds have been perpetrated by outsiders, curative measures have to be taken to safeguard the bank’s interests.

A. Frauds by outsiders Preventive curative measures
(i) Bills of exchange supported by false transport receipts are discounted at the bank, but goods not sent at all. When discounting the bank sends the Motor Transport Receipt (MTR) to its destination with the Bill, the same is returned and the Bank loses the money already given. (i) Such bill discounting facilities are to be allowed to parties with established credentials and MTRs of reputed operators approved by Indian Bankers Association (IBA) are to be accepted. Even when transport companies hand over goods to the drawee of the bill without Bank’s authority, the matter should be immediately taken up to receive the full value of the bill.
(ii) Unscrupulous traders, businessmen obtain undue credit facilities against hypothecation of useless goods, which are not of the desired quality and/or quantity. (ii) This has to be avoided by undertaking regular and adequate inspection/supervision of the stocks by branch officials at irregular intervals.
(iii) Fake title deeds are submitted cleverly, or impersonation resorted to as land /building owners while offering the land/building for equitable mortgage as collateral security. (iii) Such title deeds must be scrutinized thoroughly to find out the veracity. Even spot verification by authorized persons have to be undertaken as a rule without exception. Established registered valuers with impeccable records are to be engaged for evaluating the properties. Non-encumbrance certificates have to be obtained from Registrar’s Office/Court without fail. Collateral security from third party should be normally avoided.
A. Frauds by Outsiders Preventive curative measures
(iv)Unscrupulous persons promise to bring in huge deposits particularly fixed deposits) and mobilize such type of deposits under the condition that they would be allowed thorize the bank to grant credit facilities to the persons who credit facilities (at lower rate of interest) against those deposits in their name although the deposits are kept in the bank in some other persons’ names. (iv) When accepting such deposits, care should be exercised that such deposits are genuine and that the depositors authorize the bank to grant credit facilities to the person who mobilize such type of deposit.
B. Frauds by Bank Employee Preventive curative measures
(i) The banking industry is vulnerable to insider abuse. It is often the most trusted employees who perpetrate the greatest fraud. (i) (a) Rotating employees’ work assignments at intervals.
(b) Ensuring two or more persons are involved in one transaction.
(c) Implementing independent internal and external audit programmes.
(d) Employees should be encouraged to take leave for at east fifteen days per year.
(ii) Huge amount of cash kept in branch unnecessarily giving scope of surreptitious removal of cash. (ii) Minimum amount of cash depending upon the daily average requirement must be kept at the branch. The RBI has fixed 0.75 percent of total deposit to be kept in physica cash on an average in a branch with norma l cash transactions.
(iii) Inward clearing cheques coming to a branch for debit of a an account are quietly destroyed and not entered in the account. Excess balance in the account because of non-debit of the cheque withdrawn soon after. (iii) Usually these fraudulent transactions take place through suspense account (an account in which items are entered temporarily before allocation to the right account). Hence, suspense accounts of the branch are to be checked daily and closely monitored.
(iv) Customers are persuaded to keep their fixed deposit receipts with bank after discharge and then the same are utilized by the staff of taking loan in this name. (iv) Fixed deposit receipts must be kept under proper security and if any loan is obtained by the customer there-against, proper line marking has to be made on the receipt itself as well as on relative books.
(v) Unauthorized handling of transactions in dorman —affording false/fake credit and subsequently withdrawal from the accounts. (v) (a) Dormant/inoperative accounts must be kept in separate ledger under safe custoday of the manager. Any operation thereon must be authorized by either the manager or the officer authorized to do so.
(b) During operation in such account, the bank must obtain satisfactory proof that the transaction is taking place as per the mandate of the real account holder.
