Banking Industry Financial Statement Fraud and the Effects of Regulation Enforcement and Increased Public Scrutiny

Abstract

In October 1987, the chairman of the SEC released his committee's Report of the National Commission on Fraudulent Financial Reporting, stating that regulations and standards for auditing public companies must be adequate to safeguard public trust (CFFR p. 5). Using publicly owned banks and savings & loan institutions as a backdrop, we study the effects of regulation and increased public scrutiny on financial statement fraud. Specifically, we examine how the characteristics of bank fraud have changed over the past two decades. We hypothesize that increased public scrutiny through changes in regulation on banks and savings & loans, as well as general financial statement fraud detection standards have altered fraud strategies. The study further explores key characteristics of management fraud that occur in bank and savings & loan organizations. Results indicate that bank frauds have changed over time, and are now more likely to involve withholding real information than create fictitious information. While the frequency of frauds did not significantly change over time, the magnitude of each fraud event has declined. This may imply that public regulation and scrutiny may have little effect on the frequency of fraud, but does affect fraud strategies.

Keywords: Banking industry, financial statement fraud, auditing, bank regulation

JEL Classification: K22, G21, M41, M45