Unethical Practice of Bank

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Unethical Practice of Bank: Two Case StudyCourse Title: Social Responsibilities and Ethics in Banking Course Code: CB- 605

Submitted toDr. A.R. Khan Professor Department of Banking & Insurance University of DhakaPrepared By Abdullah-Al-Rashed ID# 51019055 Department of Banking & Insurance

Submission Date: 14th July, 2012

Corruption in Banking All forms of corruption involve the abuse of a public office for personal gain. These episodes may be either transactional or non-transactional. Transactional corruption involves a transaction between a public sector entity and a private sector entity. The act of corruption subverts this transaction for personal gain by one or both parties either in cash or in kind at the expense of society at large. Power vested in public officials is abused in subverting the transaction. Either party may initiate the subversion of the transaction. The transaction may be for a service that is withheld to extort bribes or for extra-legal considerations. In non-transactional corruption public officials abuse the power of their office or the access to public resources available through their office for private gain. Non-transactional corruption may be either collusive or non-collusive. Non-collusive corruption is a form of embezzlement. The public official, alone or in concert with other public agencies, diverts public wealth to personal wealth. In the collusive form the public official, as a partner or shareholder, allows a private sector enterprise to raid public resources. Bribery and influence are complementary and may be applied in tandem; the greater the influence the lower the bribery amount. In the limit, influence prevails without bribery and payments and gifts are given as tips and not as bribes. Influence is gained by way of political party affiliations, positions of power in the public or private sector, through friends and relatives in high places, or by virtue of sustained and mutually beneficial bribery relationships.

Non-cash bribes to bankers have included entertainment and gifts, all expense paid vacations for the family, payment of club bills, high-paying positions in the borrower's firm for the bankers or their family members,

Unethical Practice of Bank: Two Case Studies

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allotment of plots in housing development projects, houses or apartments, shares of the borrower's corporation, and offer of admission in schools or universities along with scholarships. A continuation of small gift-giving may be necessary for relationship maintenance and these may include color televisions, refrigerators, jewelry, and dinner parties. In general the acceptance of the gift implies the acceptance of the deal and it creates an expectation on the part of the giver and an obligation on the part of the taker.

Bribery may be driven both by the demand for bribes by government bureaucrats and by the supply of bribes provided primarily by large defaulting business conglomerates. Evidence in TIB diagnostic studies suggests that the supply side plays a significant role in bank corruption. Public officials involved in corruption may include bank managers, the MOF, the Prime Minister's Office (PMO), officials of BB, and members of the Standing Committee of Parliament on the Ministry of Finance. Private sector businesses including banks are the providers of bribes.

It should be noted that in our theoretical construction, insider loans by private banks to their own directors and NCB loans to failing state owned enterprises ordered by the MOF are imperfections in the financial infrastructure but not corruption/n. Numerous banking irregularities of this nature in Bangladesh underscore the need for banking reform. To this end anti-corruption measures are necessary but not sufficient. We are able to identify distinct areas of corruption in the banking industry in Bangladesh. They are inferred from operating and financial data and supported by interviews with managers and a survey of consumers. They are described as:


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1. Dictation loans 2. Fictitious loans 3. Insider loans to government officials 4. Diversion of interest payments 5. Captive government deposits in government banks 6. Use of bribery to facilitate loans 7. Use of bribery or influence to subvert the loan approval process 8. Labor union intervention in loans, procurement, and recruitment 9. Sale of a forgivable loan 10. 11. 12. 13. 14. 15. 16. 17. 18. Dictation Loans In what has been termed a "dictation loan" the normal loan application review process is completely bypassed. Managers of the NCB and the DFI are simply ordered by MOF or higher authorities to make the loan. The amount of the loan is typically more than 100 million BDT. The loan applicant is typically financially powerful and politically well connected and possibly active in the hierarchy of the political party currently in power. Bangladesh law forbids the NCB from acting on behalf of the government but recognizes the power of the government to act on behalf of the NCB. Use of bribery or influence to obtain a "sick industry" Use of bribery or influence to re-schedule loans Use of influence to waive regulatory restrictions Use of influence or political power to forestall action on Bribe demanded by bank officials to release funds Bribery of external auditors by bank managers Bribery of BB officials by PCB managers Technical loopholes in bank regulation Diversion lf loans classification

