Chapter: 6

Malpractices in Banking Sector and Financial Literacy

There are many benefits, which are documented and are expected of increasing Financial Literacy/Education correlated with financial inclusion, which in turn shall have effect on economic growth and development affecting the wellbeing of common man- specially the poor in the world in general and emerging economies like India and its States/ Union Territories. But the History indicates rise of exploitation and white colour crimes of different hues and intensity are also born parallelly in the society.Naturally there arises a question whether the said financial literacy/education can have impact on people indulging in malpractices intentional/negligent/convenience and ignorance related etc. in general and specially in banking field? F.L./F.E. in this connection and for the purposes of this thesis focusses on What types/ How many instances are there; what is the mechanism available to tackle that and how much information, relevant in the context is available as to Law/rules /regulations/ Institutions/instances with outcomes etc along with system of propagation of the entire set of facts for utilisation by others according to one’s own discretion,. The national level information in this regard will be compared with relevant information available for the State of U.P.Physical violence/loot, Dacoity,/theft etc. violent crimes are excluded from this discussion as intention is involved called mense-rea. And knowledge may be an element to prove the crime; hence taking away basic effect of F.L. which is expected to be in the nature of ‘being cause of motivation not to commit a malpractice’. Some of the non violent deviations may fall in the nature of crime itself directly and these can be catagorised as- the Hardcore activities/malpractices.Acts defined as offences in Indian Penal code,1860, are the crimes. Violent ones against property are given in Sections 378 to 402 coveringtheft, extortion, robbery, and dacoity. Financial literacy/ illiteracy have no scope of impacting these activities.

Sections 23,24,25, 28 of I.P.C. Define the words, ‘wrongful gain/wrongful loss/ gaining & losing wrongfully’; ‘Dishonestly’; ‘Fraudulently’; and ‘counterfeit’ respectively, while section 29 defines the word ‘Document’.All the above 18 types of Hard Core Acts are crimes and carry one common element with non- Hard Core type of acts viz. element of fraud. Besides all have to have Intention or ‘Rea’. In these circumstances F.L./F.E. which logically should enhance knowledge and skill and change the behavior for the good, as against Wrong Behaviour, may have very insignificant effect. If at all it can have another dimension that in case the legal Literacy is also combined alongwith F.L. then for bank employees it may be beneficial as they may be able to avoid pitfalls. The third dimension is that clients and common man ,if sufficiently trained in F.L., may help breaking that chain of financial stages/ steps, which together lead to commission of any of the above crimes. Hence,It is a logical observation that in case of crimes per se the F.L. may help bankers to protect themselves, only if Certain level of Legal Literacy is also part of syllabus for F.L.,because the fact remains that a would be criminal may not get swayed by some facts of knowledge/ skill of pure financial nature imparted to him, but the knowledge that stringent punishment is awaiting him ,if caught –this knowledge may act as deterrent and one may change his course.. As far as clients are concerned, their proficiency in financial matters, can also benefit bankers only,(if the perpetrator chooses to desist from committing the crime due to some broken chaindue to some action on part of such financially literate client and not doing any dishonest/ fraudulent etc. transactions), but it may not help the receipient of F.L.,( if he is not directly involved as an outsider and a potential accessory to crime to be committed). Crimes are always Intentional or due to strict liability statute. There are set procedures under criminal justice system to deal with. The victims can be advised to seek remedy under it and as a preventive strategy can be advised to be careful enough to avoid it as far as possible. The remedies are in criminal justice system, serving anyone or more of the punitive motive/ objectives –retributive/preventive/ reformative/vindictive/deterrence etc. If victim reports the crime- State is on his/her side pursuing the case and if it succeeds there is satisfaction in the society at large. If it fails, the victim is unhappy with Justice dispensation system,and not with the business of banking per se most often.It has been observed that if the culprit has been booked and punished under prevailing disciplinary system in the organisation itself, along with recovery of loss , the victims of white collar crime do not wish to get involved also, in the judicial process, most often.

Actually,R.B.I. has classified following as frauds:

  • Misappropriation;
  • criminal breach of Trust;
  • Fraudulent encashment through forged instruments;
  • Manipulation of books of accounts;
  • fictitious Accounts,
  • conversion of property;
  • Negligence and cash shortages;
  • cheating and Forgery;
  • Irregularities in forex transactions;
  • Unauthorised credit facilities extended for reward or illegal gratification.

Borrowal Accounts Related Frauds:

  • Fraudulent discount of instruments or Kite flying in clearing effects
  • Fraudulent removal of pledged stocks/ disposing hypothecated stocks without bank’s knowledge.
  • Inflating the value of stock statement and drawing Excess finance.
  • Diversion of funds outside the borrowing UNIT and criminal neglect on part of borrowers leading to the UNIT becoming Sick
  • R.B.I. has also left one window open for categorising any other act not covered under any of the above specific heads as fraud.

