Innovative Approaches to Fraud Risk Management

The Javelin Strategy & Research Identity Theft Report 2013 states that 5.16% of US customers suffered from identity theft amounting to US$20.9 billion. Moreover, Tablet users had the highest probability of fraud at 9.6%. Victims of data breach had a 22.5% likelihood to becoming fraud victims. Hence, it is clear that while organizations are deploying more processes, technology and resources to prevent fraud, the fraudsters are having a ball. One thing fraudsters do, is to think outside the box. So we have to take a leaf out of their book and be innovative in our approach to prevent and detect fraud. Below are some ideas on the same. Share with me your thoughts on what you think about them.

 1)    Voice Print Analysis

Presently, in most of the banks, a call center agent asks a set of questions to verify the identity of customer for telephone banking. Internal employees, external fraudsters and organized crime groups can easily steal information about date of birth, place of birth, address, secret questions, and card number.

Now voice-printing software is available for authentication of voice. The system automatically verifies the caller voice with the customer’s sample voice to identify fraudulent callers and protect the account.

Secondly, maintain voice records of earlier fraudsters. When system detects a fraudulent caller, it automatically checks against the previous fraudulent call records. Hence, the system will flag if a fraudster has previously conducted a telephone banking fraud. With this, it will be easy to nab the fraudster, if the police had caught him/her in a previous case.

A new voice identity technology is available  that captures the tone of the voice and the type of communication. The software can monitor quality of calls and customer satisfaction from call center agents’ conversations with customers. This will cut manual quality control checks significantly and result in savings in quality control department costs.

2)    Track through Photographs and Location Mapping

Besides having voice-printing software, use a system similar to WhatsApp to identify of customers. WhatsApp sends text messages, images, video recordings, audio recordings, and the location. If banks invest in a similar application and allow customers to download the application on their mobile phones and tablets, the number of telephone and internet frauds will reduce.

If a fraudulent caller is flagged, then the call center agent can request the customer to send a selfie or video. If it is the wrong person, usually the caller will cut the conversation and drop the attempt to commit a fraud.

If the caller is able to circumvent this control, the application will also track the location. Applications track the frequent places a customer visits or calls from. If the caller is from an unusual place, then s/he can be tracked immediately. For example, if a British customer is tracked to a place in India, the call centre agent can ask the caller to verify their location.

3. Track Spending Behavior

Sometimes high value fraudulent payments are processed resulting in huge losses. A study done by Vivek K. Singh*, Laura Freeman*, Bruno Lepri, Alex (Sandy) Pentland for “Classifying Spending Behaviour using Socio-Mobile Data” determined the spending behavior of customers from the social interaction patterns on mobile phones. For example, it showed that more social couple and couples with diverse business interests tend to spend more.

Using big data, insights on spending behavior of customers can be analysed based on personality traits. Tracking social patterns and payment patterns can flag out anomalies when the payment is not in line with the spending pattern. Moreover, a location map can identify the location of beneficiaries of previous payments . Hence, fraudulent payments can be identified at the time of processing itself.

Another advantage from this technology can be for processing retail loan applications. If prospective customers are willing to give the data of mobile phone transactions, then at the time of processing the application itself, the bank can identify which customers are likely to overspend and default in future. The bank can ask for additional securities and guarantees.

Moreover, if the application is installed in the loan customer’s mobile after loan disbursement, the moment s/he is about to overspend which might result in default of EMI, the bank can send the customer an alert to pay the EMI first.

 4. Fraud Risk Conversations

According to psychological studies on emotional intelligence, Negative Emotional Attractor’s activate defense systems and build resistance to change. On the other hand, Positive Emotional Attractors (PEA) activates parasympathetic nervous system and makes a person more conducive to listen and change behavior. An effective team has a 3:1 ratio of PEA:NEA. Another study shows that improving peer-to-peer conversation increases productivity of the team by 30 to 40%.

However, risk management reports are mainly critical hence activate NEA. Moreover, the communication, training material, and code of conduct are all geared towards creating fear and guilt. Hence, it is not surprising that attempts to educate business teams on fraud risks fail.

Fraud risk managers can build a positive interaction model using technology platform. A study conducted by Erez Shmueli_, Vivek Kumar Singh_, Bruno Lepri and Alex ”Sandy” Pentland on “Sensing, Understanding, and Shaping Social Behavior” enables tracking of human behavior through big data analytics. The analytic helps in understanding the behavior, the tone of the conversation and the trust relationships between people.

Using this technology, an organization can use a social networking platform to communicate fraud risks through blogs, videos, and stories. The write-ups and stories should be from the business teams. From the comments section, the application can identify the key influencers and trust holders to bring about change. Thus, change the conversation to change the behavior.

 Closing Thoughts

 The days of holding a gun to rob a bank are nearly over. Fraudsters use social engineering to obtain sensitive information to conduct account takeover frauds remotely. Hence, organizations need to use socio-physics, social networks, and technology to beat the fraudsters in their own game. Being a leader in adopting the latest technology to prevent and detect frauds has an additional advantage, the fraudsters have not discovered the antidote to it. Hence, fraud risk managers have the right weapons to fight. The right tools can make a hell of a difference.

