Data: As number of frauds increase, amount involved in frauds decreases
Sai Krishna Muthyanolla
June 13, 2022
Data from the recently released RBI’s annual report indicates that while the number of frauds involving Rs. 1 Lakh or more has consistently increased, the amount involved in those frauds has reduced in the last two years. While advances contribute to most frauds, the number of regulated entities that were levied penalties by the RBI has gone up from 14 in 2017-18 to 182 in 2021-22.
The Central Banks of any nation play a vital role in ensuring economic stability and achieving country-specific developmental goals. Central banks accomplish these goals by performing actions at two levels- macro and micro. At the macro level, the central banks try to safeguard price stability, and thereby manage inflation while at the micro-level, they perform the functions of a lender to the subordinate banks. They are often the lenders of last resort.
The Reserve Bank of India (RBI) performs these similar functions for India. Established in 1935, under the ambit of the Reserve Bank of India act, 1934, the preamble of the RBI describes its functions as, ‘to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth’ .
In addition to these, the RBI has also regulatory and enforcement functions. It derives these powers from the Banking Regulation Act, 1949. Some of the core regulatory powers of the RBI include licensing of banking companies, restrictions on the opening of new or transfer of existing business places, auditing, inspection, and the power to give directions to the banking entities under section 35A. Along with these, the RBI also has the power to impose penalties under Section 47A, and control over the management of banking companies under Part 2A of the above-mentioned act.
With this brief, we look at the performance of RBI in its regulatory and enforcement functions, as mentioned in its annual report.
Banking fraud on the rise
Banking frauds are usually detected after a long period of its perpetuation. Even after the detection, the corresponding banking entities report to the RBI with considerable delay. An assessment of the frauds between 2020-21 and 2021-22 indicates a considerable time lag between the occurrence and detection of frauds. By value, 93.7% of frauds reported in 2021-22 happened in prior financial years, compared to 91.7% in 2020-21. To prevent such delays, the Reserve Bank adopted a reporting system in which the banks follow a timeframe to report a fraud, including fixing of responsibility for any such delay. Any deviation from the said timeframe would invite penal action from RBI under Section 47A of the Banking Regulation Act, 1949.
The data for the frauds above Rs. 1 Lakh shows that the number of instances of fraud is on a rise. Except for a decrease in 2020-21 for frauds corresponding to 2019-20, data from 2014-15 to 2021-22 indicate the increasing number of frauds. The amount involved in these frauds has increased from 195 billion rupees in 2014-15 to 1855 billion rupees in 2019-20. In 2020-21, this was reduced to 1382 billion rupees, which further fell to 604 billion rupees in 2021-22. In other words, while the number of frauds is ever increasing, the amount involved in these frauds has reduced in the last two years.
Advances are still a major contributor to the total fraud
While it is important to know the cumulative number of frauds and the amount of money involved in those frauds, it is equally important to look at the area of operations that significantly contribute to these frauds. In total nine major areas of operations, advances, cards and the internet contribute significantly to the cumulative total. Almost 40-50% of the frauds occur in the advances category, while around 30-40% occur in the cards and internet category. The proportion of frauds under cards and internet category increased from 27% in 2018-19 to 40% in 2021-22, while the frauds under the deposits category reduced from 12% in 2017-18 to 5% in 2021-22.
In terms of the amount involved in those frauds, the advances category accounted for around 55% of the total amount involved in 2017-18. This rose to 90% in 2018-19, which again rose to 97% in 2021-22. The value of fraud in the off-balance sheets was 40% in 2017-18, which significantly reduced to 2% in 2021-22. While the number of frauds in the cards and internet category increased significantly, their contribution to the value of frauds is very minimal or insignificant.
Enforcement and monetary Penalties
The primary goal of the banking sector supervision and enforcement is to ensure financial stability, consumer protection and public interests. A consistent and predictable enforcement mechanism forms the core of the banking system. The enforcement mechanism should be capable of acting as a deterrent for future non-compliances and frauds. Any kind of enforcement action must be well documented so that other regulated entities modify their behaviour accordingly. This enforcement can be both proactive as well as reactive, where proactive indicates cautionary advice, and clarifications, while reactive include imposing penalties and new compliance requirements.
As mentioned earlier, the Reserve Bank of India has powers under Section 47A of the Banking Regulation Act, 1949 to impose penalties on the banks. In addition to this, it draws similar powers from provisions in other statutes like the Section 30 under Payments and Settlement systems Act 2007, Section 30A of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act 2002, and Section 25 of the Credit Information Companies (Regulation) Act, 2005, etc. As can be seen, these enforcement mechanisms were spread across different departments, the enforcement was not up to the mark and not according to international standards. In April 2017, a separate Enforcement Department was set up within the Reserve Bank. This was done to ease the process of enforcement, and to remove arbitrariness by bringing proportionality and evidence-based approach in the process of enforcement actions.