Understanding Fraud:

Frauds are deception filled acts done by persons-natural i.e. Individuals or artificial i.e. legal entities like corporates etc. or both ,on their own ,or in collusion with other similar entities . Intention behind the fraudulent act is always to make a wrongful gain, or/and, cause wrongful loss to some one. often the vehicle for such intentions are misrepresntation, or misstatement, or suppression of essential facts, or misuse of confidence, or breach of trust or dishonesty etc. or any combination of theselegally, wrongs are four types- criminal, civil, tortuous, strict liability statutory wrongs. Frauds happen mainly in three of these four legal domains i.e. criminal, civil, & tortuous. When it involves finance, it is called financial frauds but in India it is not categorisedas a separate crime and is said to be Fraud only but in U.K./USA etc depending upon magnitude of funds being large, financial frauds are a separate offence itself. Criminal dimension has already been discussed to a large extent above. All offences listed in Indian Penal Code and given above are Crimes and all have one or the other fraudulent element present. However, all frauds do not become crime. Although, the word ‘Fraudulently’ is mentioned in section 25 of the I.P.C. but it does not,per se define ‘Fraud”. With reference to banking environment, which is the object of this study, We can say that if an act or omission is done in a contractual situation, involving private/ public /combined funds, which is tainted with elements like cheating/impersonation/breach of trust of criminal dimensions/conspiracy or common object/forgery/ destruction of document/ counterfeiting/ cancellation or alteration or removal of marks/ Falsification of Accounts/ Dishonesty, misapplication/ misappropriation/ embezzlement etc., and intention is to make wrongful gain or cause wrongful loss, then such act or omission is called fraud and is an offence. But word “Fraud’ is used in many statutes as well as Regulatory notifications e.g. R.B.I. as mentioned above, which may not measure upto strict criminal liability required under I.P.C. and as such may not become Crimes per se though remaining into criminal domain. Financial Frauds are also called Scams. It is an act of cheating the public and involves Public funds e.g. Government Funds/Public Deposits/Public Investments and like. It is a matter of public concern and hence Government/ Regulators/Media etc. are so much concerned about it. Generally they are commited in a series of transactions- contractual or otherwise between two or more parties , but the victim Is general Public Interest due to funds being involved being public funds.In case of Scams there is yet another peculiarity- outcry is much louder and proving it is much more difficult. Reason for difficulty is need to prove the intention as sine qua non of criminal justice system. Normally SCAMs do not happen in situations where individuals will be transacting in one to one mode alone.In the domain of civil wrong, frauds are defined in many statutes e.g. law of contract, Negotiable Instruments Act etc.,where primacy is to the personal contractual situations. In the domain of tort, it is an action or abstinence-statutory or otherwise,which causes damage to another. Every body has a right not to be defrauded in any situation. This being a right in rem, if a fraud is done with any body, he/she can approach a court for Damages ,provided following conditions are satisfied-

  • The situation should not be contractual
  • Damage should actually be suffered by the Plaintiff
  • There should be wrongful intent or culpable negligence on part of Defendant

Rights under Tort are against the whole world(in rem), still it is a private right as contrasted with Public right. Violation of it is breach of a common law Duty, arising out of common right, as contrasted from a breach of duty arising out of personal or domestic relations. The complainant can seek redressal in form of damages in a court of Law. Thus Civil or tortuous frauds or irregularities occurring between Bank-Client Relationship are ‘Soft Core’ violations or malpractices according to focus decided for this Study. Some will be of softer category, causing limited loss but high degree of inconveniences. Some will be without loss but appreciable inconveniences. Yet, there will be other inconvenient situations created where local culture may be to ignore one’s own inconvenience and suffer in silence, rather protecting the interest of the person or organisation,which causes such inconvenience etc. of like nature. These all fall in the category of softer but hurtful events/situations.

Dealing with these soft categories of such events/ malpractices is altogether different cup of the tea. The intention to commit such acts may not be there in the first place. Quite often, the “Contract” involved in any human transaction- voluntary or involuntary, for value or without value in it, is not operated or understood properly by both the parties to the transaction. The victim is told about the circumstances which are responsible for any wrong done, and not the bank employee, per se. There is no set system which can deliver quick justice in such cases. The system of dispensation of civil justice system in the country is too slow to give relief to victim of such soft category inconveniences. One copes up with the situation, by cursing the organisation/ bank etc. and trying to become fatalist i.e. cursing one’s own fate for inconveniences caused. If hurt is deep, one may disconnect his/her relationship with the bank and spew venom against it in his own circle, tending to malign the image of the bank- (which may be much greater loss for any financial Institution in the long run but without any satisfaction being derived by the victim in the immediate perspective).Going a step further, if there is an intention present in doing such soft hurtful event, it will still be a Malpractice though malicious.Mostly, it will be an irregularity done by bank’s employees for some motive and always they may be able to take shelter behind some circumstance, which may commonly be used in that particular locality/ community/ culture or some commonly accepted humanitarian issue, to avoid responsibility for the misdeed . The victim may be knowingly or unknowingly compelledto keep quiet and not to raise any hue and cry. There is a kind of camaraderie amongst the employees to defend each other if any one protests. It has been revealed by many victims that they did not know what to do?

