Bankers’ Banks- The Role of Central Banks in Banking Crises

Central banks are relatively new inventions. An American President (Andrew Jackson) even cancelled its country’s central bank in the nineteenth century because he did not think that it was very important. But things have changed since. Central banks today are the most important feature of the financial systems of most countries of the world.

Central banks are a bizarre hybrids. Some of their functions are identical to the functions of regular, commercial banks. Other functions are unique to the central bank. On certain functions it has an absolute legal monopoly.

Central banks take deposits from other banks and, in certain cases, from foreign governments which deposit their foreign exchange and gold reserves for safekeeping (for instance, with the Federal Reserve Bank of the USA). The Central Bank invests the foreign exchange reserves of the country while trying to maintain an investment portfolio similar to the trade composition of its client – the state. The Central bank also holds onto the gold reserves of the country. Most central banks have lately tried to get rid of their gold, due to its ever declining prices. Since the gold is registered in their books in historical values, central banks are showing a handsome profit on this line of activity. Central banks (especially the American one) also participate in important, international negotiations. If they do not do so directly – they exert influence behind the scenes. The German Bundesbank virtually dictated Germany’s position in the negotiations leading to the Maastricht treaty. It forced the hands of its co-signatories to agree to strict terms of accession into the Euro single currency project. The Bunbdesbank demanded that a country’s economy be totally stable (low debt ratios, low inflation) before it is accepted as part of the Euro. It is an irony of history that Germany itself is not eligible under these criteria and cannot be accepted as a member in the club whose rules it has assisted to formulate.

But all these constitute a secondary and marginal portion of a central banks activities.

The main function of a modern central bank is the monitoring and regulation of interest rates in the economy. The central bank does this by changing the interest rates that it charges on money that it lends to the banking system through its “discount windows”. Interest rates is supposed to influence the level of economic activity in the economy. This supposed link has not unequivocally proven by economic research. Also, there usually is a delay between the alteration of interest rates and the foreseen impact on the economy. This makes assessment of the interest rate policy difficult. Still, central banks use interest rates to fine tune the economy. Higher interest rates – lower economic activity and lower inflation. The reverse is also supposed to be true. Even shifts of a quarter of a percentage point are sufficient to send the stock exchanges tumbling together with the bond markets. In 1994 a long term trend of increase in interest rate commenced in the USA, doubling interest rates from 3 to 6 percent. Investors in the bond markets lost 1 trillion (=1000 billion!) USD in 1 year. Even today, currency traders all around the world dread the decisions of the Bundesbank and sit with their eyes glued to the trading screen on days in which announcements are expected.

Interest rates is only the latest fad. Prior to this – and under the influence of the Chicago school of economics – central banks used to monitor and manipulate money supply aggregates. Simply put, they would sell bonds to the public (and, thus absorb liquid means, money) – or buy from the public (and, thus, inject liquidity). Otherwise, they would restrict the amount of printed money and limit the government’s ability to borrow. Even prior to that fashion there was a widespread belief in the effectiveness of manipulating exchange rates. This was especially true where exchange controls were still being implemented and the currency was not fully convertible. Britain removed its exchange controls only as late as 1979. The USD was pegged to a (gold) standard (and, thus not really freely tradable) as late as 1971. Free flows of currencies are a relatively new thing and their long absence reflects this wide held superstition of central banks. Nowadays, exchange rates are considered to be a “soft” monetary instrument and are rarely used by central banks. The latter continue, though, to intervene in the trading of currencies in the international and domestic markets usually to no avail and while losing their credibility in the process. Ever since the ignominious failure in implementing the infamous Louvre accord in 1985 currency intervention is considered to be a somewhat rusty relic of old ways of thinking.

Central banks are heavily enmeshed in the very fabric of the commercial banking system. They perform certain indispensable services for the latter. In most countries, interbank payments pass through the central bank or through a clearing organ which is somehow linked or reports to the central bank. All major foreign exchange transactions pass through – and, in many countries, still must be approved by – the central bank. Central banks regulate banks, licence their owners, supervise their operations, keenly observes their liquidity. The central bank is the lender of last resort in cases of insolvency or illiquidity.

The frequent claims of central banks all over the world that they were surprised by a banking crisis looks, therefore, dubious at best. No central bank can say that it had no early warning signs, or no access to all the data – and keep a straight face while saying so. Impending banking crises give out signs long before they erupt. These signs ought to be detected by a reasonably managed central bank. Only major neglect could explain a surprise on behalf of a central bank.

One sure sign is the number of times that a bank chooses to borrow using the discount windows. Another is if it offers interest rates which are way above the rates offered by other financing institutions. There are may more signs and central banks should be adept at reading them.

This heavy involvement is not limited to the collection and analysis of data. A central bank – by the very definition of its functions – sets the tone to all other banks in the economy. By altering its policies (for instance: by changing its reserve requirements) it can push banks to insolvency or create bubble economies which are bound to burst. If it were not for the easy and cheap money provided by the Bank of Japan in the eighties – the stock and real estate markets would not have inflated to the extent that they have. Subsequently, it was the same bank (under a different Governor) that tightened the reins of credit – and pierced both bubble markets.

The same mistake was repeated in 1992-3 in Israel – and with the same consequences.

This precisely is why central banks, in my view, should not supervise the banking system.

When asked to supervise the banking system – central banks are really asked to draw criticism on their past performance, their policies and their vigilance in the past. Let me explain this statement:

In most countries in the world, bank supervision is a heavy-weight department within the central bank. It samples banks, on a periodic basis. Then, it analyses their books thoroughly and imposes rules of conduct and sanctions where necessary. But the role of central banks in determining the health, behaviour and operational modes of commercial banks is so paramount that it is highly undesirable for a central bank to supervise the banks. As I have said, supervision by a central bank means that it has to criticize itself, its own policies and the way that they were enforced and also the results of past supervision. Central banks are really asked to cast themselves in the unlikely role of impartial saints.

A new trend is to put the supervision of banks under a different “sponsor” and to encourage a checks and balances system, wherein the central bank, its policies and operations are indirectly criticized by the bank supervision. This is the way it is in Switzerland and – with the exception of the Jewish money which was deposited in Switzerland never to be returned to its owners – the Swiss banking system is extremely well regulated and well supervised.

We differentiate between two types of central bank: the autonomous and the semi-autonomous.

The autonomous bank is politically and financially independent. Its Governor is appointed for a period which is longer than the periods of the incumbent elected politicians, so that he will not be subject to political pressures. Its budget is not provided by the legislature or by the executive arm. It is self sustaining: it runs itself as a corporation would. Its profits are used in leaner years in which it loses money (though for a central bank to lose money is a difficult task to achieve).

In Macedonia, for instance, annual surpluses generated by the central bank are transferred to the national budget and cannot be utilized by the bank for its own operations or for the betterment of its staff through education.

Prime examples of autonomous central banks are Germany’s Bundesbank and the American Federal Reserve Bank.

The second type of central bank is the semi autonomous one. This is a central bank that depends on the political echelons and, especially, on the Ministry of Finance. This dependence could be through its budget which is allocated to it by the Ministry or by a Parliament (ruled by one big party or by the coalition parties). The upper levels of the bank – the Governor and the Vice Governor – could be deposed of through a political decision (albeit by Parliament, which makes it somewhat more difficult). This is the case of the National Bank of Macedonia which has to report to Parliament. Such dependent banks fulfil the function of an economic advisor to the government. The Governor of the Bank of England advises the Minister of Finance (in their famous weekly meetings, the minutes of which are published) about the desirable level of interest rates. It cannot, however, determine these levels and, thus is devoid of arguably the most important policy tool. The situation is somewhat better with the Bank of Israel which can play around with interest rates and foreign exchange rates – but not entirely freely.

The National Bank of Macedonia (NBM) is highly autonomous under the law regulating its structure and its activities. Its Governor is selected for a period of seven years and can be removed from office only in the case that he is charged with criminal deeds. Still, it is very much subject to political pressures. High ranking political figures freely admit to exerting pressures on the central bank (at the same breath saying that it is completely independent).

The NBM is young and most of its staff – however bright – are inexperienced. With the kind of wages that it pays it cannot attract the best available talents. The budgetary surpluses that it generates could have been used for this purpose and to higher world renowned consultants (from Switzerland, for instance) to help the bank overcome the experience gap. But the money is transferred to the budget, as we said. So, the bank had to do with charity received from USAID, the KNOW-HOW FUND and so on. Some of the help thus provided was good and relevant – other advice was, in my view, wrong for the local circumstances. Take supervision: it was modelled after the Americans and British. Those are the worst supervisors in the West (if we do not consider the Japanese).

And with all this, the bank had to cope with extraordinarily difficult circumstances since its very inception. The 1993 banking crisis, the frozen currency accounts, the collapse of the Stedilnicas (crowned by the TAT affair). Older, more experienced central banks would have folded under the pressure. Taking everything under consideration, the NBM has performed remarkably well.

The proof is in the stability of the local currency, the Denar. This is the main function of a central bank. After the TAT affair, there was a moment or two of panic – and then the street voted confidence in the management of the central bank, the Denar-DM rate went down to where it was prior to the crisis.

Now, the central bank is facing its most daunting task: facing the truth without fear and without prejudice. Bank supervision needs to be overhauled and lessons need to be learnt. The political independence of the bank needs to be increased greatly. The bank must decide what to do with TAT and with the other failing Stedilnicas?

They could be sold to the banks as portfolios of assets and liabilities. The Bank of England sold Barings Bank in 1995 to the ING Dutch Bank.

The central bank could – and has to – force the owners of the failing Stedilnicas to increase their equity capital (by using their personal property, where necessary). This was successfully done (again, by the Bank of England) in the 1991 case of the BCCI scandal.

The State of Macedonia could decide to take over the obligations of the failed system and somehow pay back the depositors. Israel (1983), the USA (1985/7) and a dozen other countries have done so recently.

The central bank could increase the reserve requirements and the deposit insurance premiums.

But these are all artificial, ad hoc, solutions. Something more radical needs to be done:

A total restructuring of the banking system. The Stedilnicas have to be abolished. The capital required to open a bank or a branch of a bank has to be lowered to 4 million DM (to conform with world standards and with the size of the economy of Macedonia). Banks should be allowed to diversify their activities (as long as they are of a financial nature), to form joint venture with other providers of financial services (such as insurance companies) and to open a thick network of branches.

The 10 Commandments of Good Governance in Banks

Due to the banking crisis of 2008, the question of how banks can protect themselves against future failures has attracted the attention of regulators, banking experts and business media. An important area is the need for better transparency, mainly regarding remuneration in the banking sector, and how boards of banks should improve their corporate governance practices to reduce the chances of a repeat of the credit crunch.

The recent publication of Central Bank of Egypt draft Code of Corporate Governance for banks marks a significant step in this process. Banks together with their respective boards should pay close attention to the corporate governance guidelines.

There are several tips and recommendations for good governance available for the board of banks. Yet, I consider the following `10 commandments` are central in establishing a sound governance regime:

1-Set the right tone at the top.

The main concerns for the board should include guiding, approving and overseeing the bank’s strategic objectives, corporate values and policies. This could be achieved by developing a code of conduct for the bank employees, management, and board members. Likewise, the board should clearly define areas of responsibility, authority levels and reporting lines within the bank.

2-Adequate qualifications of board members

The board should have adequate knowledge and experience relevant to each of the material financial activities the bank intends to pursue to enable effective governance and oversight of the bank.

To ensure that non-executive directors have the knowledge and understanding of the business, the board should provide thematic business awareness sessions on a regular basis and each director should be provided with a tailored induction, training and development to be reviewed annually with the chairman. Similarly, suitable arrangements should be made for executive board members in business areas other than those for which they have direct responsibility.

Non-executive directors are encouraged to spend more time in the business to ensure that they can participate effectively to strategy and other board decisions.

3-Appoint independent non-executive directors

To foster an independent element within the board, banks must consider that independent directors should constitute a significant membership of the board, and that the board should have at least three independent, non-executives directors. Larger banks may have a higher proportion of non-executive directors.

Non-executives directors should be able to devote sufficient time to the role in order to assess risk and ask tough questions about strategy.

In UK, there are recommendations for banks to appoint a senior independent director (SID) whose role is to provide a sounding board for the chairman and serve as a trusted intermediary for the non-executive directors, when necessary.

