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Our Ref: B1/15C
19 July 1999
The Chief Executive
All authorized institutions
Dear Sir/Madam,
Fraud cases relating to letter of credit
In view of the significant number of letter of credit ("L/C")
related fraud cases received by the Commercial Crime Bureau ("CCB"),
I am writing to draw your attention to the schemes commonly used to
deceive banks and their trade customers and the precautionary measures
which may help prevent such frauds.
According to CCB's statistics, it has received reports on 45 L/C related
fraud cases since January 1998, involving a total of $1.2 billion. These
cases involved bills drawn under L/Cs negotiated with authorized institutions
("AIs") in Hong Kong using false negotiation documents. While
most of the L/Cs concerned were issued by banks on the Mainland, the
number of local L/Cs is also quite significant. In addition, there are
cases involving L/C kiting (see below). Details of these schemes are
given below.
Use of false negotiation documents
- The culprit lured unwary buyers to open L/Cs (local L/Cs on some
occasions) to buy goods from him by offering very attractive terms,
e.g. below market pricing,
- or
The culprit ('company A') requested another company ("company
B") to apply for L/Cs on its behalf from a bank on the Mainland.
Company B received a certain amount as commission. In some cases,
A and B were both companies on the Mainland and Company B was actually
an associate of Company A.
- The culprit or an associate of the culprit, as the beneficiary of
the L/C, then submitted false negotiation documents to an AI in Hong
Kong for discounting.
- The culprit and its associates disappeared after obtaining the proceeds
from the AI in Hong Kong.
- The buyer and the negotiating bank later on discovered that the
goods did not exist.
L/C kiting
- The culprit ('Company A') first obtained a L/C credit line from
an AI.
- Bogus transactions were then created by trading with Company B (an
associate of Company A) posing as a supplier and the AI was asked
to issue a L/C to Company B as the beneficiary.
- Company B then discounted the documents with its bank and used the
proceeds to help Company A to settle the L/C when it fell due. In
some cases, the proceeds from discounting the documents of a subsequent
L/C were used to settle the liabilities under a previous L/C.
- Company A used the concocted business volume and the good track
record to justify an increase in L/C credit line.
- More bogus transactions were created and more L/Cs were opened.
- Company B discounted all the documents under the L/Cs with its banks
and disappeared suddenly together with Company A.
Preventive measures
While some of the reported cases are still under investigation, CCB
observes that some of the fraud cases mentioned above could have been
avoided, or at least the scale of the problem could be significantly
reduced, if the following preventive measures were adopted by AIs concerned.
- In the credit assessment and approval process, AIs should pay particular
attention to the nature and history of the customer's business, including
any recent change in the ownership and management of the company,
major trading partners and its trading pattern.
- Credit lines should be approved having regard to, among other factors,
the business need of the borrower, the value of underlying collateral
and proven track record of repayment. Request for drastic increase
in credit facilities within a short period of time should be carefully
examined.
- Drastic increase in L/C outstanding balances should be closely monitored.
It would be useful to visit the borrower's office or factory to ensure
that business and production are normal and can cope with the increased
volume.
- AIs should avoid entering into L/C transactions with abnormal terms,
e.g. in cases where the nature or volume of goods is unusual, the
usance period of bills is unreasonably long, and documents required
for payment are exceptionally simple so that false documents could
be created easily.
- In handling the L/C documentation, negotiating banks should ensure
that L/Cs presented have been authenticated by the advising bank.
Where necessary, they should confirm the authenticity of the L/C with
the issuing bank. It should also review carefully the terms of L/Cs
and any subsequent amendments and where necessary, follow up with
the issuing bank. For L/Cs of substantial amount or in case of doubt,
shipping documents should be authenticated before negotiation. As
far as possible spot checks should be arranged on suppliers and inspection
certificates should be obtained from independent surveyors. These
steps could help ensure the authenticity of L/Cs and the shipping
documents.
- If the beneficiary of the L/C is not a well-established company
or the bank is not familiar with the beneficiary, extreme care should
be taken to discount the relevant bills. If not sure of the background
of the beneficiary, AIs should avoid negotiating the documents but
to send them to the L/C issuing bank for collection only.
The above measures are by no means exhaustive. Against the above background,
the HKMA expects that all AIs should review their own internal procedures
and practices in handling L/C transactions. The aim is to ensure that
adequate internal controls are established and enforced rigorously to
prevent loss from fraud.
Co-operation with the CCB
The HKMA expects institutions to report any suspicious fraud cases
to CCB as soon as possible. It also expects institutions to render as
much assistance as possible to facilitate CCB's investigation. This
would help to minimise losses of AIs from frauds and enhance the security
of the banking system.
Yours faithfully,
Y K Choi
Executive Director
(Banking Supervision)
cc: Commercial Crime Bureau (Attn: Mr Ng Sai-kuen, Shelton,
Senior Superintendent of
Police)
Chairman, HKAB
Chairman, DTC Association
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