(c) Periodic balancing of inoperative accounts ledger is a must for avoiding frauds.
(vi) Tampering with pass books of customers, which have been left with the bank’s staff for updating and then surreptitiously withdrawing amount from the account. (vi) (a) Close supervision must be maintained for updating of passbooks left behind for long periods.
(b) Special care is to be taken in those cases where are not frequent.
(vii) Tampering with Specimen Signature Card to interpolate fictitious/wrong names to show as operators. (vii) Access to such cards to be restricted to authorized persons only. If any doubt arises, the account holder(s) must be called upon to explain.
(viii) Vouchers are tampered with and/or removed to suppress fraud committed (viii) (a) Register for voucher must be checked daily by an authorized officer.
(b) Number in register must tally with total number entered in day book.
(c) Vouchers must be stitched and sealed properly date-wise everyday and kept under authorized custody.
(ix) Fictitious credits are offered in accounts and money withdrawn fraudulently. In order to suppress such transactions. Manipulations are made in balancing of books. (ix) Proper balancing of books individually with corresponding ledgers, is to be undertaken without fail at regular intervals. Deviations noticed must be rectified immediately.
C. Connivance of bank employees with outsiders Preventive curative measures
(i) Bank employees and unscrupulous persons join hands to open fictitious accounts by impersonation and without proper establishment of identity. Thereafter, such accounts are utilized for giving false credit and withdrawing money therefrom. (i) (a) Accounts should be opened invariably after establishing the identity of the prospective account-holder.
(b) High value transactions in such accounts soon after opening are to be scrutinized properly by an authorized officer of the branch.
(c) Collection of items in such accounts are to be carefully monitored, particularly when dividend warrants/interest warrants of substantial amount are deposited for collection.
(ii) Employees often arrange for outside person to withdraw money from accounts of different persons, where the arranged person impersonates the actual account-holder. (ii) While making payment in such cases, it has to ensured that the money is received by the actual account holder or by a person authorized by the account holder to receive such money.
(iii) (a) Employees often collude with outsiders in issuing demand drafts without obtaining consideration. (iii) (a) This method is often resorted to by debit of Suspense Account and hence this account has to be carefully scrutinized regularly by senior officers of the branch to obviate the fraud.
(b) Blank drafts are handed over to outsiders to note the details thereon, and with the help of these spurious drafts leaves are printed outside, to be used for siphoning off the bank’s money. (b) The best method of preventing this type of fraud is to keep the blank draft leaves as well as paid drafts under proper custody, so that the same do not fall in the hands of unauthorized persons.
(iv) officers often knowingly discount forged accommodation bills without underlying trade transactions. (iv) Bills offered for obtaining credit facilities must be scrutinized carefully, and the possibility of accommodation has to be obviated.
(v) Multiple financing to the same party against the same security. (v) The controlling office/inspectors of branches must carefully scrutinize such financing and report when such incidents come to their notice.
(vi) Sanctioning/disbursing loans against a security of gold/jewellery without proper verification by valuers. (vi) The controlling office must monitor such loan accounts periodically and ensure that securities of precious metals/jewellery offered are genuine and properly valued.
(vii) Sometimes fake title deeds are taken from prospective borrowers as securities. (vii) Title deeds must be verified and certified by the bank’s empanelled lawyers.
(viii) NRI accounts: (viii) Reserve Bank guidelines regarding opening and handling of NRI accounts have to be circulated.
(a) Not obtaining prescribed documents.
(b) opening account in fictitious names by depositing foreign currency notes/travellers’ cheques.
(c) Allowing credit of resident funds to non-resident accounts.