defaulted loans


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It is normally assumed by all parties involved that a dictation loan will not be repaid. These cases are described as "willful defaults". In willful defaults no portion of the principal or accrued interest is ever paid and the loans are typically not invested in productive assets. Some may even be converted to hard currency and moved overseas. More than a quarter of the loan defaults of the SOB fall in this category. The bad loans may be shown on the books as performing assets by recognizing uncollected "interest due" as income and by repeated rescheduling. In some cases the accrued interest and even the principal amount may be forgiven and written off under laws that were designed to assist the private sector in specific cases of economic hardship. This form of corruption occurs at the highest levels of government. The corrupt officials taking part include Ministers, members of parliament, and leaders of political parties. These officials are accessible only to a very powerful elite. The defaulters are able to maintain their position in the political hierarchy and remain immune to recourse by banks even after committing brazen acts of loan default. Fictitious Loans The fictitious loan scam is a form of embezzlement. Managers of state owned banks collude with other government officials to give loans to non-existent entities and then cause these loans to go into default. The GOB creates these opportunities when it sanctions loan disbursement targets for certain sectors. For example, BKB managers in collusion with the Hand Loom Board may invent weaver loans when disbursements for weaver loans fall short of the amount allocated by the GOB. Insider Loans to Government Officials


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Ministers, members of parliament, and other high-ranking government officials are able to take out default-able loans without scrutiny and with impunity from state owned banks by virtue of their position. Donors and not the GOB have been proactive in bank reform because government bureaucrats and elected officials along with their friends are themselves the defaulters. There is a collusive arrangement between them and a "defaulters' lobby" in Parliament. Captive Deposits Deposits of SOE and of government agencies such as WASA and DIT are held exclusively by state owned banks by an informal arrangement. These deposits fund corrupt loans that enrich government bureaucrats. Branch managers make substantial "gifts" to the official who holds the fund in order to attract these deposits. In this unusual form of corruption we actually have bribes being paid by one government official to another. Diversion of Interest Payments Not all the interest earned by government deposits in government banks is paid to the government agency that made the deposit. The government official in charge of making these deposits conspires with the bank manager to divert interest payments to personal accounts. Use of Bribery to Facilitate Loans For commercial loans a payment of 1-5% of the loan amount to officials of the NCB or DFI can smooth the progress of loan approvals. A portion of the payment may be made at the time of application and the remainder is expected from the first installment of the loan. Bank managers have developed a sophisticated clearance and settlement system for exchange of bribery funds in cases where a manager is transferred before a bribery deal is consummated. The new manager collects the bribes but forwards a


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percentage to the originator and these cross payments are netted out and a single payment changes hands to close out the transfer accounting. Even an ideal applicant with good credit and collateral and normal business financing needs but without connections may find it necessary to make a bribery payment. On the supply side the applicant may initiate the bribery transaction to expedite loan processing and to gain extra assurance of its speedy approval. On the demand side bank officials may place barriers to loan processing activities, find faults with the application material, or otherwise resist loan processing until a bribe is paid. The bribery amount in these cases is on the low end of the scale. Bribery amounts vary in inverse proportion to political influence and the degree of creditworthiness. Minor flaws in the loan application or defects in valuation of collateral or in the credit worthiness of the applicant will normally increase the bribery amount. Specific bribery strategies may apply in extreme cases of non-compliance and these are described under a separate heading. The bribery amount may be decreased by developing a good relationship with the branch manager or by the use of political influence applied at a higher level. The bribery amount for agricultural loans varies from 2-20%. The larger variation results from a greater cross-section of borrowers. Larger percentages are extorted from uneducated rural applicants. Also, the amount of the bribe for agricultural loans is generally higher than that for commercial loans because the bribe is usually shared with government officials that may be involved in the loan review process. They include the Thana Fisheries Officer, the Thana Livestock Officer, and the Thana BSCIC Officer. Bribes received by Thana level officers percolate up to District and higher levels and neutralize the monitoring function of the administrative hierarchy. ("BSCIC" is a government corporation that provides assistance to cottage industries.)