References:

1.  Javelin Strategy & Research Identity Theft Report 2013
2. Classifying Spending Behavior using Socio-Mobile Data – Vivek K. Singh*, Laura Freeman*, Bruno Lepri, Alex (Sandy) Pentland
3.  Sensing, Understanding, and Shaping Social Behaviour – Erez Shmueli_, Vivek Kumar Singh_, Bruno Lepri and Alex ”Sandy” Pentland

 

 

Routine Activity Theory Implications on Increasing Crime Rate in Indian Society

Cohen and Folsen’s Routine Activity Theory of Crime, appeals to me at an intellectual level to understand the increasing rate of crime in Indian society. However, it contradicts my personal philosophy about human beings. The theory presumes that every human being basically has a criminal tendency and is capable of crime. I believe that human beings are inherently good and each human being irrespective of the crimes they have committed is capable of good deeds. Hence, I will try to discuss the theory without bias and balance the two opposing views. If I sound partial towards my philosophy, then forgive me from the goodness of your heart.

1.      Introduction

The theory was based on analysis of US crime data of 1947-1974. During this period the average income of families increased, number of people below poverty line decreased, education levels improved, and unemployment levels decreased. However, the rate of violent crime in urban areas   increased – rape (174%), assault (164%), robbery (263%) and homicide (188%).

The Indian urban society is showing similar trends since liberalization in 1990s. While growth, income, economy, facilities, education etc. has significantly improved in urban areas, the rate of crime has increased exponentially. Before, in 1960s and 1970s, others would ostracize a middle class person if he were publicly involved in criminal activity. Now, nearly every second person is involved in a corrupt and unethical activity openly. Though we blame it on deteriorating social values, this theory helps us understand why we compromise the values and participate in a crime.

2.      Concept

The theory states that “structural changes in routine activity patterns can influence crime rates by affecting the convergence in space and time of three minimal elements of direct contact predatory violations: (1) motivated offenders, (2) suitable targets, and (3) the absence of capable guardians against a violation”. Lack of any one of these reduces crime. However, the level of control exercised by the guardians has a direct impact on crime. Even if motivated offenders and suitable targets remain the same, if control reduces, crime increases. The theory states that income of the offender does not have any impact on his desire to commit crime and contradicts the popular notion that people with less income have a higher propensity to commit crime.

Now this can be understood in Indian context. The number of people living away from their traditional homeland has increased as more people are living in nuclear families or as singles in different cities. The change in social behavior has changed the routine activity of people as social controls of family and community have decreased. These aspects reduce the worry of motivated offenders on how their community will judge them if they participate in unethical behavior. Secondly, the same aspect makes suitable targets more vulnerable to crime as protective layers have reduced. Hence, due to this changing social structure, motivated offenders and suitable targets have both increased. With it, the corruption in law enforcement agencies has reduced control. The sum total of it all has increased the crime rates in Indian urban areas.

3.      Effect

Then the theory states that motivated offenders cooperate to strengthen their efficiency in criminal activities. On the other hand, the potential victims join hands to gain collective strength to protect themselves from the attack. The challenge becomes bigger for potential victims when high-net worth individuals undertake criminal activities. The potential victims risk of victimization increases.

From the Indian context, the driver for change in social values has been the thirst for money and power. The higher level of ambition for being powerful and materialistically successful has motivated people to break the traditional social norms and move towards corruption and crime. Previously, the lack of a good criminal justice system was compensated by strict controls from family and community. Now all the three guardians have decreased control and the value of rewards gained from criminal activity is high. The other factor to consider is that voluntary help groups and social support groups are less in India; hence, the potential victims do not get the desired protection. As Cohen said – “it is ironic that the very factors which increase an opportunity to enjoy the benefits of life may also increase the opportunities for predatory violations”. Crime has become the by-product of freedom and prosperity as it has enmeshed itself in routine activities of daily life in Indian urban society.

Closing Thoughts

My personal belief is that for every action, especially criminal or unethical activity, a person needs to ask whether they need to involve themselves in it. When one accepts rewards for the wrong reasons, one cannot avoid punishment for the wrong reasons also. Hence, why go for the wrong rewards in the first place; and if one has received them, why not return them? When one is in a financially strong position and survival does not depend on income from criminal activity, why not refuse to undertake that activity. No one can involve another in a criminal activity if the participants do not wish for any monetary benefits. Hence, to enjoy the benefits of life, say no to crime and unethical activities.

References:

Routine activity theory – Crime Prevention Division – By Cohen and Folsen

 

Impact of Power Styles on Organization Risks

Power, we all want it. If we don’t have it, we associate with the powerful in the hope some of it rubs down to us. Being in the upper echelons of corporate world or the political corridors of the country’s parliamentary houses ensures that you are exempt from the rules applicable to the common person.