Source: Banking division (2003), “Reserve Bank of India Guidelines to Banks” Mumbai: Reserve Bank of India. Reprinted with permission from Reserve Bank of India.


We can identify three types of fraud in the insurance industry:

  1. Internal fraud against the insurer perpetrated by an employee;
  2. Policyholder/claims fraud committed against the insurer, in the purchase and/or execution of an insurance product by obtaining wrongful coverage or payment; and
  3. Intermediary fraud committed against the insurer or policy holders by intermediaries—independent broker/agent.

In the insurance industry, fraud could take place at any stage, from submission of proposal for insurance till settlement of the claim of the insurer. We could divide the entire process into three stages: (i) policy proposal stage; (ii) policy contract stage; and (iii) claim process stage. Besides all these, frauds can also be committed in the operational areas.

Possibilities of Fraud at Policy Proposal Stage

Generally, it is assumed that all parties to a contract are fully aware of the implications of the contract they sign on the basis of the information provided to them. But a life insurance contract is said to be one of good faith. This is because the insurer is not in a position to verify all the particulars given by the proposer, and therefore, have to accept them in good faith. Therefore, this exposes the life insurer to the risks of fraud relating to the health of the proposer, his or her financial soundness and the reason for his or her wanting to be insured.

If the insurance agent is unable to get full and reliable information, ‘the insurer is exposed to the risk of impersonation, faulty reports and inadequate assessment of mortality/morbidity risk’.13 An insurance agent has to play a crucial role in obtaining proper, adequate and reliable inputs from the proposer and providing them to the life insurer for proper assessment. The insurer on his part has to exercise extra care in scrutinizing the financial position of the proposer and the purpose of insurance as these could pose serious problems at the settlement stage.

Possibilities of Fraud During the Policy Contract Term Stage

It has been found that a number of frauds are committed during the tenure of policies, especially of the paid-up policies. Attempts are often made to fraudulently surrender the policies or obtain loans against them, often with the connivance of insurance officials. For this purpose, ‘fake policy documents are prepared and applications for loan/surrender are made by forging signature. Bank accounts are opened only for the purpose of encashing the surrender/loan cheques and the funds are siphoned off’.14

It is also possible to commit frauds if premium is paid in cash and not by cheques. Likewise, when remittances are made through drop boxes, it exposes the insurer to fraud, especially if the policyholder dies in the interregnum after the grace period for paying the premium is over.

Fraud Possibilities at Claim Stage

In case of death claims, identity of the deceased could pose problems, especially when the death was due to an accident, and if it is difficult to prove the identity of the deceased. Again, in respect of long-term paid-up policies, the claim forms are often returned undelivered, offering a chance of misuse by employees of the insurance company. While processing death claims, it has to be ensured that there was no mala fide intention to defraud the life insurer when the policy was taken.

In health insurance, like critical illness insurance, processing of claims becomes highly technical requiring interpretation of medical conditions. The dividing line between what is insured and what has happened is sometimes so thin that even through a bona fide mistake, a claim which should not have been admitted could get admitted. This provides opportunities for frauds and it is necessary that the claim processing system is such as would not allow malpractices to creep in. Admission of disability benefit claim also requires careful scrutiny as some subjectivity does creep in here, which makes it vulnerable to frauds.15

There are many other possibilities of fraud in the insurance sector. For instance, in the insurance industry, investment possibilities are large in value and officials who are privy to investment decisions can misuse this information to their advantage. Moreover, high net worth individuals buy high premium policies running into millions of rupees for money-laundering purposes. Though the government has extended anti-money-laundering legislation from the banking and securities market, in the insurance sector, the practice still continues, albeit in a reduced degree. Anti-money-laundering norms do not focus on the sum insured but the premium. An insurance policy with a INR 10 million term cover would pass muster under anti-money-laundering norms because the premium would be less than INR 30,000.

Frauds in Non-life Insurance Sector

The non-life insurance sector has a bewildering variety of frauds. Staged accidents and inflated bills of damage to vehicles are paralleled by fake bodily injuries to humans and exaggerated bills for health services. Patients can be billed for services not rendered or unnecessary procedures carried out by medical service providers in the hope of recovering from the insurers. Also, policies have been taken against non-existent persons and innocent persons have been killed for fraudulent claims. Other frauds include industries inflating inventories, claiming non-moving or expired stock as flood or fire-damaged goods, and home owners covering up typhoon losses by setting houses on fire.16

Claims of loss of goods in transit due to pilferage, theft or robbery are also common. At times, the claimant fakes a claim, inflates value of goods lost, alters its quality or arranges the goods to be stolen/robbed. Frauds are not limited to claims; there can be fraud at the time of buying insurance as well.

Effect of Insurance Fraud

It is estimated that insurance fraud in the United States could be as high as US$ 80–100 billion annually. No formal study has been made in India, but it is likely that in relative terms it could be much worse in our country. Fraudulent claims disturb the equilibrium of the insurer’s portfolio and make it unviable. Reinsurance of such loss-making portfolio becomes costlier. The burden is finally passed on to the insured population in the form of hiked premiums. Even if competition makes premium hike the last resort, the insurer uses measures such as the imposition of underwriting controls deductibles and exclusions to arrest the abnormal increase in the quantum of claims. Since this acts as a disincentive to honest people they either stop insuring or resort to unethical practices like others. This causes further dent in the number of honest policy takers, which in turn, limits a number of important products such as health insurance.17

Combating Insurance Fraud

Insurance expert Arman Oza outlines the following measures to combat fraud in the insurance sector, which is more susceptible to fraud than any other financial service:

