Detecting Bank Frauds using Benford Utiliy

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Detecting Bank Frauds using Benford Utiliy

Riskpro Technology team developed the utility for the Certified Forensic Accounting Professionals. This utility helps the forensic accountants to detect the frauds with the help of Benford Law. In order to download the Benford utility you should be the member of Indiaforensic with the valid website credentials.

This article elaborates how to use the Benford Utility for detecting the bank frauds.

Banks deal in huge vouchers and the data. The raw material of the bank is hard cash and hence the bank data is the most susceptible to the frauds. This data is found to be most suitable for applying the tests of the Benford. Benford’s law works on the financial data throughout the world, even though the data are expressed in the different currencies. When this law is applied to fraud investigation, valid, unaltered data should follow the predicted frequencies. Data that fails to correspond with these frequencies may include fraudulent items. However, the data must not contain preset minimums or maximums, breakpoints, or selected values such as policy numbers or PAN numbers, as the law does not apply to such assigned, non random information.

Application to Embezzlement in Banks

Embezzlement is a very severe issue in the co-operative banks in our country. Rather it is one of the prominent reasons that could be attributed to the collapse of the co-operative banking sector in last few years. If one dig out the history of embezzelemnt of the funds it could be easily ascertained that the perpetrators have also improved their methodologies of committing the frauds gradually. In one such case the suspect was following a simple methodology for embezzling the funds from the accounts of the depositors. He was forging the signatures of the depositors and transferring the funds to the Fixed deposit accounts of some third parties whose bank accounts were controlled by him. Filling a simple withdrawal slip effected the transfers. In most of the cases victim accounts were either dormant accounts or inoperative accounts with heavy balance lying idle. Otherwise the scam would have been easily unearthed by the complaints from the depositors.

Because human choices are not random, invented numbers are unlikely to follow Benford’s law.

The same was the case here. As is often the case in fraud, the embezzler started small and then increased amounts. However most of the amounts were just below Rs.10, 000. This was obvious because not many transactions were marked above these levels in the dormant accounts. The internal auditor would have easily caught the attention of the amounts above Rs.10000/-. The movement in the dormant accounts is actually a red flag but there was explanation available with the perpetrator. By keeping the amounts just below an additional control threshold, the manager tried to conceal the fraud.

The numbers were chosen to give the appearance of randomness. None of the amounts on withdrawal slips were duplicated; there were no round numbers; and all the amounts included sum in paise. These are the trends normally the traditional auditors look for but the lawbreakers have been always one step ahead of the lawmakers. The traditional auditing practices would not have raised any suspicions about these transactions but the auditor entered the amounts on the withdrawal slips into the Excel spreadsheet and decided to analyse it. He analysed the data with respect to the Benford’s Law. The deviation from traditional auditing practices worked.

Subconsciously, the suspect had repeated some digits and digit combinations. Among the first two digits of the invented amounts, 77, 78, 88 and 99 were all used more than twice. For the last two digits, 16, 67 and 83 were duplicated. There was a tendency toward the higher digits; note that 7 to 9 were the most frequently used digits, in contrast to Benford’s law. A total of 229 transactions were found to be made in the dormant or the inoperative accounts.

All these transactions were entered for digital analysis into the Benford’s Utility provided by Riskpro Technology. The counts for the nine digits from 1 to 9 were 35,35,21,18,12,18,39,29,22 respectively. Any Auditor familiar with Benford’s law could have easily spotted the fact that these numbers—invented to seem random by someone ignorant of Benford’s law—fall outside expected patterns and thus merit closer examination.

The digit patterns of the amounts on withdrawal slips were almost opposite to those of Benford’s law. Over 40% have 7, 8 or 9 as a first digit. Which should have been not more than 14% as per the theorem of Benford. The law applies to the set of natural numbers. If the data is manipulated then the tabulated data gives variances. Hence it gave the signals and when digged further it was observed that the manager was following the short term skimming policy to dupe the bank.He transferred the funds from the several accounts of the depositors to the Fixed deposit accounts controlled by him.He kept the funds in FD’s till nobody came to claim the balance in the dormant accounts.He earned the interest on that idle balance and the principle was refunded back.