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Use Of Bribery or Influence to Subvert the Loan Review Process Specific defects in the loan application may be overcome with corresponding bribery strategies. For example, if collateral is insufficient bribery may be used to inflate collateral valuation. Over-invoicing for import financing and valuation of goods according to selling price instead of cost are common applications of this method. Bribery may facilitate the acceptance of uninsured assets as collateral where insurance is required or of photocopies of land title deeds in lieu of the original. In extreme cases, and for equally higher bribe amounts, the bribed banker accepts falsified collateral documents even when no collateral actually exists or accepts cheap imitations when jewelry is pledged. Bribery also makes it possible for the borrower to use the same physical asset repeatedly as collateral for loans from several NCB. It is said that the same warehouse of goods with "four doors" is sufficient collateral for four loans against the entire warehouse of goods. Bribery may be applied to falsify credit reports or to otherwise remove unfavorable information from the loan application. In the Lending Risk Analysis (LRA) procedure implemented by the FSRP bribery may be used to alter the input data to create a satisfactory credit rating of the borrower. Conversely, bank managers may alter LRA data to weaken a good credit rating and extort bribes. The LRA, which was introduced as an instrument of transparency, is potentially an efficient tool for bribery. The bribery transaction normally takes place between the bank manager and the borrower. Influence with higher officials, when available, increases the probability of a successful deal and decreases the bribery amount. Labor Union Intervention


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Labor union leaders, in collusion with the ruling political party, have sufficient power to extort loans from bank managers. Their extortion power is available for sale. Labor leaders may be bribed to influence loan approval. Union leaders use their political power to intervene in other areas of managerial decisions. These include procurement, recruitment, retention, transfers, and promotion. Sale of a Forgivable Loan It is reported that rural branch managers of state owned banks charge as much as 50% of agricultural loans in exchange for a promise that the loan will eventually be forgiven by the government. No such forgiveness is actually offered in most cases but a special audit of Agricultural Credit by BB revealed more than 1.6 billion BDT of unauthorized remission of interest payments by branch managers. A local "corruption syndicate" is usually formed to perpetrate the scam. The syndicate may involve the Union Council Chairman, the police, and other local officials. In a similar scam the farmer's signature or fingerprint is obtained on a loan by telling him that he has been selected for a government grant for an amount that is about 20% of the loan. The loan is quickly approved and the managers of the SOB remove the entire loan amount from the bank and release 20% of it to the farmer who will eventually be asked to repay the entire loan with interest against which he may have unwittingly pledged his assets as collateral.

CASE 1 A corrupt official of Sonali Banks main branch in Gaibandha district misappropriated Tk 1.5 million by issuing fake pension books against dead men of the district. Principal Officer Kalipad Sarker, who had been doing pension related works for five years in the branch, has misappropriated the


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money. The officer went on leave preparatory retirement on December 30, 2010.The forgery was revealed when District Accounts Office conducted an audit of the work done by the official from July to November, 2010. Branch manager Abdul Kuddus confirmed the act of forgery. Over 1.5 million taka was misappropriated by Kalipad Sarker by issuing fake pension books against the dead pension holders, the audit team disclosed.The man in collusion with another officer of the bank also misappropriated money of the real pension holders, the team also disclosed.On disclosure of the forgery, the man refunded the money when the bank authority asked him to sign a bond that he committed the misdeed and to refund the money thereby.With the help of the other corrupt officials and CBA leaders Kalipad had been doing the job violating the rules of the bank, some officers of the bank alleged.If his work during the five-year tenure is looked intoproperly, more cases of irregularity and misappropriation may be disclosed, they also alleged.Admitting the authenticity of the fact, Abdus Samad, assistant general manager of the bank, said they would take disciplinary action against the corrupt official.A show cause notice has already been served to another official of the bank for his alleged involvement in the case, he also said.

