Kiting

Kiting

What Is Kiting?

Kiting is a type of financial crime involving the fraudulent use of financial instruments, typically checks, to obtain unauthorized credit. It exploits the "float" time, which is the delay between when a check is deposited into one bank account and when the funds are actually transferred from the originating bank account. This illegal practice creates an illusion of available funds, allowing individuals to access money that does not genuinely exist in their Bank Accounts. Kiting falls under the broader category of Financial Crime and can involve various financial instruments, though it is most commonly associated with checks. The core of a kiting scheme relies on manipulating the timing of fund transfers within the banking system²³.

History and Origin

The term "check kiting" first gained widespread use in the 1920s, but its conceptual roots trace back to the 19th century. It is believed to have originated from the practice of "flying a kite," a phrase used to describe the issuance of IOUs or bonds without any underlying collateral. In this historical context, the "kite" symbolized something floating in the air, unsupported by real assets. Similarly, in financial kiting, the checks written are not backed by actual funds, thus "floating" as an illusion of available cash²².

Initially, with slower manual check processing, the "float" period was considerable, offering more opportunities for kiting. However, advancements in Check Clearing technologies, such as the introduction of Magnetic Ink Character Recognition (MICR) in 1959 and later the Check Clearing for the 21st Century Act (Check 21), significantly expedited the process, reducing the float and making kiting more challenging but not impossible²¹,²⁰.

Key Takeaways

• Kiting is a fraudulent scheme that exploits the time delay in the banking system to access unearned funds.
• It primarily involves writing checks against accounts with insufficient funds, then covering them with deposits from other similarly underfunded accounts.
• The practice can lead to severe legal penalties, including fines and imprisonment, as it constitutes bank Fraud.
• While often associated with checks, kiting can also occur with Securities when firms fail to meet timely delivery regulations¹⁹.
• Financial institutions employ various Internal Controls and monitoring systems to detect and prevent kiting activities.

Interpreting Kiting

Kiting is interpreted as a clear act of deception aimed at illicitly gaining Credit or preventing debits from impacting an account. In the real world, detecting kiting involves recognizing patterns of unusual activity, such as frequent deposits immediately followed by large withdrawals across multiple accounts or banks¹⁸. Financial institutions look for rapid fluctuations in account balances and repeated instances of insufficient Funds Availability as red flags¹⁷. The intent behind the actions is crucial; an accidental Overdraft is not kiting, but a deliberate, systematic attempt to exploit clearing times for unauthorized access to money is¹⁶.

Hypothetical Example

Consider John, who has two bank accounts: Account A at First National Bank and Account B at Second State Bank. Both accounts currently have a balance of $100.

1. Day 1: John needs $5,000 immediately but only has $100 total. He writes a check for $5,000 from Account A and deposits it into Account B. Second State Bank, assuming the check from First National Bank will clear, makes a portion of the funds available to John based on their Funds Availability policy. John then withdraws $4,000 from Account B.
2. Day 2: First National Bank is now processing the $5,000 check from Account A. John's Account A only has $100, so the check will bounce. To prevent this, John writes a check for $5,000 from Account B (which now has $1,100 after his withdrawal and initial deposit) and deposits it into Account A. This artificially inflates the balance in Account A, hoping it will clear the initial $5,000 check before Second State Bank realizes the check from Account A was bad.
3. Ongoing: John continues this cycle, writing checks between the two accounts, continually increasing the amounts to maintain the illusion of sufficient Liquidity. The scheme relies on the delay in check clearing between the two financial institutions. If either bank detects the fraudulent activity or the checks are not covered in time, the entire scheme collapses, leaving the banks with significant losses.

Practical Applications

Kiting schemes primarily manifest in scenarios exploiting the time difference in Check Clearing processes. For Financial Institutions, the practical application lies in developing robust systems for fraud detection and prevention. This includes monitoring for suspicious transaction patterns, such as frequent large deposits followed by immediate withdrawals, especially across multiple accounts or different banks¹⁵.

For businesses and individuals, understanding kiting is crucial for safeguarding against this type of fraud. While financial technology has significantly reduced the "float" time through Electronic Payments and faster clearing, the risk still exists, particularly with paper checks¹⁴. Banks often implement holds on large check deposits to allow time for verification, which is a direct measure against kiting¹³. Regulators, like the Federal Reserve Board, issue guidelines such as Regulation CC to standardize funds availability and collection of checks, indirectly impacting kiting opportunities by speeding up the clearing process¹². Law enforcement agencies, such as the Federal Bureau of Investigation (FBI), track and prosecute financial crimes, including various forms of bank fraud, although specific kiting statistics may be aggregated under broader fraud categories¹¹.

Limitations and Criticisms

One of the primary limitations of kiting from the perpetrator's perspective is its inherent instability. The scheme is a race against time and relies on precise timing and constant intervention to keep the "kite" airborne¹⁰. Eventually, the system often collapses when a bank identifies the fraudulent activity, or the kiter runs out of avenues to obtain new, temporary funds. This can lead to severe financial losses for the involved Financial Institutions and significant legal repercussions for the perpetrator, including substantial fines and imprisonment under federal law⁹.

From a banking perspective, the challenge of detecting kiting lies in distinguishing it from legitimate, complex transaction patterns, especially in high-volume accounts⁸. While banks have sophisticated fraud detection systems and implement Regulatory Compliance measures, sophisticated kiting schemes, sometimes involving multiple individuals or posing as large businesses, can be difficult to uncover immediately. The reduction in check clearing times due to modern technology has minimized the window for kiting, but it has not eliminated the risk entirely⁷. Consequently, robust Risk Management strategies and ongoing employee training remain essential for financial institutions to identify and mitigate kiting fraud⁶.

Kiting vs. Check Fraud

While kiting is a specific form of check fraud, the terms are not interchangeable. Check fraud is a broad category encompassing any illegal act involving a check to unlawfully obtain money or property. This can include forging signatures, altering check amounts, issuing counterfeit checks, or writing bad checks without the intent to cover them⁵.

Kiting, on the other hand, is a more nuanced scheme. It specifically exploits the temporary availability of funds due to the float time in the check clearing process. A kiter writes a check from one account with insufficient funds and then deposits a check from another account, also with insufficient funds, to cover the first, creating an artificial balance. The distinguishing factor for kiting is the deliberate manipulation of the time delay between banks, using checks as unauthorized, temporary Credit. Therefore, while all kiting is check fraud, not all check fraud involves kiting.

FAQs

Q: Is kiting always illegal?
A: Yes, kiting is a federal crime because it involves the fraudulent use of Financial Instruments to obtain unauthorized credit. Even if no immediate loss occurs, the intent to deceive constitutes a crime⁴.

Q: How do banks detect kiting?
A: Banks use sophisticated fraud detection systems that monitor for unusual patterns, such as frequent large deposits and withdrawals across multiple [Bank Accounts], especially when the accounts consistently hover near an [Overdraft] state. They also look for rapid fluctuations in balances and checks drawn on accounts with consistently low or insufficient funds³.

Q: What are the penalties for kiting?
A: Penalties for kiting can be severe, ranging from account closure and negative marks with banking reporting agencies to significant fines and federal prison sentences. The severity often depends on the amount of money involved and the duration and complexity of the scheme².

Q: Can kiting happen with electronic transfers?
A: While traditional kiting primarily exploits the float time of paper [Check Clearing], the concept of manipulating timing for unauthorized funds can, in theory, extend to some forms of electronic transactions if there are delays in processing or verification. However, the speed of modern [Electronic Payments] makes it much more difficult and less common than with paper checks¹.