4-Establish board-risk governance

Banks should establish a board risk committee to work in tandem with existing audit committee. The risk committee would concentrate on risk strategy and management, free from any conflict with demands placed on audit committees. The risk committee would report regularly (as part of the annual report) on risk strategy and risk management. The risk committee has authority to seek external advice to test its risk management assumptions, particularly in the context of risk related to significant banking transactions.

Given the importance of an independent risk management function, banks should appoint a chief risk officer (CRO) with sufficient authority, stature, independence, resources and access to the board. This executive should be reporting to both the risk committee and internally to the CEO. Removal of the CRO should be subject to board discussion and public disclosure.

5-Expand scope of the remuneration committee

The scope of the remuneration committee should be expanded to cover all aspects of remuneration policy on a bank-wide basis with particular focus on the risk dimension. The remuneration committee is responsible to review the compensation philosophy and major compensation programs.

In order to reduce the perceived excessive risk-taking within banks, this committee will also be expected to approve the links between performance targets and pay or bonus schemes. At least half of bonuses should be paid in the form of a long-term incentive scheme.

6-Develop Information Technology (IT) governance

IT governance provides the structure that links IT processes, resources and information to the bank’s strategies and objectives, enhances effective board decision-making and creates greater transparency and accountability. IT governance ensures that related risks are properly identified and managed. The board needs to approve IT expenditures and provide adequate oversight over all aspects of IT governance, including procurement, outsourcing, the efficiency of systems and procedures, IT security, customer data protection and adequacy of anti-fraud and anti-money laundering systems.

7-Improve efficiency through board evaluation

The board and board committees should be subject to a formal and rigorous performance evaluation with external facilitation of the process every three years. The evaluation statement should either be included as a dedicated section of the chairman’s statement or as a separate section of the annual report, signed by the chairman. Where an external facilitator is used, this should be indicated in the statement, together with their name and other meaningful details for the shareholders.

8-Manage conflicts of interest effectively

Banks should establish information barriers (“Chinese walls”) between the different departments so that decisions by staff in one department are made in ignorance of confidential information available to staff in other departments which might affect their decision. Conflicts by board members or senior executives should be disclosed to the banks’ compliance officer. A good corporate governance practice is to put in place and disclose a conflicts of interest policy.

9-Monitor the governance of banks’ clients

It is important for banks that their clients apply the principles of good governance. Banks may consider that it is in their own best interest to check the governance framework and practices of their corporate borrowers. Even in circumstances where a bank cannot directly influence the governance practices of their borrowers, it can have an important influence by “leading by example”.

10-Track potential governance failures

Banks should have in place a policy setting out adequate procedures for employees with concerns about the integrity of the bank’s operations or its staff (so called whistle blowing policy). Employees should be able to communicate their concerns with corporate protection from retaliation from the management. The procedure should facilitate the flow of confidential and direct or indirect communication to the board (or Audit Committee) outside the internal “chain of command”. The establishment of proper communication channels would allow bank staff to discuss their concerns in confidence without fear of retaliatory action.

Conclusion

Good corporate governance is crucial for today’s complex and dynamic banking environment to ensure long-term sustainability and trust of stakeholders including regulators, investors, clients and employees. Therefore, it should be cultivated and practiced regularly within banks at board and executive management levels. Remember; Corporate governance is like a muscle, should be exercised or it will atrophy!

Hany Abou-El-Fotouh is Chief of Staff & Group Board Secretary, CI Capital Holding – the investment banking arm of Commercial International Bank which is the largest private bank in Egypt. He provides advice and direction to the Board and management with respect to corporate governance practices and formulates corporate policies.

Hany is a leading expert on money laundering and terrorist financing controls in the MENA region. Founder of the Middle East Compliance Officers’ Forum (MECOF), he has been honored for his work in promoting compliance culture and awareness in the MENA region

Hany writes articles to different newspapers and journals on a variety of subjects. He is a public speaker and professional trainer. Previously, he worked in various senior positions in leading banks in Egypt and GCC countries like HSBC, Oman International Bank, Banque Saudi Fransi among others

The Proposed Islamic Banking By Central Bank of Nigeria – The Way Forward

The Banking institution is a place where individuals or corporate organizations alike deposit their money for personal or business transactions for the purpose of savings, current or fixed transactions that would yield profit over a particular period of time. Nigeria as one of the growing economies of the world has taken the right step to restructure the banking system in the country. Dating back to the year 2005 where all the existing banks were mandated to re-capitalize to a minimum balance of Twenty five billion Naira or risk losing its operating licenses during the leadership of Prof. Charles Chukwuemeka Soludo, the then Governor of Nigeria’s apex bank, Central Bank of Nigeria.

Interestingly, this paved way for an organized and thriving banking sector where some of the banks met the expected benchmark while others merged and few dropped by the wayside. Nonetheless, this reform created free flow of capital funds for the banks to play around with – ushering of universal banking. One would not forget the role the banks played in the Capital market during the boom era where investors’ borrowed loans or applied for a margin loan facility from these banks ranging from 7% to 20% interest rates in order to reap bountiful profits on their appreciated stocks invested. Unfortunately, the proliferation of all manner of deals in our capital market over time accounted for the down turn of the economy. It must also be mentioned that Africa was not alone in this economic impasse as most countries of the world suffered the same fate including the United States of America.

In their bid to restore the good old days, economic experts and world scholars proffered solutions to revive the economy. Nigeria was not left out in the fight. With the emergence of Mallam Sanusi Lamido Sanusi as the next Governor of Central Bank of Nigeria succeeding Prof. Charles C. Soludo, he swung into action to continue on the good works of his predecessor. Between 2009 and 2010, about five bank chiefs were indicted and prosecuted for wrong use of depositors funds ranging from personal misappropriation of funds, unauthorized loans with no collateral and wasteful expenses. While others are presently on trial. Having seen the good works of the new Central Bank of Nigeria Governor, the Presidency recently established the Asset Management Corporation of Nigeria. The objectives of the Asset Management Corporation of Nigeria is to acquire ‘toxic’ assets of the troubled banks and would take majority shareholding of the insolvent banks after plugging their equity shortfalls. The public commentators commended the government for this initiative which gradually restored the confidence of the investors to invest in both the money and capital markets. No wonder in 26 April 2011 the prestigious Times Magazine honored Sanusi Lamido Sanusi as one of the 100 Most Influential People in the World in a grand Time Gala Award ceremony held in United States of America. Though, in as much as the reforms may seem to check the excesses of the bank operations, the adverse effects are quite frightening as the capital and money markets are presently witnessing low investors confidence following another purchase of three banks (Afribank, BankPHB and Spring Bank) by three relatively unknown companies (Main street, Keystone and Enterprise) respectively on August 5th, 2011 by the Sanusi led Central Bank of Nigeria.

However, at the beginning of 2011, Mallam Sanusi Lamido Sanusi re-opened the implementation of Non-interest banking, popularly known as Islamic Banking, which was initially introduced by his predecessor as one of the verifiable tools to revive the negatively skewed economy. According to Wikipedia, Worlds free encyclopedia, “interest-free banking seems to be very recent origin whereby a working partner gets a greater profit share compared to a sleeping (non-working) partner” What this simply means is that both the banks and investors (working partner) would get a greater profit share after a certain business transaction. One would ask, would this build the economic growth of the nation as being practiced in United Kingdom, Malaysia, etc? Definitely, it would build the fortunes of our economy but how we go about it is what is technically wrong. Please read Business day online of 29th June, 2011 for more explanation. The CBN Governor has the right to talk about the benefits of any product or scheme the apex bank is rolling out, but attaching more of the religious sentiments than professional cum economic gains, would sway the country to a very rough edge.

This proposed style of banking has generated heated arguments and debates across sections of the country. Remember that Nigeria is a secular state with almost equal number of Christian and Muslim faithful in population not to talk of other religious and traditional groups. For instance, the leadership of the Christian Association of Nigeria (CAN) has strongly opposed to the implementation of the Islamic Banking citing some wrong approaches by the Sanusi led Central Bank of Nigeria as using the state funds to promote the implementation of the scheme with no recourse to other religious groups in the country. The country is still facing serious security threats arising from kidnapping, militancy and most worrying, the terrorist attacks by the dreaded sect, Boko Haram especially in the Federal Capital (Abuja) and other northern parts of the country. It is surprising to know that the Presidency have been silent on the matter which needs an urgent intervention to put the facts right as the masses want better governance in terms of economic and social-political gains.

Whatever the outcome of the proposed Islamic Banking by the Central Bank of Nigeria would be, the apex body should please consider the following points as the way forward:

1. That the implementation processes of the non-interest (Islamic) banking should be done in strict adherence to the laid down procedures of the regulatory authority – Central Bank of Nigeria.
2. That It should also have greater benefits for the investors of the Islamic banking without directly or indirectly affecting other investors of interest banking in the same sector.
3. That the Central Bank of Nigeria should please continue to create more public awareness of the non-interest (Islamic) banking by having a round table discussion with all stake holders which includes: Religious sects, Economic experts, Law makers, Government officials and the Media to douse any misconception of the proposed scheme.

The fact that the non-interest (Islamic) banking with its’ numerous economic benefits as been practiced by some countries of the world, the Central Bank of Nigeria under her current leadership have to convince the over enlightened 55% Nigerians on its benefits without negatively affecting the other interest party for economic growth and tranquility.

The “Why Investment Banking?” Interview Question – How to Give a 10/10 Answer

In a sea of overachievers who are equally talented, likeable and prepared, the “Why investment banking?” interview question can be the only differentiating question left for bankers to ask; making it both a popular & decisive question.

Whilst for college students who don’t look like aspiring bankers on paper (i.e. no fin/acc major, business degree or relevant work experience) it’s of epic importance. After all, you guys need to be able to explain why you want to do investment banking when your past decisions don’t suggest anything of the kind.

How do you give a 10/10 answer to the “Why investment banking?” interview question?

There’s a huge selection of points you could make, but keep it short and sharp. Generally a good answer will contain 3-5 solid reasons why you’re interested in IB.

Typical examples like world class education, skills development, type of work, the challenge, real responsibility in billion dollar transactions etc. are all acceptable.

But try not to trot out the same BS as everyone else.

Importantly, avoid reasons that are self-centered in a ‘bad’ way

Let me explain. As a banker interviewing you I’d be OK if you mentioned investment banking attracts you because of the learning opportunities, as this is a selfish reason that also, and ironically, benefits the bank – passionate 24 year olds put in 100-hour work weeks with ease after all.

But if I heard you wanted to do IB simply in order to ‘build your resume’ and/or to secure an exit opportunity I would – in my mind at least – throw you out the freaking door and then proceed to lay a BlackBerry beat down! Being made to feel like a halfway house for financial vagrants, a mere stepping-stone, is not my idea of good times you see. So even though everyone knows investment banking is attractive for the resume & exit oops don’t say it!

What can help you avoid a BlackBerry Beat Down? Well, you would get me extremely interested if you answered the “Why investment banking?” interview question by talking about how you have older friends in banking who have over the years shared with you what it’s really like to be a banker – both the good and the bad.

And then how that’s made you realize 3 specific things about banking which make it stand out above any other graduate job.

Not only will I believe you still love banking despite the war stories, but that you’ve actually given it some thought beyond “I need a salary of Blankfein proportions if I’m ever going to pay off these student debts”.

What I’m trying to say is that a great answer will list unique and specific reasons ‘why investment banking’ and it will connect them to the sources you learned them from whether they be friends, professors, books etc.

Want 6 specific reasons ‘Why investment banking’ that are sure to work? Try talking about how you love the…

Cornerstone role investment banks play in deals and/or the role they play more broadly within the world of business – IBs are to business what the White House is to the world…central hub HQ! And this is why bankers are called masters of the universe. So bring up this point, albeit laced in more formal language and without ever mentioning ‘masters of the universe’!!
Coalface exposure to industry and financial markets, which is unique to IB – there’s not a graduate job on the planet that puts you closer to the action than banking.
Results-driven deal-oriented approach – this point distinguishes banking from so many other professions like law, consulting etc, where players often get paid for simply ‘doing’, as opposed to ‘achieving’. And by specifically mentioning this point you will show bankers that you’ve got the right mentality and that you’re not an increment-fiend like lawyers. PS Once again be sure to phrase this in a more professional kinda way!
Type of people that work in banking – talk about this from both a learning and enjoyment point of view, and most importantly reference people you know in banking (particularly at that bank) to avoid looking like you’re simply shining shoes and kissing ass!
Nature of the work – analyzing, problem solving, real-world focused. If you are going to talk about this then make sure you bring up a handful of examples in passing; eg 10k analysis, spreading comps, deal structuring etc.
The specific industry/product group you are interviewing with – this is a must! By talking about why IB through the lens of that specific group, you’ll really narrow the reasons down to specific, tangible, relatable ones – and that means bankers are more likely to believe you and like you. eg If you say to Goldman Sachs TMT that you want to do investment banking because you find the business/investing side of the tech industry fascinating after working as an unpaid intern at a social media start up over summer, then you’ll hit the “Why investment banking?” question out of the park!