While the RBI can impose both monetary and non-monetary penalties, the maximum amount of monetary penalty that can be imposed is specified in the respective statutes. This could be one of the reasons behind the divergence in the number of penalties imposed and the amount levied. Also, RBI can only impose penalties on regulated entities and not on individuals in charge of those entities or responsible for violations. The number of regulated entities that were levied penalties by the RBI has gone up from 14 in 2017-18 to 182 in 2021-22. The aggregate amount of penalties levied had declined from 1024 million rupees in 2017-18 to 194.10 million rupees in 2020-21. It again rose to 653 million rupees in 2021-22. It is to be noted that Non-Banking Financial Companies (NBFC) were also brought under the scope of the Enforcement Department from October 2018. It decides monetary penalties for NBFCs.
An increasing number of protected accounts under deposit insurance
Bank fraud impacts everyone. But this impact is felt unequally, with the small depositors facing more stress than the institutional or relatively big depositors. Small and medium-sized depositors play an important role in the functioning of the banking system. It becomes imperative to protect their interests and shield them from the adverse effects of bank fraud. For this purpose, the Deposit Insurance, and Credit Guarantee Corporation (DICGC) is constituted under the DICGC Act, 1961. This act was amended in August 2021 to provide a time-bound and interim amount to depositors up to the sum insured in instances of withdrawal limits on banks imposed by the RBI. The number of registered banks that are insured stands at 2043 as of 31 March 2022.
The Financial Resolution and Deposit Insurance Bill 2017, was also introduced along with these measures. It is designed to provide for the resolution of distressed financial service providers and to provide deposit insurance to consumers up to a certain limit. Accordingly, the limit of deposit insurance in India was initially Rs. 1 Lakh which was subsequently raised to Rs. 5 Lakh in 2020. The number of insured or protected accounts grew from 1553 million in 2016-17 to 2567 million in 2021-22. This amounts to 92.3% of the total accounts in 2016-17 which increased to 97.9% in 2021-22. The global benchmark for the percentage of insured accounts of the total accounts is 80%. Clearly, India has maintained, in fact, performed overwhelmingly in this benchmark from 2016-17 to date.
The number of insured deposits also grew consistently with the number of insured accounts. It increased from 28.3 trillion rupees in 2016-17 to 81.1 trillion rupees in 2021-22. Incidentally, there is a huge jump in the number of insured deposits in 2020 when compared to 2019, during which the limit was enhanced from Rs. 1 Lakh to Rs. 5 Lakh. The percentage of accessible deposits is 30% in 2016-17 which further rose to 59% in 2021-22, against a global benchmark of 20-30%. The performance in this aspect has also been exceedingly well.
Decent progress to date, but challenges await in regulatory governance
The times are changing, and global economies are moving towards increased digitalization. New avenues for lending and technological advancements are complicating the regulatory governance of the central banks across the globe. Even in India, the entry of big tech firms and new models of financial institutions are posing challenges to the regulatory role of the RBI. The convergence of big data, digitization of financial services, and the new models of economic crimes make the task of financial supervision and regulation quite complicated.
The RBI had made decent progress in keeping up with the technological advancements in the regulatory space. The Reserve Bank has been making consistent efforts to make supervision and regulatory mechanisms more proactive, and risk-based. It has begun to engage with the regulatory and supervisory technologies to enable seamless operations, right from data collection to the decision-making. It is yet to be seen how these actions effectively translate into better regulation and supervision on the part of RBI.
Technological advancements also are posing existential threats to the central banks. The evolution of virtual currencies using blockchain technology is posing a ‘sovereign’ threat to the central banks across the globe. The RBI is also facing a similar dilemma- to strike a balance between embracing newer technologies, and not losing the sovereignty and regulatory and supervisory control over the financial system. The Government of India is also considering enacting a bill along the lines of ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’. Efforts are continuing to provide a final shape to this bill, and an overarching framework for digital currencies in India. RBI is also said to be making progress to bring in  India’s central bank digital currency (CBDC) from 2023.
It is yet to be seen how the regulatory governance evolves in the space of digital currency, which essentially determines whether the country is capable enough to deal with technological disruptions. In this process, the focus must not be shifted completely from the current regulatory challenges, instead, it must be to improve supervision and regulation in a comprehensive manner.