However, the way a person gets power and uses it reflects the person’s character, and its influence on others. In the corporate world, the power styles used by senior managers directly influence the risk levels of the organization. Unsurprisingly,  power and politics are undiscussable topics in the corporate world; hence, when risk managers do risk assessments, they ignore the two.

I personally recommend risk managers to understand the individual power styles of the senior managers and overall organization power style. To appreciate the connection between power and risk, let us first look at the power styles and their impact on the organization.

Depending on the situation, a leader needs to use various power styles. However, if a leader uses coercive style even when it is not required, then something is wrong. Leaders frequently use power styles of reward and punishment for fulfilling illegitimate requirements. Hence, the probability of followers being involved in unethical activities requiring compromise of personal values is higher. On the other hand, the expert style ensures that followers make informed judgments as the leader attempts to enhance their ethical values and knowledge level. The reward is not in the form of a bribe and is implicit; the leader is dedicated to improving the organization.

Another aspect that requires understanding is the need for creating perception of power. When a leader is undertaking illegitimate activities (watch any Hindi movie to see the underworld Don) he needs to create a strong perception of power by using threat and punishment. Else, his coercive tactics will be ineffective, as people will not cooperate. Therefore, he makes some sacrificial goats to demonstrate that he is above the law and normal rules don’t apply to him. Another tactic is to break the social norms, and not behave rationally and predictably. Both these methods focus on creating fear to ensure compliance. Without the perception of power and fear, the leader becomes vulnerable to revolt from the common person. The only way for him to retain his power is by increasing the number of sacrificial goats, threats, and punishments.

1.   Impact on Legal and Reputation Risks

A coercive leader is usually riding a tiger. The organization risks continue multiplying as more and more people become aware of the unethical practices. An elastic can be stretched up to a limit. Eventually, the concocted environment cocoon will burst and all hell will break loose. The leader cannot trust anyone after a point. Hence, his fear increases in direct proportion to his vulnerability. The leader takes more and more risks to protect his personal fiefdom. The organizations reputation risks and legal risks increase proportionately.

2.   Impact on Human Resource Risks

Overtime, the leader’s charisma wears off. As the layers peel off, disillusion sets in. Employees realize that the leader doesn’t behave with integrity and honesty. Even the loyalists recognize that whenever it suits the leader’s personal agenda, they can face the bullet without any fault of their own. This creates disquiet among employees, and employee disengagement increases. The human resource risks increase manifold with disengaged employees.

3.   Impact on Operational and Financial Risks

The disengagement starts effecting productivity and performance as everyone grasps that meritocracy has no links with rewards. This in turn impacts the bottom line as leader fails to deliver on targets. Failure to show profitability and results makes the leader’s position precarious. The leader starts feeling pressure from the top. As he is unable to improve productivity, he attempts to manipulate results and financial statements. In nutshell, leader’s power style influences operational risks and financial risks of the organization.

Closing Thoughts

No one can deny that success in life depends quite significantly on a person’s power and influence. The general opinion is that means to the end do not matter when we strive for power. On the contrary, how we get power and maintain power, is crucial for longevity in the powerful position. For a coercive leader, the end is tragic, as the hunter becomes the hunted. Moreover, if a leader gets power by paying bribes or giving rewards, his power ends when he stops doing so. His loyalists disappear with speed. Abusing power is no longer safe in the present world, as it increases the personal risks of the leader and the organization risks. Therefore, risk managers need to ensure for continued prosperity of the organization, that leaders get power by the rights means and use it for the right purposes.

Satyagraha For Freedom From Corruption

Gandhi ji, in his book “History of Satyagraha in South Africa” narrates the coinage of the term Satyagraha and the journey of the movement. It is an amazing story of sacrifice, determination, and moral courage. Hence, I wondered whether we can use the concept to fight corruption in this century.

The irony is that Gandhi ji started the Satygraha movement in South Africa because Europeans passed unfavourable laws for Indians. They were scared of Indian traders and professionals taking a huge slice of the business, hence passed laws to restrict their liberty to live and trade freely. Greed was at the crux of it since there were plenty of natural resources in South Africa for Europeans, Blacks, and Indians. Now India is being destroyed by the greed of its leaders and public.

Gandhi ji’s story stands in stark contrast to the Anna Hazare led fight against corruption. Hazare’s was packaged as Gandhian inspired struggle but as results showed it was far from it. Hazare took the stance of my way and high way on the Lokpal Bill, whereas Gandhi ji believed in negotiation. Moreover, Hazare’s was a publicity driven exercise of a few fasts and he quickly distanced himself from it when he faced failure. Another aspect was that though thousands turned up in support at the initial stage, no one made use of that energy constructively and directed people to do something more than shout slogans on the streets. Hence, the euphoria disappeared after a short while, as the educated middle class needed an action plan to maintain their commitment.

