What is Kiting?
The term “kiting” refers to a type of financial fraud that involves taking advantage of the time difference between a cheque submission and its clearance. In this scam, the cheat executes multiple transactions using a checking or other bank account that has no real fund. In this way, a legitimate financial instrument is misused as a form of unauthorized credit.
It can be categorized into two major types of fraud:
- Issuance or alteration of cheque or bank draft without sufficient fund
- Misrepresentation of financial instrument’s value for enhancing financial leverage or extending credit limit
The term “kiting” was first used in the 1920s to refer to the issuance of IOUs and bonds without any collateral. Given that there was nothing to support the loans besides thin air, the practice of issuing these financial instruments became to be known as flying a kite.
How does Kiting work?
Typically, the fraudsters involved in kiting scams have a deep understanding of the timing delay between cheque submission and clearance. Therefore, they take advantage of this timing delay to withdraw cash (either partially or entirely) from a non-existent fund before the bank discovers the scam.
A typical kiting scam can be broken down into the following stages:
- First, a person with multiple accounts across different banks writes a cheque on day T-1 to himself from Bank 1 to Bank 2. So, funds become available in Bank 2, which is sufficient for all of its payment obligations.
- On the next business day, the person writes another cheque on Bank 2 to himself and deposits it in Bank 1. This results in artificial funds in Bank 1, which means that the cheque written on T-1 can be cleared comfortably.
- This cycle reiterates itself until the offender gets apprehended or is able to deposit actual funds, which eliminates the very need for the kite. Otherwise, a kiting scam is built with complex and convoluted transactions that go unnoticed.
Examples of Kiting
Now, let us have a look at some of the examples to understand it in detail.
Example #1
Let us take the case of David, who has multiple bank accounts in his name. He wrote himself a cheque for $1,000 from his checking account in Bank A and deposited it in another checking account in Bank B on Monday. However, the balance in Bank A is only $100. So, he promptly (before clearance of the previous cheque) withdrew the $1,000 from Bank B and deposited it in Bank A on Tuesday, which means that now Bank A has sufficient funds to honor the cheque written on Monday. In this way, the cycle continues indefinitely with the virtual fund until the financial crunch ceases or the scam is busted. This is a classic example of cheque kiting in which the fraudster uses non-existent funds.
Example #2
Let us take the case of John, who is selling his car piano on a used car selling website. A scammer confirmed to John that he liked the car and intends to purchase it for $20,000. After completing the deal, the scammer called up John and told him that “mistakenly” he wrote the check for $25,000, an amount greater than the quoted price. So, the scammer asked John to wire back the difference of $5,000, and John did accordingly. Later, John realized that the scammer’s cheque bounced, the scammer and the car were gone. In this case, John became the victim of a kiting scam.
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Importance of Kiting
Most countries don’t have a float system, and hence a cheque isn’t paid until it is cleared, which eliminates the risk of kiting entirely. However, the float system is still prevalent in the banking system of many countries, and the scammers use this float to transact illegally before the actual money is withdrawn from the account. Hence, kiting is considered to be illegal in many countries.
The fraudsters use kiting to turn a negotiable instrument, like a cheque, into a form of short-term credit that is not backed by any real financial support. The financial implications of a kiting scam vary depending on the size of the institution being scammed. However, a well-planned kiting fraud can result in losses that might run into millions of dollars. As such, it is very important to identify a kiting transaction before it results in a severe financial fiasco.
How to Prevent Kiting?
In order to prevent kiting scams, one needs to vigilantly monitor the following –
- Deposit and withdrawal activities are intended to conceal actual negative account balances.
- More often than not, overdrafts get cleared with cheques instead of cash
- The total dollar value of debits and credits are the equal
- Very frequent account balance inquiries from the account holder
- A cheque of large dollar value is being drawn on the same payee bank
Key Takeaways
Some of the key takeaways of the article are:
- Kiting refers to the illegal usage of financial instruments to deceptively obtain enhanced credit limits and better financial leverage.
- The kiters take advantage of the timing difference between submission and clearance of the cheques.
- Typically, a kiting scam involves a large number of complex and convoluted transactions that reiterate themselves until the offender stops.
- The financial transactions should be monitored very closely and minutely to prevent kiting scams.
Conclusion
Kiting resorts to misuse of financial instruments, and that is why it is a criminal offense in many countries. The implications of kiting can be serious, and hence it is important to prevent occurrence. However, the good news is that there are many checks that can be used to identify and prevent kiting transactions. So, although kiting is a threat with serious repercussions, the available monitoring mechanisms can help avoid the risk.
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