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Check kiting is similar to a hidden picture puzzle in which one
must find a picture or image within a picture. Picture puzzles are
amusing games -- check kiting is not. If one cannot find the image
in the picture puzzle, it can simply be put away and looked at
later. The same does not hold true for check kiting. If a kite is
not detected quickly and steps taken to cut it off, losses to
financial institutions can be monumental.
According to the American Bankers Association 1998 Check Fraud
Survey Report, Third Edition:
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Suspicious Activity Reports (SARs) filed by banks participating
in the survey indicated losses ranging from $10,000 to 1.2 million
dollars per bank for check kiting in 1997.
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With respect to expected fraud loss exposure in the next 12
months, community banks rated check kiting as a level 3 exposure
on a scale of 1 to 8 (1 equaling the highest exposure).
A Suspect Kite Report is used by most financial institutions to
detect kiting and is, in essence, the picture puzzle. The report
will typically generate a lengthy list of accounts based on activity
parameters indicating that a kite may be taking place. Because the
reports can be quite lengthy and often give many false readings, it
is not uncommon for staff to ignore the Suspect Kite Report or not
give it the attention that it deserves.
Unfortunately, unlike the hidden picture puzzle, the kite puzzle
cannot simply be put aside if solving its mysteries becomes too
difficult.
The following is a suggested 3-step process for solving the
kiting picture puzzle.
Step 1: The Suspect Kite Report
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Create a centralized kite detection team. Although the Suspect
Kite Report should be disseminated to senior management and all
account officers, there should be one or two people with sole
responsibility for reviewing the report on a daily basis and
making the decision to close an account. If one person is given
this responsibility, it should not be an account officer. Account
officers obviously have a vested interest in maintaining their
customer base. They would be more hesitant to objectively view a
suspected kite on one of their accounts and take immediate action
than would an independent objective party.
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The Suspect Kite Report must be scrutinized carefully. It is
not enough to casually review the accounts listed. Each account
should be reviewed specifically for:
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Deposit date spread: Are significant deposits being made
every one to three days?
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Amount of the deposits: Are they large similar dollar
amounts?
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Overdrafts: Have there been frequent overdrafts on the
account?
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High risk accounts: Is the account in question a high risk
account for kiting such as a commercial account belonging to an
auto, boat, recreation vehicle or mobile home dealer? The market
for these businesses is very seasonal and they traditionally
have cash flow problems. Accordingly, they also pose a greater
risk of kiting when compared to other
businesses.
Step 2: Account History
If a review of the Suspect Kite Report has created suspicions,
further research is necessary.
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Review the history of the account in question. Has there been a
change in the debit/credit pattern for the account? Has the volume
of the debits and credits increased dramatically when compared to
prior account history?
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Determine the source of the deposit. If deposits are drawn on
multiple financial institutions, there is less likelihood of
kiting going on. On the other hand, if the deposits are usually
from one or two other financial institutions, the likelihood of an
ongoing kite increases substantially. Likewise, it should be
determined if the accounts in question are controlled by the same
individual(s).
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Talk to other operations employees and the account officer.
Does the customer frequently call for information on account
balances or to determine whether a deposit must be made to cover
collected or paid items?
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Review the account balance history. Have there been extreme
fluctuations up and down?
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Review the collected funds balance. Is it low in relation to
the book balance for the account?
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If suspicious, order copies of the actual items deposited into
the account in question, as well as checks drawn on that account
for review. Are the funds simply going back to where they
originated?
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Complete the above research quickly. Again, time is of the
essence when it comes to a kiting scheme.
Step 3: Taking Action
Based on the above review, suspicions of a kite may no longer
exist. The account, however, should be flagged for continued review.
If, however, there still are suspicions, the following actions
should be taken:
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Review the running balance for the account and determine the
amount of potential exposure.
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Advise the account officer and senior management of the
potential kite.
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Implement exception holds on new items deposited into the
account in question. While Regulation CC helps facilitate check
kiting schemes by often requiring that funds be made available to
depositors before the check has been paid by the drawee
institution, it also permits exception holds when banks suspect
problems with deposited items. Make sure that the requirements of
Regulation CC are followed, such as providing written notification
of a hold to the account holder. The customer does not need to be
told a kite is suspected. Rather, the bank can simply use the
"reasonable cause" hold exception.
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If the suspicions of kiting are not proven, release the holds.
More importantly, if it is determined that a kite is in operation,
shut down the account immediately.
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Immediately return all items received for payment which were
drawn on uncollected funds. Do not permit any further deposits
into the account other than cash or certified checks.
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Contact the customer to discuss the bank's findings and
determine what the customer will do to cover any overdrafts that
may still be on the books.
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Finally, file a suspicious activity report with
FinCEN.
Minimizing Exposure
Early detection is the key to minimizing exposure. Internal
controls to this end include:
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Requiring officer approval on all overdrafts or payments made
against uncollected funds. Such approval should never exceed the
officer's lending authority.
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Generating and assigning an individual to review uncollected
funds reports, overdraft reports, large item reports and
significant balance change reports.
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Submitting an overdraft report to the board of directors on a
monthly basis.
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Requiring the internal audit function to examine the report
generation and review process. Any findings inconsistent with bank
policy should be reported to the audit committee and a written
response required from the operations area in
question.
Conclusion
Check kiting losses can be monumental, costing banks hundreds of
thousands of dollars. Have internal controls in place that are
consistently followed. Scrutinize the Suspect Kite Report to
determine whether there is a hidden picture. If one appears, take
immediate steps to close the account and minimize loss.
Solving the kiting puzzle can be a tedious task. Failure to do
so, however, can be catastrophic for the bank.
For more detail on coverages, contact
your underwriter and ask about our new Check Kiting Rider for the
Bond Policy.
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When it comes to preventing check fraud, all the training in the
world will not help, unless your employees are paying attention to
every detail. One method to ensure employee attention is to develop
and implement an employee reward program for detecting check fraud.
The program should be designed to reward those who follow policies
and procedures, use their training to question the suspicious, and
thus uncover and prevent fraudulent transactions. A reward program
does not have to be elaborate or expensive to be highly effective.
Some possibilities are:
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Recognition for employees who uncover fraud. Everyone likes to
be recognized for their efforts. Such recognition can be through
an employee newsletter or by posting something on the employee
bulletin board.
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Recognize an employee as the "fraud buster" of the month or
year.
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Provide a parking spot for the "fraud buster" of the month.
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Award movie tickets, small denomination gift certificates or
simply $25 in cash.
Banks that have implemented such programs have all found them to
be highly successful. Additionally, the benefits of those programs
far outweigh the minor costs associated with the program. The reason
for the success is probably very simple. That is, people like to be
recognized for doing a good job. Humans also react more favorably to
positive stimuli than negative. Positive stimuli will increase
morale whereas negative stimuli will have the opposite effect.
Additionally, such programs tend to have a contagious effect. When
employees see their peers being rewarded, they also want to join in
on that recognition and will try much harder to do so.
Employees should also be encouraged to share information. Senior
management and the board of directors must be kept informed.
Moreover, information must continue to be disseminated throughout
the bank. If a scheme was detected at one branch, all branches must
be notified immediately of the incident. Likewise, failures should
not be covered up but disclosed to all so that other individuals or
branches do not make the same mistakes.
Once a bank begins to see results, it should
not be lulled into a false sense of security. Check fraud is not a
problem that will go away any time soon. How do you keep the
criminal and check fraud out of your bank? The same way you get to
Carnegie Hall - practice, practice, practice.
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