From the angle of Financial Inclusion, such malpractices will increase voluntary exclusion in case of bank’s clients, while involuntary/ forced exclusion will result from bank’s side. As discussed in previous chapters the Financial Inclusion will suffer and density of such incidens increasing Net result will be suffering for banking business and overall economy. Hence it is necessary to manage the soft side of malpractices. This has also been called as ‘consumer protection’measures’. Now consumer protection is part of trilogy under national strategy for financial education i.e. financial literacy-financial education- consumer protection.The natural question that arises, is , whether awareness about the functioning of a financial Institution and rules / regulations governing any financial entity, and availability of quick grievance redressal mechanism, along with information about such mechanism also, will encourage people to protest more often, leading to reduction in malpractices in such entities.A hypothesis emerges that in case of financial entities- specially banks, if sufficient level of literacy and education exists in case of a relevant clientele, the operators of the financial system will desist from deviations which are done taking advantage of other’s ignorance.

The traditional view was that existing Legal system should take care of hard and soft malpractices.It did not happen. Finders of non legal methods for dealing with the consumer complaint situation which worsened day by day, since nationalisation of banks in India, came up with hypothesis that increasing competition in the market should make correction in banks’ behaviour as well as clients who will have choice of Institutions, with which to deal. But it has not succeeded for well known reasons and the hypothesis was not proved to the hilt, though it may not have failed totally.The consequential mind set and feelings getting generated in a prudent person’s mind can be depicted in following extract from the speech of E.D. of R.B.I., given at tenth M.R.PAI Memorial Award Function in Mumbai.“An increasing realisation, those competitive forces alone, the invisible hand of the market, do not ensure fair treatment or adequate quality in service to the customers at a justifiable price, in a transparent manner. Regulatory intervention and oversight are necessary In his seminal and oft quoted report, Dr. Rajan stated “Consumer Protection is important. Not every household is fully cognizant of the transactions they enter into. While the line between excessive paternalism and appropriate individual responsibility is always hard to draw in a developing country like ours, it may well veer to a little more paternalism in interactions between financial firms and less sophisticated households. It is important to improve Consumer literacy, the transparency of products that are sold and in certain cases limit sales of certain products in certain jurisdictions especially if these have prudential consequences.”

The above para and Governor Dr. Rajan’s quote indicate towards following:

  • Customers face unfair treatment.
  • Lack of quality in service
  • Unjustified charges
  • Non transparent dealings
  • Customers have unequal bargaining power to their disadvantage.It means that bank not very infrequently take advantage of customer’s ignorance. If it was once in a blue moon it would not have attracted Governor’s attention.
  • Customer’s ignorance about nature of transaction

Remedy suggested is financialliteracy/transparency/ if need be then prudential restriction on sale of financial products /services.Reserve Bank of India as the Central Bank of the country is proactively engaged in initiatives to further Customer Service. First, by building a strong banking system, which enables access to financial services for all and to enhance and expand the reach of the banking system both in quantitative and qualitative terms. RBI, through micro level supervisory processes and macro level assessments, institutes measures to increase Customer Awareness to ensure Customer Protection which is now recognized as an important function – indeed the Dharma of the Central Bank. The post-crisis financial sector is driven by a new paradigm of customer awareness, empowerment and protection. The financial crisis brought into sharp focus the importance of customer protection which underpins the stability of the financial system. Rapid increase in the use of financial services underscores the need for strengthening measures to protect the customers of financial services. We have the largest and most widespread network of Banks in Asia. Banks dominate the financial landscape of our country. The Financial intermediation process offers efficiency, rewards and optimal returns but also poses risks to the customers and hence the active regulatory initiatives on customer protection have gained traction and salience.”

Governor Reddy expressed that “Banking is a trust-based relationship and the banking licence from the regulator provides an assurance of trust to the public at large. To the banks, the banking licence provides the privilege of accepting uncollateralised deposits from the public. However, the acts of stealth banking, negative option marketing, misleading advertisements, and information gathering from customers for cross selling of products and services, and tie-up arrangements are inconsistent with the concept of a trust-based relationship. The lack of transparency, coupled with the difficulty of consumers in identifying key information from the large volume of material and communication in fine print, leads to an information asymmetry, which renders the banker-customer relationship one of unequals."