An overarching promise, Prime Minister, Narendra Modi had made at the time of taking charge for his first term beginning May, 2014 was to root out nepotism and corruption in all matters of governance – be it in various ministries/department or its agencies including public sector undertakings (PSUs) including banks. Modi’s clarion call to all in this regard was encapsulated in the euphemism he often used viz. ‘naa khaoonga, naa khaane doonga’ (neither, I will take bribe, nor allow anyone else to take).
To be fair to Modi, his commitment to this overarching principle is reflected in all his policy decisions, administrative actions, delivery of services and overall governance in every sphere. That he has made an mark in dealing with this malice, we only need to look at every rupee sanctioned for giving to the poor under welfare schemes actually reaches their bank accounts (unlike previous regime led by Congress whereby in the words of the then, Prime Minister, Rajiv Gandhi only 15 paise out of every rupee would actually reach).
While, this is a matter of deep satisfaction, the malice refuses to go away particularly when it comes to functioning of banks. A good measure is the value of frauds perpetrated on them. During 2014-15 and 2015-16, the value was about Rs 17,000 crore each. This increased to Rs 20,500 crore during 2016-17 and further to Rs 22,500 crore during 2017-18. The value of frauds leapfrogged to around Rs 64,000 crore during 2018-19 and scaled to a new high of Rs 110,000 crore during the first half of the financial year 2019-20.
A fraud essentially involves swindle or misappropriation of banks’ funds. A fraudster takes loan with the sole intent of not returning it and orchestrates all his actions keeping this malicious design at the back of his mind. These actions include creating entries for various transactions, sale/purchase, investments etc merely on paper even as there is no economic activity on ground zero. Or, the activity is very limited say, X but on paper, it is shown as 100X i.e. a case of the borrower submitting inflated valuations of various assets viz. land, buildings, brand value, inventory of goods etc. In such situations, when he runs away with the money (this is precisely his intent), the bank has very little or nothing to fall back on to recover it.
The fraud and that too on a massive scale seen in recent times can’t happen without the fraudster entering into what in jargon is termed as ‘quid pro quo’ arrangement with the bank staff. Put simply, the latter misuses his official position to let the former misappropriate bank money in lieu of a pecuniary benefit, material or otherwise. Such an official or a group of them won’t conduct due diligence or assess the viability of project for which the loan is taken and or monitor proper utilization of the funds.
Indeed, there are several instances of the management actively collaborating with the borrowers to defraud the bank. On close scrutiny, it even turns out that entities taking the loan are shell companies whose beneficial owners are none other than the top brass of the bank itself. Many of them have even been put behind the bar following investigation by the agencies viz. Central Bureau of Investigation (CBI), Enforcement Directorate (ED), prosecution and court orders.
What measures has the government taken to address this malice? Have these yielded any results? What more needs to be done to stem the rot? What is the way forward?
At the outset, let us recapitulate some hard facts. Under the UPA–regime (2008 – 2014), banks resorted to indiscriminate lending even as substantial amounts were given to dubious borrowers. The recovery of these loans was in doubt from the day one. Following standard accounting principle, the banks ought to have shown these as non-performing assets (NPAs) in their books. But, that was not done. Instead, in a bid to camouflage these as standard account, they lent more money to enable those borrowers pay back the previous loans – or ‘ever-greening’ as it is known in common parlance.
Modi – government decided to put an end to this practice. In 2015, the Reserve Bank of India (RBI) initiated an asset quality review (AQR) with a view to identify all bad loans and directed banks to reflect these in their books. This inevitably led to surge in NPAs to a high of 11.5% (as on March 31, 2018) and resultant erosion in their capital. To maintain public trust and ensure that banks continue lending, the Centre recapitalized public sector banks (PSBs) by around Rs 350,000 crore four years (2016-17 to 2019-20). The cost was worth it or else the decay would have continued endlessly.
The government also introduced far reaching reforms such as enactment of the Insolvency and Bankruptcy Code (IBC) to give banks and other lenders an opportunity to recover their money in a time bound manner using the mechanisms under IBC. But, when it comes to recovering money lost due to an act of fraud, these mechanisms are of little help. The IBC can trigger the right nodes for extracting maximum value from whatever is left from businesses (e.g. acquisition of Bhushan Steel by Tata Steel) but what if a loan was taken only to defraud the lenders/banks.
To deal with frauds, recently, the RBI came out with a directive requiring banks to red-flag accounts that have come under probe by enforcement agencies. The red-flagging is reported on a ‘data expertise platform’; a place where all banks are required to give big publicity to entities/people so that different banks/lenders can be forewarned about the danger of fraud. The idea was intended to get banks to act on early warning indicators emanating from various sources including raids by regulatory and tax authorities.
Once an account is red-flagged, banks are mandated to conduct full forensic audit within six months and take a decision within 12 months as to whether the account is fraudulent or not. In cases, where several banks are involved in lending under consortium arrangement, even if a member of the consortium decides to notify an account as fraud, other members have to follow suit.
During the last one year or so, a spate of actions by enforcement authorities viz. CBI/ED/Income Tax (IT) department etc have resulted in a number of accounts involving mammoth sums being red-flagged. These include big names such as Dewan Housing Finance Corporation Limited (DHFL) and Religare Finvest which have been in the media glare for quite some time. The RBI is now pushing banks to record these loans as fraudulent.
A mere declaration of an account as ‘fraudulent’ by itself may not be of much help in ensuring that fraudsters are booked and the money recovered. Nevertheless, it is a move in the right direction as it brings transparency (in sync with Modi’s philosophy of recognizing all non-performing assets) besides giving a free hand to the agencies do their job. But, the banks don’t appear to be comfortable.
Their concern stems from the fact that once an account gets the ‘fraud’ tag, they will have to put aside provisions for 100% of the mortgage amount (even if a big part of it is recoverable). This in turn, will lead to a big jump in provisions and resultant increase in loss during April-June, 2020. Last year also, the banks had to increase provisioning consequent to classification of Bhushan Power & Steel (BPSL) as a fraud. They don’t want a repeat of last year.
The banks can’t have the cake and eat it too. They need to make a clear-cut choice between effectively dealing with frauds and worrying about their profit and loss/balance sheet (BS). The foremost requirement for dealing with fraud is to recognize it and financial implications. Merely because such an act will reflect badly on the BS can’t be a reason for not taking this important step. Likewise, even if a good slice of the mortgage amount is recoverable, this too can’t come in the way of making provision.
As per standard accounting methodology, whenever a loan account becomes non-performing, necessary provision has to be made against such account. This is not to suggest that the loan is not recoverable; that the bank won’t be making efforts to recover it. On the same logic, if in case of fraud, 100% provision is made, there is nothing to prevent the bank from making efforts to recover. As and when, the money is recovered, the same can always be written back.
To sum up, the government and RBI have created the necessary legal framework to deal with NPAs and frauds, in particular. However, the banks need to be proactive and alert at all stages from sanctioning of a loan to monitoring to recovery. For instance, why should the bank on its own not detect (being an insider, it is best equipped to do it) and give early warning signal about a potential fraud instead of waiting for an enforcement agency or regulator to act.