Bank fraud in Asia

RMA Journal, The, Oct, 2004 by Jee Meng Chen

A sampling of frauds experienced in Asia shows that many "new" frauds are actually old schemes with a new twist. Thus, good old-fashioned due diligence, combined with new technology-based solutions, is called for. Three caveats discussed here are management left unchecked, outdated audit techniques, and packaged deals.

Frauds have been referred to as "unmanaged risks." The term "unmanaged" connotes the practical difficulties associated with managing fraud risk effectively and dynamically. In recent years, while the number of publicized frauds--unauthorized usage of credit and ATM cards, checking account fraud, Nigerian scams, etc.--increased, these cases merely constituted the tip of the iceberg. Estimates are that just 20% of frauds are exposed and made public. The remaining frauds are either undetected or discovered but not made public because of reputation risk.

Past causes of Asian bank crises include lack of depositor confidence due to perceived deterioration in loan quality, unsound lending practices and lax credit controls, uncontrolled diversification into new business segments, overtrading, and liability mismanagement. The framework and technology for bank risk management have improved over time, mitigating these risks.

The risk of fraud--another crisis that can bring down a bank--remains more difficult to predict and manage. The inherent vulnerabilities of the banking and finance system provide a conduit for fraudulent activities. Coupled with an accelerated pace of financial development and an emphasis on realizing short-term returns, bank frauds are likely to increase in Asia, as they may in the rest of the world.

The greater concern, however, is the growing sophistication and complexity of frauds. Banks should contemplate two interrelated issues.

1. Is the risk architecture capable of protecting the institution against fraud attacks? That is, are there preventive controls designed to identify potential fraudulent activities either prior to or at the time of executing a transaction or contract? These controls are the foundation of the bank's overall business processes.

2. In 2003, Asia witnessed a spectrum of frauds. What happened and what are Asia's banks doing to combat frauds? And what should bank and risk practitioners look for in managing fraud risk?

A Review of Fraud Cases

The first step in managing fraud risk is to understand why it occurs. Fraud can be expressed as a function of circumstances x human behavior x opportunities (see Table 1).

Bankers may ask, "What's so special about Asian fraud cases?" Old ways of stealing are being accomplished using new skills. According to well-known fraud expert Courtenay Thompson, being educated on past frauds is a stepping stone to combating current ones, as many "new" frauds are simply old schemes that have returned, sometimes with a twist.

Information theft. While information theft historically has been deemed "low level" fraud, it is generally less complex and therefore easier to perpetuate. Consider this: Pan Asia Bank (PAB) was under investigation for information leaks. Credit histories of nearly 1,000 people were reportedly leaked through PAB's consumer banking service center. Six staff members suspected of involvement in the case had been called in for investigation. Criminals used the names of two people to apply for loans totaling NT450,000 from the Union Bank of Taiwan (Union Bank) and Chinese Bank. Union Bank reported that one of its depositors was a victim of identity theft, in which the customer's name was allegedly used to borrow NT190,000. (1) (NT stands for New Taiwanese Dollar, commonly abbreviated as NT.)

Shipping-related frauds.

* Fraudulent trade deals. Southeast Asia's log industry was reportedly hit by a wave of fraudulent documents. Banks asked the International Maritime Bureau (IMB) to verify the authenticity of documents presented under various letters of credit (LCs) associated with log consignments in Southeast Asia. In most cases, the documents were fraudulent. (2)

* Financing fictitious LCs. Bank Negara Indonesia (BNI) faced huge losses in connection with the alleged issuance of fictitious LCs worth U.S. $200 million between December 2002 and July 2003. A BNI branch disbursed monies to finance commodity exports to Congo and Kenya, but the exports never materialized. Requests for export credit facilities were supported with LCs from little-known banks in Kenya, Switzerland, and the Cook Islands that were not on BNI's list of approved correspondent banks. A total of 105 transactions purportedly were processed without formal assessments. (3)

Maritime or shipping fraud--in particular, documentary credit fraud--is nothing new. Yet although knowledge of trade frauds had grown considerably over time, such cases never seemed to cease. Why? In the first case, greed had lured the defrauded buyers into the trap. Responding to unsolicited offers of "cheap" cargo, buyers readily conceded to making payments without checking the validity of documents and/or background of the sellers. As it turned out, the shipments were nonexistent. The second case probably involved insiders who facilitated circumvention of stipulated controls, without which it would be difficult to explain how 10S transactions could have been approved over time when they were clearly in violation of the bank's guidelines.