Employees work in a bank in New Delhi, India (Photographer: Anindito Mukherjee/Bloomberg)

Public Sector Banks More Prone To Frauds, Says RBI’s Financial Stability Report

Frauds across the Indian banking system are rising and public sector banks are the worst hit.

Data released as part of the Reserve Bank of India’s Financial Stability Report shows that the amount involved in frauds rose to more than Rs 30,000 crore in 2017-18. Public sector banks accounted for nearly 85 percent of this.

The increase in frauds comes in a year when government-owned Punjab National Bank detected a Rs 14,000-crore fraud linked to the issue of letters of undertaking. But this may not have been an outlier. Longer-term data provided by the RBI shows that private banks have been far more successful in containing incidents of fraud compared to their public sector peers.

In terms of the relative share of frauds, PSBs have a disproportionate share (>85 percent) significantly exceeding their relative business share (credit and deposit ≈ 65-75 percent).
RBI’s Financial Stability Report

Also Read: Banks’ Gross Bad Loans May Rise To Over 12% In FY19: RBI’s Financial Stability Report

A study of the composition of frauds, showed that the increase in the number of frauds was driven by credit and debit cards along with internet banking. However, in value terms, advances-related frauds contributed most to the total amount involved.

  • 83 percent of the fraud amount involved in public sector banks was linked to advances
  • 10 percent of the fraud amount was linked to off-balance sheet transactions
  • 3 percent of the fraud amount was linked to foreign exchange transactions
  • 81 percent of fraud amount in private banks was linked to advances
  • 11 percent of fraud amount in private banks was linked to foreign exchange transactions

In particular, the instance of fraud related to working capital loans given out by public sector banks was seen to be high, according to the RBI report. This points to coordination issues in implementing the ‘three lines of defence architecture’, said the RBI.

The three lines of defence in bank transactions is what is typically known as the maker-checker-verifier system. The first line of defence is the line function which assumes, owns and manages the risk. The second line of defence are the risk monitoring processes put in place by the bank. The third line of defence is the concurrent, internal or statutory audit.

The RBI questioned why private banks have managed to contain operational risks using such tried and tested mechanisms but public sector banks have not.

Structurally, the operational risk oversight frameworks of public sector banks and private banks is not different. Yet, significant differences realised in operational risk calls for a deeper introspection as to the effectiveness of the oversight of ‘processes’ at the exclusion of ‘outcomes’ in public sector banks.
RBI’s Financial Stability Report

In light of the increased incidence of fraud across Indian banks, the RBI called for a more proactive approach towards addressing operational risks. It added that the information asymmetry between external auditors and internal stakeholders is a way to reduce emerging operational risks.

Recent global reforms aim to put in place institutional structures that incentivise auditors to learn more and internal stakeholders to divulge more about the functioning of the institutions.
RBI’s Financial Stability Report
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