Whatever you choose, be sure you can talk intelligently about it if probed by the bankers.

Special note for those of you with non-banking experience

If you have work experience in accounting, consulting etc. then tell the bankers that whilst your time at KPMG or BCG or wherever you worked was a terrific experience, it didn’t offer…[reasons why you love IB].

This is a hidden opportunity to further explain your story, point out why you want to change into banking now and assure them again that IB is what you truly want above all else.

Any comparison you make should be delivered subtly though. Not because your interviewer might have worked at KPMG or BCG, but simply because it looks unprofessional to blatantly badmouth others. Negativity in any form doesn’t look good.

Special note for aspiring investment banking analysts

PS for those of you who get this question in an investment banking analyst interview (ie not a summer internship interview), you’ll need to push your story of why IB even harder to convince bankers to take you on. This is because bankers hate offering permanent spots to candidates who might quit the minute things get tough.

Passion is a banker’s best insurance policy against this – so make sure you show it guys!!

If you want to go one step further and really impress the bankers with your answer, then tell them how you became interested in IB years ago and point to the real life things you’ve since done that have confirmed your passion; studies elected, college clubs joined, people met, friends talked to, books read, jobs taken.

Showing a long and considered journey to get into investment banking is the idea here.

What’s the final secret to a magic answer here?

Recognize the downers of banking, not just the uppers. Bankers you see, want to hire students who aren’t being drawn to banking based simply on Hollywood-hype or CNBC-glamor. They want to know you are realistic about the job, prepared to do grunt work, and yet still super passionate.

After all, the Jimmy Cramer fan club and the Gekko Wannabe students will never be able to hack it when they find out what investment banking really involves – and this sort of drop out costs the banks a bomb.

So with all that in mind, during your answer briefly mention how your friends in banking have clued you in on the realities of the job too – the long hours, sacrifice and other downers which we’ll talk candidly about in the Inside Investment Banking System when it comes out this fall.

Of course, don’t end your question on a downer – meaning be sure to follow up any reality checking with your 3 main reasons why IB repeated in very very short form, kind of like “…but of course banking is an easy choice for me, because of…”.

Now that you’ve conquered the “Why investment banking?” interview question, check out our advice on other common investment banking interview questions and answers now.

Richard is the head writer for Inside Investment Banking – a one-stop shop of advice for students just like you who want to know how to get into investment banking without a 4.0 GPA from Harvard or nepotistic connections on Wall Street.

Created by a team of 5 young bankers, Inside Investment Banking contains all the real insider advice you need to write killer banking resumes, answer tough interview questions, network with bankers and much more.

Mobile Banking Grows More Popular Each Year

The term “Mobile Banking” has grown in popularity in recent years, especially with the proliferation of cellular phones around the world. The term does not refer to specific technology, but instead is broadly used when discussing several different methods of using your mobile phone to perform various banking tasks, such as checking balances, transferring funds and making payments. Some mobile customers bank via text messaging, others by accessing their bank’s on-line banking web site via their Smartphone browser, and yet others by using bank-specific applications developed for the mobile phone. Whichever method is selected, the overall trend is the increasing popularity of mobile banking in all demographic groups.

At the end of 2012, a survey and report were prepared by the Consumer Research Section of the Federal Reserve Board’s Division of Consumer and Community Affairs, known as the DCCA. It was a follow-up to a similar study done the previous year. All findings indicate that Smartphones are becoming more and more ubiquitous in the U.S., and as a result, banking via Smartphone is on the rise. The reasons are obvious – portability and convenience make Smartphones a logical choice for keeping track of your finances. And more banks have apps available to mobile customers for a variety of devices, making it even more readily accessible and simple to navigate, even for novice users.

How many mobile owners utilize mobile banking?

87% of adults in the U.S. own a mobile phone, with 52% of those being internet-enabled; the technology referred to generically as Smartphones. Mobile phones that are not able to access the internet can bank via text message, but the survey reports that Smartphone users are much more likely to utilize banking applications than those with non-internet phones. 48% of Smartphone users have taken advantage of mobile banking, but the overall percentage of cell users banking by phone is just 28%. Even that number is on the rise, up from 21% at the end of 2011. Another 10% of cell phone users responded that they most likely would begin during 2013, indicating that the trend will continue. Of course the mobile phone has a wide variety of uses, with banking being far down on the list. It has been noted that even making phone calls is far less common on Smartphones than checking the time, browsing the internet and playing games.

What groups are most likely to bank by phone?

Younger mobile phone users are much more likely to adapt banking via their mobile than their older counterparts, with over 38% of those aged 18-29 banking on their phone versus just 8% of those over the age of 60.
The higher the household income, the more likely a person is to have banked via their phone, with those earning over $100,000 per year at a 28% usage rate compared with 16% for those earning less than $25,000.
Education also factors into banking on a mobile, with 37% of college graduates having banked by mobile phone while less than 6% of those without a high school education have done so.

What kind of banking do people do via their phones?

The study found that by far the most common banking task initiated via mobile phone was balance and transaction checking (87% of mobile banking customers), followed by the transfer of cash between accounts (53% of mobile bank users). On the rise is the usage of mobile devices to deposit checks, by utilizing a service such as Mobile Deposit, which allows bank customers who are Smartphone users to deposit a check into their account by taking a photo of each side of the check and submitting it to the bank via a Smartphone app. 21% of mobile banking users have utilized such a service.

Why don’t people use mobile banking?

Of those surveyed who did not utilize mobile banking, there were 2 common reasons why. The most frequent response was that other banking methods were more useful and convenient, and the customer could see no reason to start banking by phone. The second most cited reason was a concern for the security of their information and finances. In reality, mobile banking applications do offer a high degree of security, with data encryption, strict user authentication and connection limits. If in doubt about the security of your bank’s mobile application, visit their web site or contact a bank representative for additional details.

The Federal Reserve report is available for viewing on-line at the Federal Reserve web site for those interested in additional details. It does seem clear that the trend toward mobile banking is firmly implanted in our current culture, and will continue to expand as technology brings us even better security and fast, easy-to-use applications for managing finances. If you are a mobile phone user who doesn’t utilize mobile banking, contact your bank for details about their options and how to get started!

U.OL Defining “Commercial Banking”

“Commercial banking” was defined in the previous edition of this book as the activity of a banking institution whose “principal business is to accept deposits, make loans, collect commercial paper, and arrange the transfer of funds.” Under the banking law from the adoption of the Glass-Steagall Act in the 1930s until the beginning of the 1980s, there was a distinct demarcation between commercial banks and other financial institutions, such as investment banks, securities firms, and commercial financial services conglomerates.

AH this is changing. The types of institutions that can engage in traditional commercial banking functions have enlarged as a result of legislation giving additional powers to thrift institutions. The types of activities commercial banks engage in have expanded as a result of legislation at both the state and federal levels and as a result of judicial decisions dismantling parts of the wall erected by the Glass-Steagall Act to keep commercial banks insulated from the risks of dealing in securities. The “nonbank bank” explosion has started a restructuring of the banking market into holding companies capable of offering an array of financial services. In light of these developments, perhaps the most suitable definition is one offered by an English texi: “[B]anks come in all shapes and sizes, with different name tags applied indifferent countries, often quite loosely. Banks make most of their money from the difference between interest rates paid to depositors and charged to borrowers.” Commercial banks are “publicly quoted and profit oriented. They deal directly with the public, taking deposits, making loans and providing a range of financial services from foreign exchange to investment advice. Most countries have settled for between four and ten;” but in the United States there are nearly 15,000 because of “banking laws that have prevented banks operating in more than one state, and in different types of business,..

In addition to commercial banks, there are many specialized depository institutions that have been established to perform specialized roles. Thrift insti­tutions such as savings and loan associations and credit unions are important examples. At their inception, savings and loan associations primarily engaged in home mortgage lending and offering passbook-type savings to consumers. With the enactment of the Depository Institutions Deregulation and Monetary Con­trol Act of 1980, thrifts gained expanded authority to engage in commercial banking activities. Further incorporation into the general banking market has occurred as a result of the restructuring brought about by the financial failures and weakened condition of thrift institutions in the 1980s, which led to changes in the law to encourage the acquisition and merger of weak institutions with stronger financial institutions, including banks. To a great extent, thrift institutions are subject to a regulatory regime similar to that governing commercial banks, and engage in banking functions similar to those of commercial banks. Subsequent chapters discuss how thrifts fit into this regulatory scheme.

There are other specialized consumer-oriented financial companies. Credit unions may be organized under state and federal statutes with the power to maintain customer share accounts against which drafts may be drawn payable i n a manner similar to checks. There are also personal finance loan organizations authorized under the laws of the several states that loan small amounts of money to consumers, often at specially regulated rates that are higher than the usual interest rates allowed. These organizations normally are not deposit-taking institutions but operate with their own capital and credit. Banks often have their own small loan depart­ments to make the same type of loans, and holding companies may have special consumer loan subsidiaries or affiliate companies.

Although trust activities have become a part of the activity of many com­mercial banks,1 this book does not deal with the laws that govern these trustee relationships and activities. The competition for funds has led some banks to offer managed investment accounts through their trust departments similar to those offered by mutual funds and other securities firms. Again, there are trust companies organized under state law that operate by accepting money for the purpose of investment where the beneficial interest in the funds remains in the original owner.

There are other types of banking functions and specialized banks: for exam­ple, reserve banks, which are really bankers’ banks; investment banks, whose chief business is underwriting and dealing in securities, and providing financial advice and aid in corporate acquisitions and mergers; agricultural banks; foreign trade banks; and other specialized banks that have charters to engage in particu­lar types of business. Further, the peculiarities of federal laws regulating bank holding companies have encouraged the proliferation of various financial institutions that have been chartered as full-service banks but that limit their functions to activities such as consumer lending and credit card operations.

Because of the diversity of functions of commercial banks and the variety of depository institutions involved in them, this book does not attempt a compre­hensive survey of all banking activity. Rather, it emphasizes the basic regulatory structure that governs traditional commercial banking institutions and the com­mercial activities associated with accepting deposits, collecting commercial paper, making payments and transferring funds, and engaging in certain credit transactions.

As this introduction indicates, the laws and regulations that govern com­mercial banking are numerous and complex. The various types of financial institutions engaging in commercial banking activities are matched by an equal activities. The Depository Institutions Deregulation and Monetary Control Act of 1980 also gave thrift institutions chartered by the Federal Home Loan Bank Board the author­ity to engage in trust activities under certain conditions. 12 USC § 1464(n) (1982).

In addition, the law governing the transactions of commercial banks is complex. The Uniform Commercial Code has brought a desirable uniformity to the law in many areas, but there are many special purpose statutes, frequently intended to give special consumer protection, that must be taken into account in analyzing banking transactions. There is a growing body of federal law that must be considered along with the state commercial law of the UCC and common law. This book is intended to serve as a beginning guide for the bank officer engaged in these commercial banking transactions and the attorneys called upon to advise in banking matters. It is not a substitute for careful legal counsel, how­ever, and such assistance should be obtained because this book can neither cover all the details applicable in particular matters, especially at the regulatory level, nor report on all the local variations, changes, and new developments. More­over, the facts of a particular situation will vary in ways that may introduce new legal problems or otherwise affect the legal analysis. Obtaining the advice of competent legal counsel is essential.

How to Open an Offshore Bank Account As an American

With the world in chaos and bankrupt governments everywhere dreaming up new schemes to get their hands on your hard-earned money, more and more people are looking offshore for a place to move some of their assets.

I don’t encourage you to sit around and wait for some three-letter agency to swoop in a decide to dip into your retirement funds or bump up your tax rates or devalue your money by firing up the printing press. In a connected world, opportunities out of your home country are everywhere, and to make the most of your money and your freedom, you should explore those options.