It brings back to our understanding of Satyagraha. We generally confuse it with “passive resistance” and it was the same situation when Gandhi ji developed the concept a century back. Below are few points from the book:

1)      Satyagraha

Gandhi ji considered Satyagraha as a soul-force. The Satyagrahies never used physical force even when they had the capability for it. In Gandhi ji’s word – “Satyagraha is soul-force pure and simple, and whenever and to whatever extent there is room for the use of arms or physical force or brute force, there and to that extent is there so much less possibility for soul-force. These are purely antagonistic forces in my view, and I had full realization of this antagonism even at the time of the advent of Satyagraha”

2)     Passive resistance

The term “passive resistance” originated in Europe as a weapon of the weak. It was generally used when other options of fighting were not available. It was a method used by people without voting rights, or lacking public support. The people were not averse to using arms for attaining their goals. But they did not go for it because they didn’t think they would succeed with it. Hence, passive resistance was more of a strategic manoeuvre than commitment to non-violence.

3)    Difference between the two

Gandhi ji described the fundamental difference in the concepts in the following paragraphs –

 “The power of suggestion is such that a man at last becomes what he believes himself to be. If we continue to believe ourselves and let others believe that we are weak and therefore offer passive resistance, our resistance will never make us strong, and at the earliest opportunity we will give up passive resistance as a weapon of the weak.

 On the other hand if we are satyagrahis and offer satyagraha believing ourselves to be strong, two clear consequences result from it. Fostering the idea of strength, we grow stronger and stronger every day. With the increase in our strength, our satyagraha too becomes more effective and we would never be casting about for an opportunity to give it up.

 Again, there is no scope for love in passive resistance; on the other hand, not only has hatred no place in satyagraha, but it is a positive breach of its ruling principle. While in passive resistance there is a scope for the use of  arms when a suitable occasion arrives, in satyagraha physical force is forbidden even in the most favourable circumstances. Passive resistance is often looked upon as a preparation for the use of force while satyagraha can never be utilized as such. Passive resistance may be offered side by side with the use of arms. Satyagraha and brute force, being each a negation of the other, can never go together.

 Satyagraha may be offered to one’s nearest and dearest; passive resistance can never be offered to them unless of course they have ceased to be dear and become an object of hatred to us.

 In passive resistance there is always present an idea of harassing the other party and there is a simultaneous readiness to undergo any hardships entailed upon us by such activity; while in satyagraha there is not the remotest idea of injuring the opponent. Satyagraha postulates the conquest of the adversary by suffering in one’s own person.”

 4)    Freedom From Corruption

Considering the above definition of Satyagraha and the differences highlighted by Gandhi ji, I haven’t seen very many noteworthy cases of mass movement of Satyagraha. Hazare’s movement just entailed short-term sacrifice and not a long-term struggle. When the public disappeared so did he.

The Satyagrahies courted prison and lived a simple life to fight for their cause. Hence, the question is that do we lack commitment and determination for long-term struggle to root out wrong habits. Is it possible and realistic to expect people to make these sacrifices in the present age of instant gratification. Can we expect Indian public to take a vow not to take or give bribes and kickbacks? Will it be expecting too much from the citizens to sacrifice a few luxuries. Will the public stay committed to the cause or leave it when it gets bored, to participate in the next novel thing.

We need to seriously think of eradicating corruption on this Independence Day. India has come a long way in one century but the corruption is eroding its sheen and destroying the country from within. We must not forget the sacrifices a whole generation of Indians made to ensure that the next generations live with freedom. Let us pledge to keep our souls free of greed.

Wishing all Indians a Very Happy Independence Day.

References:

History of Satyagraha in South Africa by M.K. Gandhi 

Indian Banks Give Customer Service for Money Laundering

Recently a string operation exposed money laundering services provided by some Indian private banks. The employees and bank managers were caught on camera advising the disguised reporter on ways and means he can convert his illicit money into legal money.

1. Caught in the act

Some of the helpful advice given by bankers included:

1. Open multiple accounts so that the amount remains below the reporting limits. Do not deposit over Rs 10 lakhs (Rs 1 million) in a single instance.
2. Obtain a demand draft from a Cooperative Bank and deposit the draft with us. Cooperative Banks do not require an account hence it will be easy to obtain a draft. Since cash would not be directly deposited and private banks do not have to check the source of funds, the deposit will not raise any alerts.
3. Route the cash money through another bank to avoid detection.
4. The Income Tax act prohibits keeping cash in bank lockers. However, if you do not inform the bank staff, they can look the other way.
5. Open an NRI account and slowly transferring the money offshore. We need a passport and visa for opening an NRI account. No pan card required.  Deposit Rs 25 lakhs per month. Better still start by opening a NRO account.

The bankers offered to visit the client’s residence to open an account and collect the money. One has to watch the video clippings to see the level of customer service provided by the bankers. No one can say they were not being helpful.

2. Standard response from senior management

As expected the senior management of the banks denied all knowledge, claimed they maintained highest ethical standards, suspended the branch managers and the staff, and commenced an internal investigation. But this is an open secret. Every business person in India knows that the banks will help them convert black money into white and transfer illegal money. If it was not so, how can a parallel black money economy exist in India for so long. Did the expose really shock anyone?