  1. Collection of proper evidence: The onus of proving a fraud lies on the insurer. As such it is the insurer who has to collect all tenable evidence of fraud that is capable of succeeding judicial scrutiny. Since the courts will take a strict view against the insurers, it is extremely important to collect proper evidence before arriving at a decision.
  2. Need for regulation: Regulation is another aspect relevant to combating fraud. The insurer has to be equipped with sufficient legal recourses for collection of evidence from external parties like hospitals, government departments, revenue authorities, etc. in order to make it possible for an insurer to prove fraud ‘beyond reasonable doubt’ in a court of law.
  3. Regulation of allied services: Proper regulation of the sectors touching insurance is also strongly required. For example, the healthcare sector which is today a INR 1500 billion industry in India does not have a formal regulation at all.
  4. Need for judicial cooperation: Criminal cases take years to conclude. By the time a case comes up for final hearing, vital evidence is destroyed and witnesses turn hostile. While there is a case of suitable amendments in the Criminal Procedure Code (CrPC) and the Indian Evidence Act to take care of such instances, judiciary also needs to exercise firmness on issues like perjury.
  5. Insurers should aim at conviction: The insurers need to show determination in bringing fraudsters to book. Presently, the insurers’ interest in detecting a fraud is limited to repudiation of liability and no further. If this menace has to be checked, insurers have to look beyond their books and file criminal complaints against fraudsters wherever sufficient evidence is available. Unless there are some examples of conviction for insurance fraud, deterrence of this silent crime will remain far-fetched.
  6. Need for transparency and fair play: Insurers also have to bridge the credibility gap which leads an average insured to believe that insurers unfairly treat honest policyholders. Transparency and fair-play in underwriting and claim practices, consumer education, ethical marketing policies, and better engagement with customers are some of the areas that need to be addressed. In order to be reciprocated, honesty has to be first practised in the right earnest. The common perception that insurers make money at the cost of policyholders and that premium will increase regardless of claims, needs to be broken through transparent and consistent business practices.

    Added to these suggestions of Arman Oza, V. Ramakrishna offers a few more to fight fraud in the insurance industry.18

  7. Insurers’ coalition: To begin with, insurers should work closely together with the Insurance Regulatory Development Authority (IRDA) to combat fraud. Information of fraudsters should be exchanged and a national database maintained so that such elements are refused access to other ‘unsuspecting’ insurers. In India, banks and consumer finance majors have been practising this for several years now to protect against chronic defaulters.
  8. Building consumer awareness: The biggest battle to be won is that of educating the insuring public on the evils of insurance fraud and ways to prevent it. This would sensitize the average insured towards this issue. It is only when insurance fraud is regarded as something ‘shameful’ and ‘criminal’ by a large section of consumers that all other efforts will begin to bear fruit.
  9. Rewards for whistle-blowers: As a sequel to building awareness, insurers and the regulator should actively encourage ‘whistle-blowing’ or just plain ‘squealing’ on fraudsters and publicly announce reward for anybody who helps in preventing an insurance fraud, for example, an employee of the fraudster or even a neighbour.
  10. Effective legislation and judicial action: Insurance fraud deserves special legislation and judicial attention—a few quick, high-profile and highly publicized convictions are probably the strongest medicine for potential fraudsters. Without legislative and judicial support, all the activism of insurers and regulators will be rendered toothless.

The financial services industry has several players such as insurance agents, brokers, individual investors, institutional investors, brokerage firms, mutual fund companies and so many more. The industry churns out several products and services which by the use of specialized skills and talents are managed efficiently. However, while the agents and brokers owe a critical duty of care and diligence to their clients, they often tend to violate these.