There’s nothing illegal about having an offshore bank account. At least for now. While Hollywood has created a scene where those who bank out of the country are briefcase-carrying criminals or guys in Tommy Bahama shirts flying prop planes onto tiny island landing strips, nothing could be further from the truth. Your government doesn’t want you to move money to another country because it makes it more difficult for them to tax.

When I said it’s not illegal “for now”, I mean that you can never tell when things will get so bad that any loose change that can be grabbed to prop up a failing country will be grabbed without a second thought. The debacle in Cyprus has shown us just how desperate things could become. Sure, the EU can spin it as a tax on the Russian mob, but you know the government will always make up an excuse for their dirty deeds.

As an American, you’re at a disadvantage thanks to FATCA – the Foreign Account Tax Compliance Act. Washington wants you to believe that the only people keeping their money offshore are rogues and scoundrels. Never mind the six million Americans living and working in other countries. As such, they’ve imposed a draconian set of rules on foreign banks, basically making them as well as their sovereign governments a bunch of tattletales for the IRS. Some banks have given up on Americans altogether. But there is still hope.

First, put out of your mind the idea that “offshore” means somewhere where you can sit on a shore. Islands with crystal blue waters are not high on my list of offshore jurisdictions. If you’re an America, anywhere out of the United States is an offshore jurisdiction. Think Hong Kong, Singapore, Chile, and so on. While it is also associated with offshore banking, Switzerland is no longer available to Americans, thanks to IRS crackdowns there that have led most banks to shun US citizens.

Second, know that the days of numbered bank accounts and intense secrecy are over. Just ask the millionaires who got turned over to the US government. There are several short forms you will need to fill out each year, one with your tax return, another sent in separately. If you’re a US citizen or resident, you must declare any accounts – or combination of accounts – with a value of at least $10,000 at any time during a calendar year.

Third, focus on your goals. Once you’ve moved beyond the cliches and propaganda about offshore bank accounts, you can focus on what you really want. No, you’re not going to be able to hide a bunch of money from the tax authorities. Yes, you will have to pay tax at home on any interest you earn. But while your account won’t be a secret to your home government, you will have separation from them. Some bureaucrat with a fat finger won’t be able to freeze your account with one keystroke. It will be harder for an ambulance chaser to get at. And while you will have to pay tax in the US on interest earned, that interest rate could be double, triple, or even fifteen times higher than what you’re earning now.

Determine what you’re looking for in a bank account. Do you want a simple place to store savings away from the grubby hands of your local government? Do you want to hold part of your money in a different currency or currencies to diminish your sovereign risk? Do you want to earn a higher interest rate or benefit from appreciation of a foreign currency? Or do you want sophisticated wealth management tools and private bank service?

Fourth, once you know what you’re looking for, find the right environment for you. The good news is that most of the goals above can be had with just about any offshore account. Just having a portion of your assets out of your home country gives you more freedom. If the government here goes Argentina on you and imposes capital controls, you’ll have a nest egg you can access somewhere else. Any good offshore bank will give you a debit card to access your cash, as well.

Unlike in the United States, most foreign banks offer accounts in a multitude of currencies. Think the Australian dollar will go up thanks to a resources boom? No problem; you can hold it in your account. With most banks, you can swap out to another currency later if you change your mind. You can often times hold multiple currencies in the same account at once.

In Andorra, for instance, you can actually write checks in any currency the banks offers. If you need that kind of flexibility, Andorra is a great place to bank. It’s also one of the most stable jurisdictions in the world, with liquidity and capital ratios that blow away the US or most other “safe” banking jurisdictions. Banks are locally run by banking families that provide personalized service.

Because offshore banks offer multiple currencies to bank in, you can also choose your interest rate. While rates in the US are near zero, making savers suffer, rates in Australia and New Zealand are much higher. The governments there didn’t play the race-to-the-bottom game that their western counterparts did. Banks both in Australia, and those offering Australian dollar deposits, routinely offer near 5% interest rates on savings – even short-term savings – at a time when you’re lucky to get 0.75% in an online account in the US. If you want to branch out to an emerging destination like Mongolia, you can earn up to 15% on your money.

If you like the stability of the US dollar but want higher interest, places like Georgia, a small but economically robust emerging nation in the Caucasuses offers as high as 7-8% interest on medium-term deposits not in their local currency, but in US dollars. Georgia is one of the twenty most economically free countries in the world (the US is tenth) and not a bad place to earn some extra interest.

Fifth, consider the risks. Americans are used to $250,000 in deposit insurance from the FDIC. Some countries, like Mongolia, don’t offer such insurance at all. Others have lower limits, or don’t insure deposits in certain currencies. For the most part, countries around the world have enacted deposit insurance plans of some type to keep peoples’ money safe. But it’s up to you to do the research on each jurisdiction and each bank and determine where you’re most comfortable.

Keep in mind that the FDIC, for example, has less than the equivalent of 0.5% of all bank deposits in its fund. To me, that’s not very safe when you consider how thinly capitalized US banks are. While local banks in Hong Kong and Andorra have very conservative lending practices and high liquidity ratios, US banks get money from the Federal Reserve and go right out and loan it indiscriminately and then come running to the government when things go bust.

The FDIC may pay out if your bank goes bust, but consider the decline in the US dollar over the last few years and over the last decade. The dollar just isn’t what it once was. If the US banking sector had another run of bank failures like it did in the recent recession, you’d see more “Too Big to Fail” type nonsense, and as a result, more money printing to pay off depositors. So you might get your money, but it wouldn’t be worth as much.

Of course, deposit insurance wasn’t of much use in Cyprus, where the European Union basically forced the country to dip into bank accounts – first for 7 to 10%, then for much more – to keep from going bankrupt. Tens of thousands of dollars of your money could have been wiped away in an instant, with no way to get it out as the government kept banks closed until they could figure out just how much of your money to steal.

The good news is that having an offshore bank account isn’t shady, scary or difficult to open. In some cases, you can open one with a couple hundred dollars or even less. In some cases, you have to visit the country, which could be easy if you live near the Canadian border, for instance, or are taking a vacation sometime soon. There are, however, banks in Norway, Gibraltar, the Channel Islands (UK), and elsewhere where you don’t need to visit to open your account. You can do it all through the mail.

When you realize all of the things going on in the world today, you just might wonder why you didn’t look into getting a bank account out of the country earlier.

ENTREPRENEURIAL CHALLENGES – The Case of Royal Bank Zimbabwe Ltd

Industry Shake-up

In December 2003 Mzwimbi went on a well deserved family vacation to the United States, satisfied with the progress and confident that his sprawling empire was on a solid footing. However a call from a business magnate in January 2004 alerted him to what was termed a looming shake- up in the financial services sector. It appears that the incoming governor had confided in a few close colleagues and acquaintances about his plans. This confirmed to Mzwimbi the fears that were arising as RBZ refused to accommodate banks which had liquidity challenges.

The last two months of 2003 saw interest rates soar close to 900% p.a., with the RBZ watching helplessly. The RBZ had the tools and capacity to control these rates but nothing was done to ease the situation. This hiking of interest rates wiped out nearly all the bank’s income made within the year. Bankers normally rely on treasury bills (TBs) since they are easily tradable. Their yield had been good until the interest rates skyrocketed. Consequently bankers were now borrowing at higher interest rates than the treasury bills could cover. Bankers were put in the uncomfortable position of borrowing expensive money and on-lending it cheaply. An example at Royal Bank was an entrepreneur who borrowed $120 million in December 2003, which by March 2004 had ballooned to $500 million due to the excessive rates. Although the cost of funds was now at 900% p.a., Royal Bank had just increased its interest rates to only 400% p.a, meaning that it was funding the client’s shortfall. However this client could not pay it and just returned the $120 million and demonstrated that he had no capacity to pay back the $400 million interest charge. Most bankers accepted this anomaly because they thought it was a temporary dysfunction perpetuated by the inability of an acting governor to make bold decisions. Bankers believed that once a substantive governor was sworn in he would control the interest rates. Much to their dismay, on assuming the governorship Dr. Gono left the rates untamed and hence the situation worsened. This scenario continued up to August 2004, causing considerable strain on entrepreneurial bankers.

On reflection, some bankers feel that the central bank deliberately hiked the interest rates, as this would allow it to restructure the financial services sector. They argue that during the cash crisis of the last half of 2003, bank CEOs would meet often with the RBZ in an effort to find solutions to the crisis. Retrospectively they claim that there is evidence indicating that the current governor though not appointed yet was already in control of the RBZ operations during that time period and was thus responsible for the untenable interest rate regime.

In January 2004, after his vacation, Mzwimbi was informed by the RBZ that Royal had been accommodated for $2 billion on the 28th of December 2003. The Central Bank wanted to know whether this accommodation should be formalised and placed into the newly created Troubled Bank Fund. However, this was expensive money both in terms of the interest rates and also in terms of the conditions and terms of the loan. At Trust Bank, access to this facility had already given the Central Bank the right to force out the top executives, restructure the Board and virtually take over the management of the bank.

Royal Bank turned down the offer and used deposits to pay off the money. However the interest rates did not come down.

During the first quarter of 2004 Trust Bank, Barbican bank and Intermarket Bank were identified as distressed and put under severe corrective orders by the Central Bank.

Royal Assault

Royal Bank remained stable until March 2004. People who had their funds locked up in Intermarket Bank withdrew huge sums of funds from Royal Bank while others were moving to foreign owned banks as the perception created by Central Bank was read by the market to mean that entrepreneurial bankers were fraudsters.

Others withdrew their money on the basis that if financial behemoths like Intermarket can sink, then it could happen to any other indigenously controlled bank. Royal Bank had an advantage that in the smaller towns it was the only bank, so people had no choice. However even in this scenario there were no stable deposits as people kept their funds moving to avoid being caught unawares. For example in one week Royal Bank had withdrawals of over $40 billion but weathered the storm without recourse to Central Bank accommodation.

At this time, newspaper reports indicating some leakage of confidential information started appearing. When confronted, one public paper reporter confided that the information was being supplied to them by the Central Bank. These reports were aimed at causing panic withdrawals and hence exposing banks to depositor flight.

Statutory Reserves

In March 2004, at the point of significant vulnerability, Royal Bank received a letter from RBZ cancelling the exemption from statutory reserve requirements. Statutory reserves are funds, (making up a certain percentage of their total deposits), banks are required to deposit with the Central Bank, at no interest.

When Royal Bank began operations, Mzwimbi applied to the Central Bank – then under Dr Tsumba, for foreign currency to pay for supplies, software and technology infrastructure. No foreign currency could be availed but instead Royal Bank was exempted from paying statutory reserves for one year, thus releasing funds which Royal could use to acquire foreign currency and purchase the needed resources. This was a normal procedure and practice of the Central Bank, which had been made available to other banking institutions as well. This would also enhance the bank’s liquidity position.

Even investors are sometimes offered tax exemptions to encourage and promote investments in any industry. This exemption was delayed due to bungling in the Banking Supervision and Surveillance Department of the RBZ and was thus only implemented a year later, consequently it would run from May 2003 until May 2004. The premature cancellation of this exemption caught Royal Bank by surprise as its cash flow projections had been based on these commencing in May 2004.

When the RBZ insisted, Royal Bank calculated the statutory reserves and noted that, due to a decline in its deposits, it was not eligible for the payment of statutory reserves at that time. When the bank submitted its returns with zero statutory reserves, the Central Bank claimed that the bank was now due for the whole statutory reserve since inception. In effect this was not being treated as a statutory reserve exemption but more as a penalty for evading statutory reserves. Royal Bank appealed. There were conflicting opinions between the Bank Supervision and Capital Markets divisions on the issue as Bank Supervision conceded to the validity of Royal’s position. However Capital Markets insisted that it had instructions from the top to recall the full amount of $23 billion. This was forced onto Royal Bank and transferred without consent to the Troubled Banks Fund at exorbitant rates of 450% p. a.

FML Saga

When FML was demutualising, the executives were concerned about the possibility of being swallowed by its huge strategic partner, Trust Holdings. FML approached Royal Bank and other banks to act as buffers. The agreement was that FML would fund the deal by placing funds with Royal Bank so that Royal would not fund it from its balance sheet.