3. Lip service by regulators

Of course Reserve Bank of India has given detailed guidelines on Know Your Customer and submission of suspicious transaction reporting. There is only theoretical application of guidelines of Financial Action Task Force (FATF) on Anti Money Laundering (AML) standards and on Combating Financing of Terrorism (CFT). The Financial Intelligence Unit of India received just over 30,000 suspicious transaction reports in 2011-2012. It received 100,00,000 cash transaction reports. If you read these numbers in reference to the size of banking business in India, it would not be even .01% of the total yearly transactions.

In February 2012, the director of the Central Bureau of Investigation had said that Indians have $500 billion of illegal funds in foreign tax havens, more than any other country. Some reports estimate the amount over a trillion.

Hence, can we actually believe that regulators and bankers are serious about preventing money laundering in India? The annual report 2011-2012 of Financial Intelligence Unit doesn’t really mention any investigations done that would make the bankers uncomfortable. In India the detection and investigation capabilities of financial regulators is still in nascent stages.  Unlike US which has full-fledged organizations and systems to check money laundering.

Closing Thoughts

In the pursuit of growth numbers bankers are willing to compromise ethics and legal requirements. However, in Indian society because of the high level corruption, most businesses are doing the same. In such a scenario, it amounts to pot calling the kettle black. Unless we really get serious about removing corruption, as a society we can’t succeed. Some things required are – public to withdraw support from companies using unethical practices to succeed, regulators take organizations to task, and government prosecutes politicians and other individuals for dealing with illicit money. Till this happens only media will benefit by doing exposes to improve their ratings.

References:

1. Cobra Post Expose
2. Financial Intelligence Unit India
3. Black Money Market in India

Fraud Risk Management in Ancient India

Presently, the Serious Fraud Investigation Office of India lacks sufficient powers to initiate investigations and prosecute. The Central Bureau of Intelligence isn’t independent due to which politicians escape prosecution for corruption and money laundering. Indian police force Economic Crime wing doesn’t have expertise in dealing with electronic and financial frauds. The legal system is pathetic and takes a long time to prosecute white-collar criminals. India has a shortfall of trained fraud investigators as it hardly has any courses for students in this line.

All these aspects may make you think that Indians are new to the concept of fraud risk management. This is far from the truth. Kautilya addressed financial fraud risks in 4^th century BC and most of the concepts are still used presently. Let me narrate you some of the concepts he formulated in earlier times.

1.      Formation of a Central Investigation Agency

Kautilya proposed a central investigation agency for a kingdom to do espionage work. A network of spies located in different parts of the kingdom reported information to their handlers. The handlers in turn checked the authenticity of the information from three sources and if correct reported to the agency. The spies did not have direct contact with the agency to conceal true identities..

Spy selection depended on character and social position. Spies were recruited from all sections of society. Spies were positioned in all the departments and commercial ventures of the king to ensure that the head of the departments do not abuse their power or cheat the king. Women were considered particularly useful to penetrate wealthy households to get the inside story. In current India, there is a scarcity of female fraud investigators as it now considered a masculine job. However, in ancient India, women investigators and spies were quite common.

2.      Types of Financial Frauds

Kautilya identified 40 ways of embezzlement. Some of them are mentioned below:

• Overpricing and under-pricing of goods
• Incorrect recording of quantity of raw material and other stocks
• Misappropriation of funds
• Teaming and lading
• Misrepresentation of sources of income
• Incorrect recording of debtors and creditors
• Incorrect valuing and distribution of gifts
• Inconsistency in donations and distributions for charity
• Misappropriating goods during barter exchange
• Manipulating weights and tools for measurement
• Misrepresentation of test marks or the standard of fineness (of gold and silver)

It is interesting to note that Kautilya mentioned most of the frauds that occur in accounting and preparation of financial statements. It shows human psychology has remained the same. However, in India the value system has deteriorated that has resulted in increased fraud and corruption. In olden times, the value of honour was held high. For example, the prime thought in Hindi was – “prann jiye pur vachan na jiye.” (meaning – it is better to lose one’s life rather than go back on a verbal promise given)

3.      Mechanism for Investigation and Punishment

The investigation process was quite similar to the current process followed. Information was initially gathered regarding the fraud from informants, spies, whistle blowers and audits. Background information of the suspects was gathered by sending spies to their residence and business premises.

Subsequently, the people involved, the suspects and witnesses were interrogated. Kautilya suggested separately examining ” the treasurer (nidháyaka), the prescriber (nibandhaka), the receiver (pratigráhaka), the payer (dáyaka), the person who caused the payment (dápaka), the ministerial servants of the officer (mantri-vaiyávrityakara)” for financial frauds. If any person lied, s/he received the same punishment as the main culprit.

Another fascinating aspect is that India doesn’t not have any law similar to the whistle blower provisions of Dodd Frank Act. However, Kautilya proposed –  “Any informant (súchaka) who supplies information about embezzlement just under perpetration shall, if he succeeds in proving it, get as reward one-sixth of the amount in question; if he happens to be a government servant (bhritaka), he shall get for the same act one-twelfth of the amount.”