Take, for example, the case of Ketan Parekh, widely known as the ‘Big Bull’. A chartered accountant by profession, Ketan Parekh owned his own business and had connections to wealthy businessmen and the movers and shakers in the industry. Ketan Parekh was a highly successful broker. His modus operandi was to borrow heavily from various sources, especially banks. He bought shares with this borrowed money at low prices and observed the stock prices rising in value. He then pledged these stocks with banks as collateral for more money. The Madhavapura Mercantile Co-op Bank (MMCB) was the main accused for lending huge amounts of money for stocks. It loaned nearly INR 8 billion to Parekh. Parekh’s activities were so rampant and widespread that many of MMCB’s branches were also involved in the scheme of lending money for stocks. As long as the stock prices stayed high, there was not much to fear. Bankers were happy to watch stock climbing and making a clean profit. However, in March 2000 the Nasdaq fell and the money started vanishing. Post March 2000, he recovered with some momentum in the technology stock. But the big crisis came when in December 2000 the stock market crashed with the technology bubble burst. To save some money, Parekh moved some money into the now illegal badla system on the Calcutta Stock Exchange. When Calcutta Stock Exchange demanded cash for the transactions, Parekh borrowed more money without collateral from banks. SEBI immediately ordered investigations and stepped in to control any more damage. As per details available from its investigations, SEBI charged Ketan Parekh for defrauding Bank of India to the tune of US$ 30 million. It was also revealed that Ramesh Gelli, the chief promoter of Global Trust Bank, gave huge unsecured loans to Ketan Parekh and group companies of Zee Telefilms. The RBI indicted Gelli in 2001 for being hand-in-glove with the scamster in the stock market manipulations and was later removed as the chairman of the board of the bank. All these developments snowballed and led finally to the collapse of the much-promising Global Trust Bank. Apart from these major developments several small brokers were believed to have committed suicide due to financial ruin and hundreds of investors, small and big, were driven to bankruptcy. Ketan Parekh was solely responsible for the collapse of the system that led to the downfall of many innocent investors. Parekh not only violated the basic ethics in the handling of others’ hard-earned money, but also played on people’s sentiment and trust. Financial services as an industry has trust as the basic premise, where people hand over their lifetime earnings to the agents in the industry for getting better returns on their investments.

While stock markets are a means to better returns on investments, many people also invest in the real estate for a high percentage of returns. With the fall in bank interest rates, individuals have more access to borrow money and invest in real estate. While banks and mortgage companies are principally bound to investigate the worth of the property they intend to invest in, they often tend to be lenient and allow a few rules to be bent. Thus more and more people tend to invest readily in properties which sometimes do not have proper clearances, or are not worth the current asking price.

Yet another example of ethics violations by people in organizations is the case of mutual fund offers. Often mutual funds seek large institutional investors, since the fees on managing funds are a direct percentage of the holding. Mutual funds use the highly specialized skills of trained finance professionals to invest huge amounts of money in a variety of stocks, thus creating a portfolio that is safe and diversified with good amount of returns for its holders. But the race for these funds often leads fund managers to violate rules laid down for the use of such funds. The sole motivation is the fees that could be earned on the large base and every switch further adds to the fees.

Financial ethics, according to Professor Boatright is more than just trust. He mentions the difficulty in summing up the various aspects of the subject. He believes that the difficulty lies in:

  1. Finance being a field not identified as a single occupation such as medicine, law or engineering, ethics in this field involves several different aspects and people.
  2. Another area of complexity is the number of people not only in organizations, but also in the various financial markets and financial institutions.

According to him, ethics in finance is a function of personal integrity of individuals, ethical leadership and an understanding of ethics in the areas of finance and accounting.19


Xerox Modi Limited (XML) which is the Indian branch of Xerox reported that in the years 1998 and 1999 it manipulated its books to make fictitious payments which were recorded as commissions or discounts. According to the US-based parent company’s own admission, Xerox India paid over US$ 600,000 as bribes to various government employees to win contracts, though it was a serious criminal offence for an American company under the Foreign Corrupt Practices Act (FCPA) to pay bribes in a foreign country to obtain contracts. When these bribes were paid between 1998 and 1999, Xerox India was being controlled by the B.K. Modi group that owned a majority of shares in the joint venture. The fraud came to the limelight after the parent company acquired a majority of shares in 2000 and ordered their audit firm, Price WaterhouseCooper to inspect the accounts. It was then the audit firm made it known that the money went into several fictitious accounts that were yet to be unearthed. Unaccounted cash worth US$ 200,000 was recovered by the Income Tax Department, who then claimed over US$ 5 million of tax evasion by the Indian arm of Xerox.20 This case clearly highlights how the bookkeepers misrepresent information in financial statements to skim money from the company into individual pockets.

This case also clearly shows the blatant robbery by internal managers, and accountants who cleverly diverted money from the company funds into individual accounts. The role of internal accountants is to record accurate, verifiable data in the company’s accounting system. Their primary role is to record correct and timely information which is essentially verifiable by paper trail. In the above case, however, the accountants led by greed recorded false transactions into books as expenses to the company while taking out money into personal accounts.