Consequently FML would leave the deposits with Royal Bank for the tenor of the loan. The deal was consummated through Regal Asset Managers and was to mature in December 2004, at which time it was anticipated that the share price of First Mutual would have blossomed, allowing Royal Bank to harvest its investment and exit profitably. The deal resulted in Regal Asset Managers owning 57 million FML shares. Royal Bank gave FML some securities in the form of treasury bills as collateral for the deposit.

The Reserve Bank and the curator wrote off this investment because at that time FML was suspended at the ZSE. However the fact that it was suspended did not invalidate its value. Recent events have shown that this investment has generated huge capital value for Regal Asset Managers as the ZSE rebounded. Yet the curator valued this investment negatively. Around March 2004 there had been a contagion effect at FML due to the challenges at Trust Bank. This resulted in the forced departure of the FML CEO and chairman. FML was suspended from the local bourse as investigations into the financing structure of Capital Alliance’s acquisition were carried out. Because of the pressure brought to bear on FML, it wanted to withdraw the deposits held by Royal Bank, contrary to the agreement. FML could not locate and return the treasury bills that had been provided as collateral by Royal. Royal Bank suspected that these had been placed with ENG, another asset management company which collapsed in December 2003. A public row broke out. Royal Bank executives sought counsel from Renaissance Merchant Bank, which had brokered the deal, and the Chairman of the ZSE, who both agreed with Royal that the deal was legitimate and FML had to honour the agreement. At this stage FML sought court intervention in an attempt to force Royal Bank into liquidation. Even the curator contested the FML position resulting in his taking it for arbitration. Royal’s position remained that if FML fails to return the securities then it will not get the funds.

Royal bank directors claimed political interference on the issue. The Royal Bank executives believe that the governor, against his better judgment, decided to act against Royal Bank under the pretext of the political pressure. In retrospect, the political support for cracking the whip at Royal gave credence to the rumour that the governor had an underlying agenda in taking Royal and merging it into ZABG because of its strong branch network.

Royal Bank had been warned by friendly RBZ insiders that if it ever accessed the Troubled Bank Fund it would be in trouble, so it sought to avoid this at all costs.

However on 4th August 2004, Royal was served with papers that effectively placed it under the curator. Interestingly, the curator’s contract was signed two days earlier. Until this time no depositor had ever failed to withdraw his deposits from Royal Bank.

The lack of credibility of the Reserve Bank in handling this case is exposed when one considers that some banks were given more than eight months to stabilise under curators, e.g. Intermarket and CFX Banks, and were able to recover. But Royal and Trust Bank were under the curator for less than two months before being amalgamated. The press raised concerns about the curators assuming the role of undertaker rather than nurse, and hence burying these banks.This seemed to confirm the possibility of a hidden agenda on the part of the Central Bank.

Victor Chando

Chando was an excellent financial engineer who set up Victory Financial Services after a stint with MBCA. He had been the brains behind the setting up of the predecessor of Century Discount House which he later sold to Century Holdings. Royal Bank initially had an interest in discount houses and so at inception had included Victor as a significant shareholder. He later acquired Barnfords Securities which Royal intended to bring in-house.

Victory Financial Services was involved in foreign currency dealings, using offshore companies that bought free funds from Zimbabweans abroad and purchased raw materials for Zimbabwean corporations. One such deal with National Foods went sour and the MD reported it to the Central Bank. On investigations the deal was found to be clean but the RBZ went ahead to publish that he was involved in illegal foreign currency transactions and linked this to Royal Bank. However this was a transaction done by a shareholder as an account holder, in which the bank had no interest. What confused matters, was that Victory Financial Services was housed in the same building as Royal Bank.

After failing to nail Chando to any criminal charges, the Central Bank issued an order for Royal Bank to force him out as a shareholder and board member. It is ridiculous that the Central Bank would vet who is a shareholder or not in banks – particularly when the people had no criminal records.

Negotiations with OPEC were underway for it to take over Chando’s shareholding. The Reserve Bank was aware of these developments. OPEC would then help in the recapitalisation as well as open up lines of credit for the bank.

The Arrest

In September 2004 the executive directors of Royal Bank, Mzwimbi and Durajadi, were arrested on five allegations of fraudulently prejudicing the bank. One of the charges was that they fraudulently used depositors’ funds to recapitalise the bank.

Three of the charges after police investigations were dropped, as they were not true. The two remaining charges were:

a) a conflict of interest on loans that were made available to the directors. The RBZ alleges that they did not disclose their interests when companies controlled by them accessed loans at concessionary rates from the bank. However the enterprising bankers dispute these charges, as they claim the Board minutes prove that this interest was disclosed. Even the annual financial statements of the bank acknowledge that they accessed loans as part of their employment contract with the bank.

b) money was owed to Finsreal Asset Management. However Mzwimbi argues that Finsreal actually owes them money and not the other way round. Royal Bank shareholders needed to inject money for recapitalisation of the bank and were requested to deposit their funds with Finsreal Asset Management. Since some had not paid their portion of the recapitalisation by the due date, Royal Financial Holdings, which had an account with Finsreal, paid the money on behalf of the shareholders – who were then indebted to Royal Financial Holdings. Somehow the RBZ confused this transaction as the bank’s funds and therefore accused the

shareholders of using depositors’ funds to recapitalise.

By retrospectively analysing the court case wherein the Royal Bank executive directors are accused of defrauding the bank it appears that the RBZ created a falsehood in order to frustrate the bankers. The curator who initially refused to take a stand before the RBZ appointed Independent Appeal, has in court clearly testified that no monies were stolen from the bank by the directors and that the curator did not (contrary to RBZ assertions) recommend charges against the bankers. In January 2007 the former executive directors of Royal Bank were acquitted by the High Court on the remaining criminal charges after the prosecution failed to present a convincing argument.

Royal Bank assets were sold by the curator to ZABG barely two months after being placed under the curator, without any audited financial statements. The speed at which an agreement of sale was reached is astonishing. The owners of Royal Bank went to court and, after a protracted legal struggle, the court ruled that the assets were sold illegally and hence the sale was “illegal and of no force or effect and therefore null and void”. The court then directed that the owners should appeal to the Central Bank for a determination of the actions of the curators. The Central Bank begrudgingly set up an “independent panel” to adjudicate the case. Strangely ZABG continued to trade on the illegal assets.

The panel advised that the appeal by Royal bank be rejected as it would be difficult to disentangle it from ZABG. They also cited the fact that ZABG had some contractual obligations with third parties who may not want to do business with Royal bank. This strange ruling fails to explain why these considerations were not made when the amalgamation was done. The ruling also redefined the agreements between the curator of Royal bank and ZABG as not being an “agreement of sale” even though the parties which entered into the agreement clearly intended it to be viewed as such. This was a way of circumventing the Supreme Court ruling that the agreement of sale was null and void.

But the panel did not explain how this disposal of the assets should be considered if it was not a sale.

Consequently the major shareholders of Royal appealed to the Minister of Finance who upheld the RBZ decision. Mzwimbi and his colleagues have therefore appealed to the courts. In the meanwhile there was a failed attempt to sell the disputed assets by ZABG despite the outstanding legal challenge. Just ice delayed is justice denied.

Mzwimbi and his team have been denied access to all bank records and yet are expected to defend themselves. As he characteristically puts it, “We are going into this fight blind folded and our hands bound, while fighting someone who has armour and a sword.”

Around 2002-3 there were press reports indicating that the ruling party/state wanted to have a stake in the profitable banking sector. A minister of government at the time of the arrest confirmed this to Mzwimbi and his team. Another bank, NMB, had allegedly been assaulted and the major shareholders were told to dispose of their shareholdings to certain politically connected persons. They refused and had to leave the country after some trumped up charges were preferred against them. Unfortunately, the governor faced resistance and the politicians distanced themselves. One indigenous banker reported how he was summoned to the Central Bank governor’s office and informed that he should leave the country, as his bank would be closed. This banker credits Royal Bank’s resistance to being manipulated as the reason why his own bank survived. The bank was placed under curatorship on 4th August 2004. Mzwimbi had secured potential investors for the recapitalisation of the bank just before the deadline of 30th September 2004. Three days before that deadline, Mzwimbi met the curator and explained in detail the position for the recapitalisation exercise. Investors who had shown interest and were in advanced negotiations were OPEC, Fidelity Insurance and some South African investors. He further asked the curator to request the Central Bank for an extension of about a week. The very next day he was arrested on the pretext that he was about to leave the country. Mzwimbi and his team believe that his arrest at that critical stage was meant to intimidate the would-be investors and result in the failure to recapitalise. This lends credence to the view that the decision to acquire the bank and amalgamate it in ZABG had already been made. The recapitalisation would have scuppered these plans. Notably, other banks were given an extension to regularise their recapitalisation plans.

Shakeman Mugari reported that the central bank has in principle agreed to enter into a scheme of arrangement with Royal, Trust and Barbican banks which could see the final resolution of this issue. He argues that the central bank disregarded the value of securities that the banks had pledged to the central bank for the loans. If these are factored in, then the bank shareholders have some significant value within ZABG. If this scheme had been consummated it would have protected RBZ officials from being sued in their personal capacity for the loss of value to shareholders. From the article it appears like a memorandum of agreement had been signed to effect a reduction of Allied Financial Services’ share in ZABG while the former banks’ shareholders will take up their share in proportion to the value of their assets. This seems to indicate that the central bank has noted a weakness in its arguments.

If this proves true Royal Bank could regain a fairly big stake of ZABG due to its assets which included the real estate and its paper assets which had been undervalued.

The legal hassles show that entrepreneurs in volatile environments face unnecessary political and legal challenges. The rule of law in these countries is sometimes nonexistent. The legislative and political environments, instead of supporting investors, pose serious challenges to entrepreneurs. Entrepreneurs in these environments have to assess the associated risk in setting up their enterprises. However a new breed of entrepreneurs who do not fear the vicissitudes of political interference is making a difference. Entrepreneurs recognise that the environment is a constraint but can be manipulated until worthwhile opportunities are exploited for commercial value. These entrepreneurs choose not to be victims of the environment.
Assault on Entrepreneurs’ Character

The information asymmetry whereby the Central Bank played its case in the public press while the accused bankers had no right of response created a false impression, in the minds of the populace, of entrepreneurs being greedy and unscrupulous.

The Central Bank accused Jeff Mzwimbi and Durajadi Simba of siphoning funds from the bank. An example appeared in a press article in which it was alleged that the sale of Barclays Bank branches to Royal Bank was annulled and the refunded funds were remitted to Mzwimbi and Durajadi at Finsreal Asset Managers and not Royal Bank’s account. This was a clear case of deliberate misinformation as the Central Bank was aware of the truth. Royal Bank had included the purchase of the Bulawayo Barclays Bank branch building which Barclays Bank would lease a portion of from Royal Bank. When Royal Bank fell short at the Interbank Clearing House, it renegotiated with Barclays. This was after Royal was threatened that if it did not clear this amount it would be placed into the Troubled Bank Fund – which carried severe penalties.

The result was that Barclays refunded the amount paying it directly to Royal’s Central Bank account. The RBZ acknowledged receiving these funds. How can they now accuse the founding shareholders of siphoning the same funds which went directly to the RBZ account? Mzwimbi insists that Barclays can easily testify to this.

Banking Fraud – Prevention and Control

Banking Fraud is posing threat to Indian Economy. Its vibrant effect can be understood be the fact that in the year 2004 number of Cyber Crime were 347 in India which rose to 481 in 2005 showing an increase of 38.5% while I.P.C. category crime stood at 302 in 2005 including 186 cases of cyber fraud and 68 cases cyber forgery. Thus it becomes very important that occurrence of such frauds should be minimized. More upsetting is the fact that such frauds are entering in Banking Sector as well.

In the present day, Global Scenario Banking System has acquired new dimensions. Banking did spread in India. Today, the banking system has entered into competitive markets in areas covering resource mobilization, human resource development, customer services and credit management as well.

Indian’s banking system has several outstanding achievements to its credit, the most striking of which is its reach. In fact, Indian banks are now spread out into the remotest areas of our country. Indian banking, which was operating in a highly comfortable and protected environment till the beginning of 1990s, has been pushed into the choppy waters of intense competition.