The punishment for fraud depended on the nature and value of fraud. It ranged from nominal fines to death penalty. The victim was compensated for the losses suffered.

Closing Thoughts

The processes proposed by Kautilya for fraud detection were followed even until the Moghul rule. However, these were dismantled during the time of British Rule as the Indian Penal Code was formulated.  The difference between Mogul rule was that Moguls settled in India, marriages took place between Indian royalty and Mogul rulers and the culture got integrated over time.

The British came to rule for economic purposes. They wished to take advantage of India’s natural resources and vibrant economy. They levied their own rules and did not integrate them with the Indian culture. Hence, over time the Indian value system was lost or kept for namesake only. Overtime, as even after independence the British education system was used, a split ethical value system developed between personal values and business ethics. Therefore, corruption increased in the business environment till it became all-pervasive in the society. It is going to take a lot of effort to change the system now. No short-term solutions  will work.

Accounting and Auditing in Ancient India

Professionals want to know the origin of their profession, the work done in olden times and the level of knowledge. I thought of sharing with you the history of Indian accounting and auditing profession. I discovered in Kautilya’s Arthshastra that it existed in ancient India in 4^th century BC. Therefore, my guess is that it would have originated at least a few centuries earlier.  The accounting principles and standards used in the present century are similar to those that existed in the 4^th century BC. This nugget of information may have surprised you.

Broadly, Kautilya’s Arthshastra covers accounting principles and standards, role and responsibilities of accountants and auditors, the methodology of accounting, auditing and fraud risk management, and the role of ethics in managing financial activities. Let me share some of the concepts with you in the next couple of posts.

1.     Maintenance of Accounts

The accounting financial year was fixed to July-June period and with a full process for closure of accounts and audit of the same. It covered the method of consolidating the accounts from various departments of the government to assess the net income and loss. The accountants were required to furnish the completed annual accounts to the head office mid-July. Delay and/or failure to do so attracted financial penalties.

 2.  Classification of Receipts

 Kautilya states that “receipts may be (1) current, (2) last balance, and (3) accidental (anyajátah= received from external source).” In it, he differentiates between cash receipts and debtors, current and accrued income, income from other sources, windfall gains, and recovery of bad debts. He recognized the concept of risk and suggested different rate of interests for loans. Foreign trade loan attracted the highest interest, as the returns were uncertain.

3. Classification of Expenditure

Expenditure classification was similar to receipts classification and included the differentiation between capital expenditure and revenue expenses. Kautilya described it as – “Expenditure is of two kinds—daily expenditure and profitable expenditure.” The difference between income and expenditure was termed as “net balance”. He insisted on making long-term investments in construction and other works as these would generate profits over a period. It also entailed keeping track of work in progress.

4. Role and responsibility of accountants

A hierarchical organization structure of senior to junior accountants existed within the king’s treasury function. The accountants maintained books of accounts on an annual basis according to prescribed standards. The same were furnished for audit at year-end. Kautilya suggested good salaries to accountants and auditors as high income would keep them ethical. Accountants would be more prone to commit fraud if they earned very little.

5.     Segregation of Roles of Treasury and Auditor

The fascinating part of Kautilya’s approach was that he recognized conflict of interest between finance and auditing functions. He categorically stated that the head of finance and head of audit should independently and separately report to the king. He recognized the possibility of collision between the two. In India, in the government the Comptroller General of Audit and Ministry of Finance are two separate functions. However, in the corporate world still in quite a few companies chief audit executive are reporting to chief financial officer rather than the chief executive officer.

6.     Building an Ethical Culture

Kautilya believed character reflected personal values of individual and ethical values learning must commence from childhood. Even as an adult ethical conduct was as important as professional skills. He proposed measures to build ethical climate in the kingdom. However, he was practical and recognized the potential of corruption. In accounting, he talked about misstating financial statements due to abuse of power and fraudulent reporting. He devised a system of reward and punishment to ensure compliance to rules and regulations.

7.     Verification and Auditing of Accounts

The concept of continuous monitoring, periodical auditing, verification and vouching existed in ancient times. Checks were done daily and periodically (five nights, pakshás, months, four-months, and the year). The attributes used in the present day for verifying income and payment vouchers were also used in earlier times. Interestingly, each department had spies to provide information and report wrongdoing to the seniors. There was a full process for discovering fraudulent transactions and punishing accountants for misstating financial statements. I shall cover that in the next post.

Closing Thoughts

Kautilya prescribed the accounting theory that included bookkeeping, preparation of financial statements, auditing and fraud risk management. He considered accounting as an integral part of economics. Various kingdoms in India used his work until the 15^th century AD i.e. before the colonial rule. I am not aware whether similar level of knowledge existed in other parts of the world before the Christian era. If you do have information, please share it with me. It will be an enthralling journey into the past.

