Banks as Victims? Fraud Cases Expose Gaps in Internal Controls < GLOBAL

South Korean banks are facing a new test of their internal control systems as a series of large-scale financial fraud cases involving outside parties has emerged, with fraudsters deceiving lenders into extending loans or diverting repayments.

Bank controls have traditionally focused on preventing misconduct by employees, including embezzlement and breach of trust. But recent cases have raised questions over whether those systems are equipped to detect fraud committed by external parties. In some instances, multiple banks fell victim to the same counterparty, while others discovered their exposure only after fraud at another financial institution had come under investigation or been reported by the media.

According to the financial industry on Sept. 3, the value of external fraud-related financial incidents disclosed or revised by major banks this year has exceeded 200 billion won ($143 million).

One of the largest cases occurred at the Chinese subsidiary of Industrial Bank of Korea, or IBK, involving 83.38 billion won.

The subsidiary had partnered with a local non-bank financial institution to provide online loans. An online lending platform involved in the arrangement is suspected of diverting principal and interest payments made by borrowers instead of remitting the funds to IBK.

While IBK provided the loans directly, repayments were collected through the outside platform. The alleged misconduct continued from December last year through June.

There were warning signs, but the bank failed to detect them. Five Chinese financial institutions stopped working with the platform in March and April, but IBK was unaware of the moves. The bank first identified the problem on June 24, after scheduled payments failed to arrive and complaints from borrowers increased.

Only after the incident did IBK establish a system allowing borrowers to make repayments directly without going through the platform. Financial incidents disclosed by IBK this year, including the case at its Chinese subsidiary, have surpassed 110 billion won.

In a separate case, three banks were exposed to alleged fraud involving the same corporate counterparty.

Korea Development Bank this month disclosed a 58.35 billion won financial incident involving suspected corporate finance fraud by a client. IBK subsequently identified 9.44 billion won in exposure and Hana Bank 2.42 billion won. The incidents at the three banks are understood to stem from the same case, bringing the combined amount disclosed to about 70.2 billion won. The company was recently reported to have obtained loans by overstating its sales.

Banks have also been hit by loan fraud involving fraudulent real estate sales.

The combined amount disclosed or revised by KB Kookmin Bank, Shinhan Bank, Woori Bank and IBK in connection with such cases stands at about 49 billion won. KB Kookmin reported 3.58 billion won, Shinhan 17.34 billion won, Woori 9.87 billion won and IBK 18.22…