The Ministry of Company Affairs, on 24 January 2006, proposed to initiate prosecution against Raj Basantani, promoter of SoundCraft Industries Ltd and its auditors. The ministry decided to prosecute the auditors after consulting with the Institute of Charted Accountants of India (ICAI) and Serious Fraud Investigation Office (SFIO). The main business of SoundCraft Industries Ltd. on paper was export of diamond and local trading of diamond. The company reported INR 2,110 million worth of diamonds on its books as stock. Income tax raids, however, confirmed that there was no stock. The company was found to misrepresent the financial position and collect huge amounts of deposits (worth INR 178.2 million) and defaulted in payment. By jacking up the share prices by showing inflated profits, the promoter and auditors have been blamed to have mobilized deposits from general investors. The company also cheated General Insurance Company and New India Assurance Company through preferential allotment of equity shares at inflated prices. The loss caused by the company to UTI and other financial institutions amount to a whopping INR 460 million.21

This case clearly highlights auditors’ brazen disregard for investors’ money by failing to highlight serious distortions in the financial statements of the company that are provided to investors for raising capital.


Former CEO of Computer Associates, Sanjay Kumar was indicted in September 2004 for manipulating finances illegally. Along with Stephen Richards (former head, worldwide sales), Kumar, admitted to fraudulent business practices, such as backdating contracts to show inflated sales and earnings and hence trying to meet analysts expectations. This resulted in a misstatement of revenues to the tune of US$ 2 million. Kumar admitted to flying to Paris to personally sign a contract and backdating the same. He also encouraged this practice within his business unit. Business development managers under him enjoyed millions of dollars of bonuses for meeting their targets using this method. When prosecutors confronted him with these issues, he denied and lied about such activities and sought to cover up his crimes. Kumar took extreme measures like sending people to Hawaii as means to buy their silence.

Investors suffered untold losses when this scam was unearthed. Internal auditors brought down the revenue that was booked improperly for the years 2000 and 2001 by US$ 2.2 billion.22

This case highlights the practices within the management team where managers right from the CEO manipulate and involve in activities which are unethical to the outsiders as well as to the company’s overall health.


The chief financial officer (CFO) of a company is responsible for budgeting and control. Budget is the score-card by which the company is measured. The CFO ensures that an appropriate system is in place to measure the company’s performance. The CFO is also involved in the treasury function, where he or she allocates resources within the context of the budget. He or she identifies the financial resources such as banks, institutional investors, etc., and then begins the allocation of these resources.

In contrast to the responsibilities of a CFO, Prabhat Goyal, former CFO of Network Associates was charged with orchestrating a scheme to inflate the company’s sales and earnings. He was indicted on the grounds of ordering millions of dollars in improper payments to mask the company’s financial troubles. He was also charged with insider trading.23 Prabhat Goyal failed in his duties as the monitor of financial resources and involved in fraudulent practices to cover financial losses.

  • Financial accounting
  • Language of business
  • Financial management
  • Insider trading
  • Financial services
  • Pension
  • Investment trusts
  • Immovable property
  • Collateral
  • Phishing
  • Ombudsman’s jurisdiction
  • Inordinate delay
  • Corporate democracy
  • Rogue industries
  • Escalation in claim
  1. Explain what is covered under the subject financial management. While doing so, distinguish between financial accounting and financial management.
  2. Make a brief analysis of (i) ethical issues in financial markets and (ii) ethical issues in financial services industry. Explain how these issues multiplied several fold due to the growth of use of technology in these sectors.
  3. What are the types of bank frauds? What are the measures available to combat such frauds?
  4. Explain the role of Reserve Bank of India (RBI) in combating bank frauds. To what extent is the RBI’s role effective in curbing the menace?
  5. Discuss the salient features of Prevention of Money Laundering Act 2002. Should the government think of more stringent measures to put more teeth to the Act and make it more effective?
  6. Bring out the salient features of the Banking Ombudsman Scheme 2006. Explain the latest amendments RBI has added to the scheme.
  7. What are the frauds that are generally committed in the insurance sector? How can these be prevented? Suggest some proactive measures Insurance Regulatory and Development Authority can initiate to curb the menace.

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The author is indebted to Reshama Deshmukh, R. Dwarakanathan, his colleague and his banker-friend, and C. Radhakrishnan for the inputs provided by them for writing this chapter.