References:

Kautilya’s Arthshastra 

Money Can Buy Everything

A woman called me up recently and said that someone is willing to pay her huge amount of money for investment in her business. Problem was, they did not want to disclose their identity and would be transferring money from Sri Lanka. I told her I suspected that the people involved are attempting money laundering. She believed the same and refused the transfer of funds.

I realized that the people behind white-collar crime believe one thing – “Money can buy everything”. That is the core motivation. Otherwise, professionals earning huge salaries would not be rationalizing fraud. The American money market economy reiterates this concept; hence, even the normal people are pursuing money blindly. All relationships and every person seem to have a price. So let me ask you the question:

Now let me paint you a picture of the future world. In that world you do not have to produce kids, no woman has to get pregnant and tolerate the pregnancy woes for nine months. Whenever you feel like becoming a parent, you just have to visit a shop. Lifeless kids’ bodies are available of all sizes and shapes. When you choose one, the shopkeeper installs a battery and wham, the kid is alive. You can choose a new-born, a two-year-old etc. at a certain price.

Next, you don’t have to train the child on anything if you don’t want to. You have the option of raising the child the normal way or using patches. For example, if you wish your child to learn cricket, you just purchase a patch and install it, and the kid knows cricket.

Contemplate the advantages of this situation. As a parent, you won’t have to spend countless hours changing dirty nappies and watching the child struggle to learn to walk and talk. Mothers won’t have to sacrifice their professional and social life. You won’t have to sacrifice Dhoni and teams match to watch your son’s floundering attempts on the cricket field. You won’t have to watch your daughters giving a disastrous dance performance. After these, you won’t have to give a beaming smile and make it sound that it was the greatest performance in the world. You won’t have to make any sacrifices. There will be no pain, no tears of frustration and no disappointments. So now, let me ask you a question.

If you have answered that you would prefer the natural way, then the question is why? Why choose hard work, heartbreak and pain over an automatic high quality child? The reason goes back to root of our psychology. Raising a child gives purpose and meaning to the life. When our child does well, we feel a sense of satisfaction, accomplishment and pride. The joy and happiness we get are worth all the tears, heart breaks and sacrifices. Parents put their life on hold for 20 years to raise a child and then the child leaves home to make his/her own life. If you look it from a financial angle, it doesn’t sound much of a deal. Yet, nearly every adult wants to do it.

If I look this from another angle, another basic human need is sex. Hence, according to this viewpoint  prostitution should be legal in all countries (It is illegal in India). There should be no moral judgment on purchasing sex. The question is then why do the people who use prostitutes don’t stay with them? Why do they come back home? Why do most of them go back to the same prostitute rather than try a new one every time? The reason is simple. However good the sex was, it doesn’t give a sense of belonging. Objects don’t give happiness, relationships do. Commoditizing takes away the warmth, peace and happiness.

The same difference applies for money earned through hard work and by frauds. Money earned the wrong way doesn’t give you pride and joy. I think all of us remember our first salary and the sense of “I did it”. The salary was peanuts in comparison to twenty years of studying hard. But we remember the first salary till our dying day.

In my opinion, money can only give a comfortable standard of living and nothing more. We don’t even need money even power, recognition and status. We simply are getting lost in the mad race.

Closing Thoughts

Today is Mahatma Gandhi’s death anniversary, one of the most recognized and respected leaders of the 20^th century. Even in this day and age, his dhoti, shawl and chapel can be purchased in India in less than Rs 1000/-. In President Obama’s inauguration ceremonies, Michelle Obama’s clothes were a topic of discussion. Some would argue that present days leaders need it. I think if Gandhi ji had been alive today, he would be living in less than Rs 20,000/- a month.  We need to re-look where we are heading in the mindless pursuit of money while convincing ourselves that our life in other areas is fine. As Mahatma Gandhi said – “One man cannot do right in one department of life whilst he is occupied in doing wrong in any other departments. Life is one indivisible whole.”

Barclays War on Culture Change

Barclays is again in the limelight due to a damaging report on the deviant culture existing in the Investment division. After LIBOR rate fixing scandal and quick departures of senior managers, trouble is again brewing in Barclays. The COO of Investment banking division, Andrew Tinney quit when it was discovered that he shredded the only copy of a report that clearly stated the bullying culture of the organization. Then the new CEO, Anthony Jenkins discovered when an internal whistle blower mentioned it to him. He sent out a message to staff on culture change. Here are some insights into the story.

1. The Damaging Report on Dysfunctional Culture

Daily Mail story states that the report prepared by Genesis Ventures – “paints a devastating picture of incompetence and arrogance at the bank, showing that executives:

• Pursued a ‘revenue at all costs’ strategy.
• Fostered a culture of fear and intimidation.
• Were ‘actively hostile’ to the idea of compliance with banking rules.
• Presided over a ‘broken culture’ where problems were ignored or buried.
• Allowed the business to spin ‘out of control.”

The senior management intentionally understaffed support functions, was hostile to compliance and attacked those who spoke contrary to senior management views. A senior manager threw the risk management report publically saying – “this is a piece of s***” showing utter contempt and disregard for the same.