A sound banking system should possess three basic characteristics to protect depositor’s interest and public faith. Theses are (i) a fraud free culture, (ii) a time tested Best Practice Code, and (iii) an in house immediate grievance remedial system. All these conditions are their missing or extremely weak in India. Section 5(b) of the Banking Regulation Act, 1949 defines banking… “Banking is the accepting for the purpose of lending or investment, deposits of money from the purpose of lending or investment, deposits of money from the public, repayable on demand or otherwise and withdraw able by cheque, draft, order or otherwise.” But if his money has fraudulently been drawn from the bank the latter is under strict obligation to pay the depositor. The bank therefore has to ensure at all times that the money of the depositors is not drawn fraudulently. Time has come when the security aspects of the banks have to be dealt with on priority basis.

The banking system in our country has been taking care of all segments of our socio-economic set up. The Article contains a discussion on the rise of banking frauds and various methods that can be used to avoid such frauds. A bank fraud is a deliberate act of omission or commission by any person carried out in the course of banking transactions or in the books of accounts, resulting in wrongful gain to any person for a temporary period or otherwise, with or without any monetary loss to the bank. The relevant provisions of Indian Penal Code, Criminal Procedure Code, Indian Contract Act, and Negotiable Instruments Act relating to banking frauds has been cited in the present Article.

EVOLUTION OF BANKING SYSTEM IN INDIA

Banking system occupies an important place in a nation’s economy. A banking institution is indispensable in a modern society. It plays a pivotal role in economic development of a country and forms the core of the money market in an advanced country.

Banking industry in India has traversed a long way to assume its present stature. It has undergone a major structural transformation after the nationalization of 14 major commercial banks in 1969 and 6 more on 15 April 1980. The Indian banking system is unique and perhaps has no parallels in the banking history of any country in the world.

RESERVE BANK OF INDIA-ECONOMIC AND SOCIAL OBJECTIVE

The Reserve Bank of India has an important role to play in the maintenance of the exchange value of the rupee in view of the close interdependence of international trade and national economic growth and well being. This aspect is of the wider responsibly of the central bank for the maintenance of economic and financial stability. For this the bank is entrusted with the custody and the management of country’s international reserves; it acts also as the agent of the government in respect of India’s membership of the international monetary fund. With economic development the bank also performs a variety of developmental and promotional functions which in the past were registered being outside the normal purview of central banking. It also acts an important regulator.

BANK FRAUDS: CONCEPT AND DIMENSIONS

Banks are the engines that drive the operations in the financial sector, which is vital for the economy. With the nationalization of banks in 1969, they also have emerged as engines for social change. After Independence, the banks have passed through three stages. They have moved from the character based lending to ideology based lending to today competitiveness based lending in the context of India’s economic liberalization policies and the process of linking with the global economy.

While the operations of the bank have become increasingly significant banking frauds in banks are also increasing and fraudsters are becoming more and more sophisticated and ingenious. In a bid to keep pace with the changing times, the banking sector has diversified it business manifold. And the old philosophy of class banking has been replaced by mass banking. The challenge in management of social responsibility with economic viability has increased.

DEFINITION OF FRAUD

Fraud is defined as “any behavior by which one person intends to gain a dishonest advantage over another”. In other words , fraud is an act or omission which is intended to cause wrongful gain to one person and wrongful loss to the other, either by way of concealment of facts or otherwise.

Fraud is defined u/s 421 of the Indian Penal Code and u/s 17 of the Indian Contract Act. Thus essential elements of frauds are:

1. There must be a representation and assertion;

2. It must relate to a fact;

3. It must be with the knowledge that it is false or without belief in its truth; and

4. It must induce another to act upon the assertion in question or to do or not to do certain act.

BANK FRAUDS

Losses sustained by banks as a result of frauds exceed the losses due to robbery, dacoity, burglary and theft-all put together. Unauthorized credit facilities are extended for illegal gratification such as case credit allowed against pledge of goods, hypothecation of goods against bills or against book debts. Common modus operandi are, pledging of spurious goods, inletting the value of goods, hypothecating goods to more than one bank, fraudulent removal of goods with the knowledge and connivance of in negligence of bank staff, pledging of goods belonging to a third party. Goods hypothecated to a bank are found to contain obsolete stocks packed in between goods stocks and case of shortage in weight is not uncommon.

An analysis made of cases brings out broadly the under mentioned four major elements responsible for the commission of frauds in banks.

1. Active involvement of the staff-both supervisor and clerical either independent of external elements or in connivance with outsiders.

2. Failure on the part of the bank staff to follow meticulously laid down instructions and guidelines.

3. External elements perpetuating frauds on banks by forgeries or manipulations of cheques, drafts and other instruments.

4. There has been a growing collusion between business, top banks executives, civil servants and politicians in power to defraud the banks, by getting the rules bent, regulations flouted and banking norms thrown to the winds.

FRAUDS-PREVENTION AND DETECTION

A close study of any fraud in bank reveals many common basic features. There may have been negligence or dishonesty at some stage, on part of one or more of the bank employees. One of them may have colluded with the borrower. The bank official may have been putting up with the borrower’s sharp practices for a personal gain. The proper care which was expected of the staff, as custodians of banks interest may not have been taken. The bank’s rules and procedures laid down in the Manual instructions and the circulars may not have been observed or may have been deliberately ignored.

Bank frauds are the failure of the banker. It does not mean that the external frauds do not defraud banks. But if the banker is upright and knows his job, the task of defrauder will become extremely difficult, if not possible.

Detection of Frauds

Despite all care and vigilance there may still be some frauds, though their number, periodicity and intensity may be considerably reduced. The following procedure would be very helpful if taken into consideration:

1. All relevant data-papers, documents etc. Should be promptly collected. Original vouchers or other papers forming the basis of the investigation should be kept under lock and key.

2. All persons in the bank who may be knowing something about the time, place a modus operandi of the fraud should be examined and their statements should be recorded.

3. The probable order of events should thereafter be reconstructed by the officer, in his own mind.

4. It is advisable to keep the central office informed about the fraud and further developments in regard thereto.

Classification of Frauds and Action Required by Banks

The Reserve Bank of India had set-up a high level committee in 1992 which was headed by Mr. A… Ghosh, the then Dy. Governor Reserve Bank of India to inquire into various aspects relating to frauds malpractice in banks. The committee had noticed/observed three major causes for perpetration of fraud as given hereunder:

1. Laxity in observance of the laid down system and procedures by operational and supervising staff.

2. Over confidence reposed in the clients who indulged in breach of trust.

3. Unscrupulous clients by taking advantages of the laxity in observance of established, time tested safeguards also committed frauds.

In order to have uniformity in reporting cases of frauds, RBI considered the question of classification of bank frauds on the basis of the provisions of the IPC.
Given below are the Provisions and their Remedial measures that can be taken.

1. Cheating (Section 415, IPC)

Remedial Measures.

The preventive measures in respect of the cheating can be concentrated on cross-checking regarding identity, genuineness, verification of particulars, etc. in respect of various instruments as well as persons involved in encashment or dealing with the property of the bank.

2. Criminal misappropriation of property (Section 403 IPC).

Remedial Measure

Criminal misappropriation of property, presuppose the custody or control of funds or property, so subjected, with that of the person committing such frauds. Preventive measures, for this class of fraud should be taken at the level the custody or control of the funds or property of the bank generally vests. Such a measure should be sufficient, it is extended to these persons who are actually handling or having actual custody or control of the fund or movable properties of the bank.

3. Criminal breach of trust (Section 405, IPC)

Remedial Measure

Care should be taken from the initial step when a person comes to the bank. Care needs to be taken at the time of recruitment in bank as well.

4. Forgery (Section 463, IPC)

Remedial Measure

Both the prevention and detection of frauds through forgery are important for a bank. Forgery of signatures is the most frequent fraud in banking business. The bank should take special care when the instrument has been presented either bearer or order; in case a bank pays forged instrument he would be liable for the loss to the genuine costumer.

5. Falsification of accounts (Section 477A)

Remedial Measure

Proper diligence is required while filling of forms and accounts. The accounts should be rechecked on daily basis.

6. Theft (Section 378, IPC)

Remedial Measures

Encashment of stolen’ cheque can be prevented if the bank clearly specify the age, sex and two visible identify action marks on the body of the person traveler’s cheques on the back of the cheque leaf. This will help the paying bank to easily identify the cheque holder. Theft from lockers and safe deposit vaults are not easy to commit because the master-key remains with the banker and the individual key of the locker is handed over to the costumer with due acknowledgement.

7. Criminal conspiracy (Section 120 A, IPC)

In the case of State of Andhra Pradesh v. IBS Prasad Rao and Other, the accused, who were clerks in a cooperative Central Bank were all convicted of the offences of cheating under Section 420 read along with Section 120 A. all the four accused had conspired together to defraud the bank by making false demand drafts and receipt vouchers.

8. Offences relating to currency notes and banks notes (Section 489 A-489E, IPC)
These sections provide for the protection of currency-notes and bank notes from forgery. The offences under section are:

(a) Counterfeiting currency notes or banks.

(b) Selling, buying or using as genuine, forged or counterfeit currency notes or bank notes. Knowing the same to be forged or counterfeit.

(c) Possession of forged or counterfeit currency notes or bank-notes, knowing or counterfeit and intending to use the same as genuine.

(d) Making or passing instruments or materials for forging or counterfeiting currency notes or banks.

(e) Making or using documents resembling currency-notes or bank notes.

Most of the above provisions are Cognizable Offences under Section 2(c) of the Code of Criminal Procedure, 1973.

FRAUD PRONE AREAS IN DIFFERENT ACCOUNTS

The following are the potential fraud prone areas in Banking Sector. In addition to those areas I have also given kinds of fraud that are common in these areas.

Savings Bank Accounts

The following are some of the examples being played in respect of savings bank accounts:

(a) Cheques bearing the forged signatures of depositors may be presented and paid.

(b) Specimen signatures of the depositors may be changed, particularly after the death of depositors,

(c) Dormant accounts may be operated by dishonest persons with or without collusion of bank employees, and

(d) Unauthorized withdrawals from customer’s accounts by employee of the bank maintaining the savings ledger and later destruction of the recent vouchers by them.

Current Account Fraud

The following types are likely to be committed in case of current accounts.

(a) Opening of frauds in the names of limited companies or firms by unauthorized persons;

(b) Presentation and payment of cheques bearing forged signatures;

(c) Breach of trust by the employees of the companies or firms possessing cheque leaves duly signed by the authorized signatures;

(d) Fraudulent alteration of the amount of the cheques and getting it paid either at the counter or though another bank.

Frauds In Case Of Advances

Following types may be committed in respect of advances:

(a) Spurious gold ornaments may be pledged.

(b) Sub-standard goods may be pledged with the bank or their value may be shown at inflated figures.
(c) Same goods may be hypothecated in favour of different banks.

LEGAL REGIME TO CONTROL BANK FRAUDS

Frauds constitute white-collar crime, committed by unscrupulous persons deftly advantage of loopholes existing in systems/procedures. The ideal situation is one there is no fraud, but taking ground realities of the nation’s environment and human nature’s fragility, an institution should always like to keep the overreach of frauds at the minimum occurrence level.

Following are the relevant sections relating to Bank Frauds

Indian Penal Code (45 of 1860)

(a) Section 23 “Wrongful gain”.-

“Wrongful gain” is gain by unlawful means of property to which the person gaining is not legally entitled.

(b) “Wrongful loss”

“Wrongful loss” is the loss by unlawful means of property to which the person losing it is legally entitled.
(c) Gaining wrongfully.

Losing wrongfully-A person is said to gain wrongfully when such person retains wrongfully, as well as when such person acquires wrongfully. A person is said to lose wrongfully when such person is wrongfully kept out of any property, as well as when such person is wrongfully deprived of property.

(d) Section 24. “Dishonestly”

Whoever does anything with the intention of causing wrongful gain to one person or wrongful loss to another person, is said to do that thing “dishonestly”.

(e) Section 28. “Counterfeit”

A person is said to “counterfeit” who causes one thing to resemble another thing, intending by means of that resemblance to practice deception, or knowing it to be likely that deception will thereby be practiced.

BREACH OF TRUST

1. Section 408- Criminal breach of trust by clerk or servant.

2. Section 409- Criminal breach of trust by public servant, or by banker, merchant or agent.

3. Section 416- Cheating by personating

4. Section 419- Punishment for cheating by personation.

OFFENCES RELATING TO DOCMENTS

1) Section 463-Forgery

2) Section 464 -Making a false document

3) Section 465- Punishment for forgery.

4) Section 467- Forgery of valuable security, will, etc

5) Section 468- Forgery for purpose of cheating

6) Section 469- Forgery for purpose of harming reputation

7) Section 470- Forged document.