CASE 2 Two more general managers of Sonali Bank have been accused of irregularities in giving loans of Tk 2,638 crore. The board of the state-run commercial bank at a meeting Tuesday night decided to take action against them, complying with a Bangladesh Bank directive, the bank officials said. Mir Mohidur Rahman, general manager of the bank's Ruposhi Bangla Hotel branch, has been made officer on special duty (OSD) and attached to the


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head office. Another former GM, Mahbubul Haque, has been held responsible. He has been on leave preparatory to retirement (LPR) from December last year. A BB inspection team had found that the branch gave loans of Tk 2,638.21 crore to three little-known companies, including Hallmark Group, and that there was uncertainty as to whether the bank could recover the money. BB on May 21 gave Sonali Bank Chairman Kazi Baharul Islam a 17-point directive along with the inspection report for necessary steps against the people behind the irregularities. Three days later, Sonali Bank held a special board meeting and issued directives to attach AKM Azizur Rahman, deputy general manager of the bank's Ruposhi Bangla Hotel branch, and Saiful Hasan, assistant general manager of the same branch, to Sonali Bank's head office. The board observed that the branch in an inventive way had given the loans and the bank's top management at the head office had been engaged in the process. The board in its observation also quoted the central bank report as saying the responsibility of the GM office and senior management at the bank's head office for the irregularities had to be determined. An external special auditor has to be appointed to identify the people whose carelessness caused the irregularities, it said. According to the central bank's inspection, the loans were sanctioned against fake export documents and vouchers. The Sonali Bank will relieve three of its senior officials of their duties for lending Tk 2,638 crore to a little-known group beyond their authority.


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The board of the state-run commercial bank at a special meeting last night decided to take the action to comply with a Bangladesh Bank order. The BB had asked the bank to take punitive steps against the three. They include AKM Azizur Rahman, deputy general manager of the bank's Ruposhi Bangla Hotel branch, and Saiful Hasan, assistant general manager of the same branch. The board also came down heavily on the bank's management for failing to act in advance to stop such embezzlement, said an official who was present at the meeting. The Ruposhi Bangla Hotel branch lent Hallmark Group around Tk 2,000 crore through a plot. Hallmark Group recently opened local letters of credit worth around Tk 500 crore in favour of Anwara Spinning Mills, Max Spinning Mills and Star Spinning Mills to buy yarn. The three companies are also the clients of the same branch. The group also gave guarantees to repay the LCs. Following the guarantee, the bank put in the money with the accounts of the three companies through the purchase of acceptance bill. A few days later, the companies urged the branch to transfer the money to the account of Hallmark Group and the branch duly obliged. In a 17-point letter to Sonali Bank, the central bank on May 21 said Anwara Spinning Mills, Max Spinning Mills and Star Spinning Mills are owned by the key person of Hallmark Group, Md Tanvir Mahmud. He is also the main beneficiary of the loans. The letter said the Ruposhi Bangla branch had demonstrated utter negligence to banking regulations.


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The branch manager has breached credibility in discharging responsibilities by lending beyond jurisdiction and without taking permission from the central bank, it read. The central bank said of the Tk 2,638 crore, Tk 1,735 crore is funded loans and Tk 902.99 crore is non-funded loans. Altogether, Tk 2,638.21 crore has come under additional risks at the branch. Officials said the Sonali Bank head office had instructed all its branches to lend less compared to the previous year, as the bank was facing liquidity crisis. The Ruposhi Bangla branch did not follow the instructions. According to the instructions of the Sonali Bank headquarters, a DGM can buy a maximum of Tk 30 crore as acceptance bill from a group or organisation, but DGM AKM Azizur Rahman bought acceptance bill worth Tk 500 crore given to Hallmark Group on a single day. The central bank asked Sonali Bank to classify its loans through its own auditors in the next one month. The bank has to report to the central bank within the following 10 days about the steps it has taken.

ConclusionCorruption is a wealth transfer engine that moves wealth from the poor to the rich and distorts income distribution. There is a non-linear relationship between corruption and income distribution. Distortions in income distribution cause corruption and corruption causes distortions in income distribution.


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Unethical Practice of Bank

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