The summarization of the report states – ‘The senior team portray themselves as all-powerful and all-knowing… and people chose to disagree with them at their own peril. It is a mentality of superiority which, when combined with other deficiencies, stops the team from tackling their blind spots. When those deficiencies are in compliance, this results in serious issues that no one else has the power to address.’

The bank’s culture has become completely deviant, and it will be a long road ahead for significant change to occur. The problem is that this issue is prevailing in other banks also. They depict the same culture and attitude. Unless we understand why it is occurring and senior managers take sincere steps, nothing positive will happen.

 2. The Psychological Explanation

Western banks are known for their arrogant and aggressive culture. Some view arrogance as a positive trait and humility as a negative trait, while the opposite is true. Stanley Silverman developed Workplace Arrogance Scale to measure arrogance level in the organizations. He stated the arrogant people demean others to prove superiority and competence. However, as per his results arrogant people showed lower intelligence and self-esteem in comparison to their peers. He identified four red flags to identify arrogant behaviour:

• Does your boss put his/her personal agenda ahead of the organization’s agenda?
• Does the boss discredit others’ ideas during meetings and often make them look bad?
• Does your boss reject constructive feedback?
• Does the boss exaggerate his/her superiority and make others feel inferior?

If you link back to the damaging report, the senior management at Barclays showed these traits in abundance. Even during the financial crises, the bankers didn’t feel apologetic and showed no humility. Now, being in such senior positions one cannot say they lack intelligence, however, questioning their self-esteem is definitely a valid path.

In another psychological study conducted by Angela Y. Lee, a professor of marketing at the Kellogg School of Management, it was determined that people with low self-esteem defend the brands more when their favourite brands are attacked. This explains why bankers refused to change and continued their behaviour when under attack during the financial crises.

3. The CEO Message for Culture Change

Deal Book reported that Anthony Jenkins, the CEO of Barclays sent a mail out to the staff with a clear message – “change or leave”. He categorically stated the values – Respect, Integrity, Service, Excellence and Stewardship – to be adopted by Barclays employees. He further added that those who do not change their behavior are free to leave. His words were – “My message to those people is simple: Barclays is not the place for you. The rules have changed. You won’t feel comfortable at Barclays and, to be frank, we won’t feel comfortable with you as colleagues.”

He highlighted that in the last two decades financial institutions pursued profits and compromised integrity and reputation of the organization. He said there is no choice between values and profits. Employees must pursue profits while maintaining values. Evaluation of ethical behaviour will be incorporated in performance appraisal process.

That is a very strong message from the CEO of the organization to transform the culture of the organization. Two questions in everyone’s minds are – will they succeed and how long will it take.

Closing thoughts

Bill Gates had famously said – “The world won’t care about your self-esteem. The world will expect you to accomplish something BEFORE you feel good about yourself.” Maybe organizations should care about the self-esteem of their employees and their senior management team. Studies have shown that people with higher self-esteem show more ethical behaviour and are less likely to get involved in wrongful acts. The present trend of pursuing material gains at the expense of personal values destroys self-esteem in the long run. Bankers have shown extreme tendencies to flaunt expensive toys to feel good and build a superior image. In all probability, they are caught in a catch-22 situation at a psychological level. It might not be possible to change the culture without addressing the core issues faced by the staff.

References:

1. Exposed: The regime of fear inside Barclays – and how the boss lied and shredded the evidence
2. Identifying the arrogant boss
3. Leave My Brand Alone – Kellogg School of Management
4. New Barclays Chief Tells Staff to Accept Changes or Leave

 

 

Manipulating Purchasing Decisions

I read “Influenced Decisions” on Philos blog. It talks about Dan Ariely’s experiment on rationality of decision-making. According to the experiment, though we think we are making rational decisions, we can get easily influenced in making the wrong decisions. He experimented students for subscribing for a magazine with the following results.

As per Philos blog, 100 MIT students tested for Economist.com gave the following preferences:

Interestingly, 84% chose the third option and no one subscribed for second option.

Ariely, then conducted the experiment with just two choices and removed the dummy choice.

Students preference changed. While in the first experiment they preferred the third option, in the second experiment, majority chose  the first option. The dummy option played a major role in the first experiment as students thought they were getting a better deal.

Now think of the impact this has from fraud perspective. Either a purchasing manager to get approval for a favoured supplier can insert fictitious proposals or have real suppliers submit dummy-like proposal

Submission of a fictitious proposal will be a clear case of fraud. Auditors might detect in regular course of audit and definitely during investigation. However, a dummy-like proposal will appear completely normal in the course of business and will be far more difficult to detect.

The question is whether on detection the purchasing manager’s behavior will be considering unethical or fraudulent? As the intent was to defraud the company, it should be considered fraudulent. However, it will be more difficult to  pursue legally. A small twist changes the whole picture.

Closing thoughts

Think carefully when doing your Christmas shopping. Check out whether the pricing is done to influence your decision towards certain product choices.

Wish you and your loved ones a Merry Christmas. Happy Holidays!