8) Section 471- Using as genuine a forged document

9) Section 477- Fraudulent cancellation, destruction, etc., of will, authority to adopt, or valuable security.

10) Section 477A- Falsification of accounts.

THE RESERVE BANK OF INDIA ACT, 1934

Issue of demand bills and notes Section 31.

Provides that only Bank and except provided by Central Government shall be authorized to draw, accept, make or issue any bill of exchange, hundi, promissory note or engagement for the payment of money payable to bearer on demand, or borrow, owe or take up any sum or sums of money on the bills, hundis or notes payable to bearer on demand of any such person

THE NEGOTIABLE INSTRUMENTS ACT, 1881

Holder’s right to duplicate of lost bill Section 45A.

1. The finder of lost bill or note acquires no title to it. The title remains with the true owner. He is entitled to recover from the true owner.

2. If the finder obtains payment on a lost bill or note in due course, the payee may be able to get a valid discharge for it. But the true owner can recover the money due on the instrument as damages from the finder.

Section 58

When an Instrument is obtained by unlawful means or for unlawful consideration no possessor or indorse who claims through the person who found or so obtained the instrument is entitled to receive the amount due thereon from such maker, acceptor or holder, or from any party prior to such holder, unless such possessor or indorse is, or some person through whom he claims was, a holder thereof in due course.

Section 85:

Cheque payable to order.

1. By this section, bankers are placed in privileged position. It provides that if an order cheque is indorsed by or on behalf of the payee, and the banker on whom it is drawn pays it in due course, the banker is discharged. He can debit his customer with the amount so paid, though the endorsement of the payee might turn out to be a forgery.

2. The claim protection under this section the banker has to prove that the payment was a payment in due course, in good faith and without negligence.

Section 87. Effect of material alteration

Under this section any alteration made without the consent of party would be void. Alteration would be valid only if is made with common intention of the party.

Section 138. Dishonour of cheque for insufficiency, etc., of funds in the account.

Where any cheque drawn by a person on an account maintained by him with a banker for payment of any amount of money to another person from out of that account for the discharge, in whole or in part, of any debt or other liability, is returned by the bank unpaid. either because of the amount of money standing to the credit of that account is insufficient to honour the cheque or that it exceeds the amount arranged to be paid from that account by an agreement made with that bank, such person shall be deemed to have committed an offence and shall, without prejudice.

Section 141(1) Offences by companies.

If the person committing an offence under Section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to, the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly.

SECURITY REGIME IN BANKING SYSTEM

Security implies sense of safety and of freedom from danger or anxiety. When a banker takes a collateral security, say in the form of gold or a title deed, against the money lent by him, he has a sense of safety and of freedom from anxiety about the possible non-payment of the loan by the borrower. These should be communicated to all strata of the organization through appropriate means. Before staff managers should analyze current practices. Security procedure should be stated explicitly and agreed upon by each user in the specific environment. Such practices ensure information security and enhance availability. Bank security is essentially a defense against unforced attacks by thieves, dacoits and burglars.

PHYSICAL SECURITY MEASURES-CONCEPT

A large part of banks security depends on social security measures. Physical security measures can be defined as those specific and special protective or defensive measures adopted to deter, detect, delay, defend and defeat or to perform any one or more of these functions against culpable acts, both covert and covert and acclamations natural events. The protective or defensive, measures adopted involve construction, installation and deployment of structures, equipment and persons respectively.

The following are few guidelines to check malpractices:

1. To rotate the cash work within the staff.

2. One person should not continue on the same seat for more than two months.

3. Daybook should not be written by the Cashier where an other person is available to the job

4. No cash withdrawal should be allowed within passbook in case of withdrawal by pay order.

5. The branch manager should ensure that all staff members have recorder their presence in the attendance registrar, before starting work.

Execution of Documents

1. A bank officer must adopt a strict professional approach in the execution of documents. The ink and the pen used for the execution must be maintained uniformly.

2. Bank documents should not be typed on a typewriter for execution. These should be invariably handwritten for execution.

3. The execution should always be done in the presence of the officer responsible for obtain them,
4. The borrowers should be asked to sign in full signatures in same style throughout the documents.

5. Unless there is a specific requirement in the document, it should not be got attested or witnessed as such attestation may change the character of the instruments and the documents may subject to ad volrem stamp duty.

6. The paper on which the bank documents are made should be pilfer proof. It should be unique and available to the banks only.

7. The printing of the bank documents should have highly artistic intricate and complex graphics.

8. The documents executed between Banker and Borrowers must be kept in safe custody,

CHANGES IN LEGISLATIONS AFTER ELECTRONIC TRANSACTIONS

1. Section 91 of IPC shall be amended to include electronic documents also.

2. Section 92 of Indian Evidence Act, 1872 shall be amended to include commuter based communications

3. Section 93 of Bankers Book Evidence Act, 1891 has been amended to give legal sanctity for books of account maintained in the electronic form by the banks.

4. Section 94 of the Reserve Bank of India Act, 1939 shall be amended to facilitate electronic fund transfers between the financial institutions and the banks. A new clause (pp) has been inserted in Section 58(2).

RECENT TRENDS OF BANKING SYSTEM IN INDIA

In the banking and financial sectors, the introduction of electronic technology for transactions, settlement of accounts, book-keeping and all other related functions is now an imperative. Increasingly, whether we like it or not, all banking transactions are going to be electronic. The thrust is on commercially important centers, which account for 65 percent of banking business in terms of value. There are now a large number of fully computerized branches across the country.

A switchover from cash-based transactions to paper-based transactions is being accelerated. Magnetic Ink character recognition clearing of cheques is now operational in many cities, beside the four metro cities. In India, the design, management and regulation of electronically-based payments system are becoming the focus of policy deliberations. The imperatives of developing an effective, efficient and speedy payment and settlement systems are getting sharper with introduction of new instruments such as credit cards, telebanking, ATMs, retail Electronic Funds Transfer (EFT) and Electronic Clearing Services (ECS). We are moving towards smart cards, credit and financial Electronic Data Interchange (EDI) for straight through processing.

Financial Fraud (Investigation, Prosecution, Recovery and Restoration of property) Bill, 2001

Further the Financial Fraud (Investigation, Prosecution, Recovery and Restoration of property) Bill, 2001 was introduced in Parliament to curb the menace of Bank Fraud. The Act was to prohibit, control, investigate financial frauds; recover and restore properties subject to such fraud; prosecute for causing financial fraud and matters connected therewith or incidental thereto.

Under the said act the term Financial Fraud has been defined as under:

Section 512 – Financial Fraud

Financial frauds means and includes any of the following acts committed by a person or with his connivance, or by his agent, in his dealings with any bank or financial institution or any other entity holding public funds;

1. The suggestion, as a fact, of that which is not true, by one who does not believe it to be true;

2. The active concealment of a fact by one having knowledge or belief of the fact;

3. A promise made with out any intention of performing it;

4. Any other act fitted to deceive;

5. Any such act or omission as the law specially declares to be fraudulent.
Provided that whoever acquires, possesses or transfers any proceeds of financial fraud or enters into any transaction which is related to proceeds of fraud either directly or indirectly or conceals or aids in the concealment of the proceeds of financial fraud, commits financial fraud.

513(a) – Punishment for Financial Fraud

Whoever commits financial fraud shall be: (a) Punished with rigorous imprisonment for a term, which may extend to seven years and shall also be liable to fine.

(b)Whoever commits serious financial fraud shall be punished with rigorous imprisonment for a term which may extend to ten years but shall not be less than five years and shall also be liable for fine up to double the amount involved in such fraud.

Provided that in both (a) and (b) all funds, bank accounts and properties acquired using such funds subjected to the financial fraud as may reasonably be attributed by the investigating agency shall be recovered and restored to the rightful owner according to the procedure established by law.

CONCLUSION

The Indian Banking Industry has undergone tremendous growth since nationalization of 14 banks in the year 1969. There has an almost eight times increase in the bank branches from about 8000 during 1969 to mote than 60,000 belonging to 289 commercial banks, of which 66 banks are in private sector.

It was the result of two successive Committees on Computerization (Rangarajan Committee) that set the tone for computerization in India. While the first committee drew the blue print in 1983-84 for the mechanization and computerization in banking industry, the second committee set up in 1989 paved the way for integrated use of telecommunications and computers for applying technogical breakthroughs in banking sector.

However, with the spread of banking and banks, frauds have been on a constant increase. It could be a natural corollary to increase in the number of customers who are using banks these days. In the year 2000 alone we have lost Rs 673 crores in as many as 3,072 number of fraud cases. These are only reported figures. Though, this is 0.075% of Rs 8,96,696 crores of total deposits and 0.15% of Rs 4,44,125 crores of loans & advances, there are any numbers of cases that are not reported. There were nearly 65,800 bank branches of a total of 295 commercial banks in India as on June 30, 2001 reporting a total of nearly 3,072 bank fraud cases. This makes nearly 10.4 frauds per bank and roughly 0.47 frauds per branch.

An Expert Committee on Bank Frauds (Chairman: Dr.N.L.Mitra) submitted its Report to RBI in September 2001. The Committee examined and suggested both the preventive and curative aspects of bank frauds.

The important recommendations of the Committee include:

o A need for including financial fraud as a criminal offence;

o Amendments to the IPC by including a new chapter on financial fraud;

o Amendments to the Evidence Act to shift the burden of proof on the accused person;

o Special provision in the Cr. PC for properties involved in the Financial Fraud.

o Confiscating unlawful gains; and preventive measures including the development of Best Code Procedures by banks and financial institutions.

Thus it can be concluded that following measures should necessarily be adopted by the Ministry of Finance in order to reduce cases of Fraud.

o There must be a Special Court to try financial fraud cases of serious nature.

o The law should provide separate structural and recovery procedure. Every bank must have a domestic enquiry officer to enquire about the civil dimension of fraud.

o A fraud involving an amount of ten crore of rupees and above may be considered serious and be tried in the Special Court.

Impact Of China Pakistan Economic Corridor (CPEC) On The Banking Industry Of Pakistan

A Karachi-based banker receives the latest update on stocks from his counterpart in Hong Kong in a blink of an eye. That information is then relayed to a customer in Doha who then orders electronics made in Chengdu transported across the proposed CPEC route and then by sea on a bulker ship to its final destination. The breakneck pace and the astonishing volumes at which goods, information, and money move from one part of the world to another is conquering inhospitable terrains, exploring new sea lanes, defying traditional methods of communication, taking the world online, and exploiting untapped energies. Global interconnectedness through trade has always and is constantly determining, redesigning, and reshaping human life at a scale never imagined before. London shoppers buy garments made in Pakistan. Chinese watch American TV seasons. Arabs use software developed in Silicon Valley to instigate an earth shattering revolution. The overbearing influence of international trade on human lives is remarkable in the truest sense of the word. Both literally and otherwise, international trade is having a great impact on the way humans conducted life and business.

But the idea of global interconnectedness is not new, in fact, it can be traced back to the time of Han Dynasty in 221 BCE when all of China came under one supreme rule. About the same time, the conquests of Alexander established a veritable contact between the Western and Eastern societies widening existing road networks and creating new trade routes. Over the course of next several centuries, a gigantic web of trade networks emerged which spanned continents drawing from China silk, tea, porcelain, and jade while gold and glass wares travelled from Rome, the western terminus of the famous Silk Road. Along the way, many items were picked up from many regions and local kingdoms of Middle East and India which eventually benefited the local populations also. The trade links formed along the breadth and width of the 5000 miles long Silk Road were commercial, cultural, technological, but also financial in nature. The goods, technologies, and even diseases of all kinds were exchanged; such was the power of international trade. Back then, the roads were long, treacherous, and unpredictable. And crossing the inhospitable terrains was incredibly dangerous but the huge demand for goods led to the creation of a complex web of trade networks which were duly supported by local financial moneylenders and money-exchangers backed by local governments and fiefdoms.

The long-awaited revival of the old Silk Road (as enshrined in the One Belt, One Road Project of China) has the potential to genuinely alter the world economics like never before in history. This largest ever financial undertaking since the Marshall Plan by USA for Europe post World War II will include over 60 countries and most likely to generate $ 2.5 trillion dollars in trade, if the regional plan works according to the design. This regional pact promises to economically benefit the countries included in it by linking them to global trade networks. Imagine a good chunk of that trade passing through Pakistan and affecting the life and finances of ordinary Pakistanis. This life altering, game-changing, golden goose transformed into a trade route is called China Pakistan Economic Corridor.

The $ 46 billion dollar China Pakistan Economic Corridor (CPEC) is an important part of this OBOR project which connects the Western parts of China and Central Asian Republics to the Gawadar port in the Arabian Sea. The deep sea port of Gawadar is strategically located just outside the Strait of Hormuz and near the main shipping route of global oil trade and it is the closest trade route to the landlocked Central Asian Countries which have enormous natural resources and untapped market potential. And Pakistan stands to benefit from all that because this CPEC is not just a trade route but a complete project for life which includes energy projects, railroads, 25 industrial zones, and cross border fiber optics which will connect Pakistan with the world both on technological and trade fronts.

Developing countries struggle in the wake of hindered access to markets, lack of finance, and limited infrastructure at home to support economic activities. In that context, the CPEC promises to take Pakistan straight into the international foray where big players play.

But here is the kicker: when the global trade fever kicks in through the CPEC, then Pakistan must be ready to welcome it.

The ability to meet the challenges of international trade head-on and that too with great success will largely depend on Pakistan’s banking & financial sector’s readiness in adjusting to the new trade environment.

The influence and impact of local and domestic players and a whole host of homebred economic forces may ratchet down with the increased international trade moving feverishly back and forth and back again across the CPEC routes. Pakistan’s banks will have to calibrate their strategic position in order to be able to take advantage of the money movements resulting from increased trade passing through the country.

Increased integration through increased trade and more of international trade passing through the proposed CPEC routes will create a new set of challenges, opportunities, and risks for the Pakistani banking and financial sector offering financial services to local businesses and their foreign affiliates, to the government and investors at home and abroad.

If history offers any guidance, then it is a known fact that Pakistan’s economy never really depended on huge trade volumes (with the current trade volume hovering at about $ 80 billion) as so much as it will do in near future. For once, the central bank of Pakistan (State Bank of Pakistan) in particular will have to use interest rate swings to keep inflation in check, and others banks may have to make considerable adjustments in their positions by administering some radical and some not so radical but smart changes and tweaks here and there in their financial offerings to meet the changing dynamics of the new trade environment in Pakistan. The economic shocks resulting from the new trade environment can be both positive and negative depending on how they are confronted. Therefore, adjustments have to be made accordingly which could result in a great earning opportunity for many.

The contrasting snapshot of Pakistan’s current trade environment juxtaposed with the picture of trade likely to emerge in near future offers a great insight into what the local businesses and financial & banking sector might have to deal with when billions of dollars of trade starts to pass through Pakistan. It is important to understand this because the CPEC is going to touch Pakistan on many levels. Pakistan’s current business environment is characterized by a massive shortfall of electricity which can reach as much as 5 million kilowatts in the summers. This electricity shortage acts as a bottleneck in the process of industrialization of underdeveloped economies which means that production lines and factories come to a grinding halt due to lack of energy. Many companies, banks, private businesses, government offices, and even the shopkeepers & students especially only those who have the means are forced to use private generators when the light goes out. But all that is about to change: the Neelum-Jehlum Hydropower plant which is the largest ever overseas power plant undertaking by any Chinese firm will alleviate 15% of electricity shortage. It will generate 45 billion Rupees or $ 400 million in revenues. It is just one of the 22 projects which are included in the CPEC. Thus, the CPEC is truly a game changer as it possesses the ability to get the infrastructure ready for integrating Pakistan with the international trade regimes.

The improvement in the macro environment is evidently in the pipeline with substantial investments taking place in the infrastructural development which if supported by the banking sector and small improvements in the basic micro infrastructure stands to give huge advantage to Pakistan on the back of three major global trends promising to alter fortunes of Pakistan for the better now and forever which include investments from China coming in, the return of Iran into the international economy, and the low oil prices.

Therefore, the new trade environment of Pakistan will be made up of the results of the CPEC which will offer greater, seamless, and hassle-free access to Central Asia Countries where the potential for business, banking, and trade is immense and the markets there virtually untapped, untouched, and not fully exploited or explored. This means that the trade volumes are going to skyrocket, or break the ceiling, or simply exceed expectations as new markets are explored and regional economies get ready for more consumption. Thus, the prospect of making some serious moolahs on the back of the CPEC is too alluring to ignore for both businesses and banks.

Where there is increased trade, there is a trail of money to be found, and there must be a bank nearby. And all trades since the ancient times required a most secure method for all kinds of financial transactions. And that is where banks jump right into the foray big time. Even in the old days when trade was happening through the Silk Road, local money lenders and money exchangers acting as small bankers were offering some kind of safety and security to the financial transactions taking place along the route. The safety and security of financial transactions is as important as giving a real boost to international trade.

There are two important things: first and foremost, no country can ever grow quickly and persistently over a long period of time by staying disconnected from the international trade. And second of all, no country can become a thriving economy on the back of trade without the active backing of an equally robust and thriving banking sector facilitating that trade.

In any trade environment, the most important thing for an exporter is to get paid and for an importer to get his goods. If the exporter is not getting paid, then he is sending gifts. The banks can facilitate the trade by offering guarantees and other financial services to both exporters and importers in Pakistan. The payment methods if made secure and mediated by banks can help both the trade and bank. The international trade has many payment methods which include Cash-in-Advance, Letters of Credit, Bills of Exchange or Documentary Collections, and Open Account etc. Cash in advance method is best for exporters and riskier for importers. However, LCs or letters of credit is considered to be the most reliable and secure method available to international traders which is basically a guarantee given by a bank on behalf of the importer that if the terms of the LC are met by the exporter, the exporter will get his agreed payment. Billions of dollars of trade in USA is made secure by LCs offered by their banking sector. Documentary Collections or Bills of Exchange is another product which banks offer and is available to international traders. In this method of payment, a bank is nominated which receives the shipping documents from the exporter and once the importer comes in with the money, the goods can be claimed and picked up by the importer. Even in the open account payment method, banks are used as intermediaries between international traders.

Therefore, the biggest question that confronts Pakistani banking sector is this: are they ready for what is about to hit them? Because there could be 1001 ways to make real wampum once the CPEC gets underway. Sooner rather than later, Pakistan’s trade environment will be truly global. The banks will have to offer new financial services or old financial offerings into a newly designed package but at an unprecedented scale and magnitude. The bank will to adjust to new trade environment taking shape in the country because it is no secret that international trade slows down if the financial banks are unable to offer secure payment methods.

According to the estimates of World Trade Organization, around 80 percent of world trade is backed up by financial offerings and credit guarantees offered by the banks. The reason is fairly simple: everyone wants to be on the safer and beneficial side when the trade happens. The exporter wants to receive payment as soon as the goods are delivered and the importer wants to keep his money with him until he has received the goods because there is an element of risk involved in international trade. Thus, the role played by banks in facilitating global trade is huge. For the developing countries, this role played by banks assumes greater significance because the growth of developing countries greatly depends upon trade volumes which are likely to stay strong and persistent if the banking sector is able to meet the demand for LCs, payment guarantees, and other insured financial services and help keep the wheels of trade moving along smoothly and surely. That is how the banking sector stands to benefit from the shifting trends in the trade environment of Pakistan which will be soon connected with the economies of the world that matter.

Pakistani banks will be able to explore new ways for making more revenues for themselves and for traders by forging new and unbreakable alliances with the corporate world, make cross border financial agreements, taking their services worldwide, and facilitating the trade so that the trade could move seamlessly across the borders.

Pakistani banks will have to find ways to offer cost effective solutions to international traders. The banks must offer these services in an efficient manner on an absolutely new scale and manage its own operations in a way that the banks can stay competitive and truly global over the coming decades. Their offerings of LCs and Bills of Exchange must be more efficient, robust, and really good if not better than those offered by international bankers. Pakistani banks can automate their financial services in the wake of the new trade environment.

The banks in Pakistan can make use of the latest technology which helps in automatically classifying LCs as they are generated in the form of invoices, purchase orders, agreements, and other certificates facilitating cross border trade. This wholehearted adoption of technology is going to put Pakistani banks on par with the rest of the banks in the world but will also prove to be less cumbersome, cost effective, and time saving. This in turn will help boost the trade big time. Pakistani banks will also have to ensure accuracy of their data in order to ensure compliance regulations. This can be done by the use of intelligent technology which helps in ensuring timely extraction, validation, and screening of the data and documents submitted with the banks. These are some of the things that banks in Pakistan must possess if they wish to improve their financial services for the facilitation of trade and also position themselves to better manage the trade happening and passing through the country. The adoption of the right kind of technology, better positioning of trade financial services, and making right adjustments to the scale and magnitude of the expected trade will definitely put Pakistani banks on the world map that helped the country become more competitive both globally and regionally.

The new Silk Road is estimated to generate $ 2.5 trillion in trade over the next ten years and some of that trade will pass through the proposed CPEC routes. China imports 60% of its oil from the Gulf and 48% of China’s oil is transported via tanker ships which have to travel 16,000 kilometers for up to three months through the Malaka Straits and through the South China Sea which is fast becoming a contested region marked by competing claims to the sea lanes. That makes the trade through that route somewhat unsafe, uncertain, and ridden with untoward risks. And due to this ensuing uncertainty Gawadar Port offers a much less expensive alternative route which offers savings worth billions of dollars. Just in terms of numbers, CPEC once fully underway will add two percentage points to the GDP growth of Pakistan which will effectively take the GDP beyond 6% growth rate annually. That figure in itself speaks volumes about the sheer money potential of this proposed project. It has the potential to bring in huge influxes of money which would definitely force the banking industry to grow.

In the wake of CPEC, a great number of opportunities are coming to Pakistan. The need for strategic management, strategic budgeting, forecasting, planning, overall project accounting, investment banking, new and improved financial services are going to surge. The sectors of shipping, storing, transportation, and finance are going to jack up with huge financial appetite requiring more innovative and improved fast-paced financial and banking services on a larger than life scale. The need for taxation and streamlining of the taxation regime post CPEC will be undeniably great.

Anti-money laundering specialists, branch managers, financial analysts, CFOs, financial consultants, tax managers, financial management, banking consultants, investment bankers, trade marketers, and trade accountants will be in great demand over the next decade. Financial services and financial and banking sector will be in full swing once the trade through CPEC begins to flourish.

Increasing trade is the key to alleviating abject poverty, boosting economic activities and achieving shared prosperity. Evidence shows that countries open to trade and with better access to markets and better financial support infrastructure and regime for businesses and trade are able to provide more opportunities to their people to become successful businessmen, bankers, traders, and entrepreneurs. With enhanced participation in world economy, Pakistan stands a chance to become a major world economy.

Pakistani banks can learn a lesson or two from the banks of China and India. 3 out of top ten banks in the world are Chinese. They got to the place where they are today by actively supporting the international trade and offering products that helped in transforming local traders into world beaters.This happened because in order to ensure double digit economic growth, Chinese banks stepped up their game and grew exponentially in order to provide funds and credit for China’s rapid economic development. Banks in India are reaching out to the remotest areas through a wide network of branch banking.

Risky investments are likely to go up as soon as the trade along the CPEC jumps into proper action. In a short span of time, economic wheels will start to roll with increased trade gyrations. With the increased privatization and undiscovered investment opportunities emerging in the economy, Pakistani banks could very well be looking at a rosy fiscal picture. Even an ordinary fruit exporter could be looking the way of the investment bankers to suggest ways for more financing opportunities for improving trade with the CARs.

In the wake of what is about to happen, Pakistani banking industry can do a few things to meet the ensuing challenges of CPEC: mobilizing savings through a wide network of branch banking; transforming savings into capital formation which could become the basis for more economic prosperity and development; finance the industrial sector and boost the capital markets; promote entrepreneurship by underwriting shares of new or existing companies; and help people acquire new skill sets in order to be able to better cope with the impending changes and major alterations expected to be caused by the new trade environment in Pakistan.

International trade is risky. Exporters want to be paid and importers want to receive their goods.To reduce the risk of losing money or goods, banks offer trade finance products like LCs etc., to facilitate trade. A shortfall in the supply of trade finance could result in trade also plunging – a scenario which Pakistani banks can avoid. G20 countries are already supporting trade finance. Now the ball is in the court of Pakistani banks to lead the charge. Now is the time to make or break: facilitate trade or run the risk of losing the game to other players.