Scam Fault Line Harms Indian Banks

Additional measures to prevent fraud are needed, including strengthening banks’ internal and external audit systems

Additional measures to prevent fraud are needed, including strengthening banks’ internal and external audit systems

India’s biggest banking scam has come to the fore amid ‘Aazadi Ka Amrit Mahotsav’ celebrations; in this case, Dewan Housing Finance Corporation Limited (DHFL) deceived a syndicate of banks led by the Union Bank of India out of ₹35,000 crore through financial misrepresentation. The DHCP case was not an isolated case. In February this year, ABG Shipyard Limited of Surat had already taken out a loan of around ₹23,000 crore on a fictitious basis.

Take a hit

On February 1, 2019, a consortium of banks had held a meeting to hear about the serious loan default allegations against DHFL. Subsequently, a select committee of seven of the largest banks – State Bank of India (SBI), Bank of Baroda (BoB), Bank of India, Canara Bank, Central Bank of India, Syndicate Bank and the Union Bank of India (UBI) – was formed. KPMG (a “global network of professional firms providing audit, tax and advisory services”) has been engaged as an assessor to conduct a one-time survey of DHFL for the period April 1, 2015 to March 31, 2019 .

The Central Bureau of Investigation (CBI), in its First Information Report, showed that State Bank of India was the hardest hit with a non-performing asset (NPA) base of ₹9,898 crore, the sum even that DHLL acquired some. . Essentially, Bank of India and Canara Bank were looted to the tune of over ₹4,000 crore each by the DHFL. Also, more than ₹3,000 crore each was supposedly cleaned up by the DHFL from Union Bank of India and Punjab National Bank.

The banking system of any country is the backbone of its economy. The excessive losses of the banks affect every person in the country because the sums deposited in the banks belong to the citizens of the country. The NPAs that banks incur are mainly due to bad debts and scams.

Data from the Reserve Bank of India (RBI) shows that around 34% of scams in the banking industry are due to insider work and poor lending practices and the involvement of junior and middle managers. RBI data also shows that one of the fundamental problems in the development of the banking sector in India is due to the increase in banking scams and the consequent costs imposed on the framework. Strangely, as in a Global Banking Fraud Survey (KPMG), the problem is not unique to India; it is a global problem.

An NPA projection, a list

In a Financial Stability Report released by the RBI in December 2021, there is a projection of banks’ gross NPAs rising from 6.9% in September 2021 to 8.1% of total assets by September 2022 (under a baseline scenario) and 9.5% under a severe stress scenario. Fraud in the banking sector can be grouped into four categories: “Management”, “Outsider”, “Insider” and “Insider and Outsider” (jointly). All scams, whether inside or outside, result from operational failures. Deloitte research found that limited post-disbursement asset tracking (38%) was the top reason for stressed assets and insufficient pre-disbursement due diligence (21%) was among the top contributors to these NPAs.

There are news reports every few weeks about some new banking scam or the other that is shattering the common man’s faith in the banking system. There are many examples of banking scams: the Nirav Modi and Mehul Choksi scam involving the National Bank of Punjab (₹11,400 crore), the case of businessman Vijay Mallya (₹9,000 crore) involving nearly of 13 banks, Andhra Bank fraud (₹8,100 crore), PMC scam (₹4,355 crore), Rotomac Pen scam (₹3,695 crore), Videocon affair (₹3,250 crore), Allahabad Bank fraud (₹1,775 crore), Syndicate Bank scam (₹1,000 crore), Bank of Maharashtra scam (₹836 crore), Kanishk Gold Bank fraud (₹824 crore) , IDBI Bank fraud (₹600 crore) and RP Info Systems Bank scam (₹515 crore) to name a few.

A high NPA also reduces the net interest margin of banks in addition to increasing their operating cost; these banks meet this cost by increasing the convenience fees of their small customers on a daily basis.

According to data from the RBI, business loans account for almost 70% of these bad debts, while personal loans, which include car loans, home loans and personal loans, account for only 4%. A study by the Indian Institute of Management Bangalore has shown that poor bank governance is the cause of the increase in bank scams and NPAs.

Steps to Consider

Over time, bad debts lead to higher NPAs. Thus, banks must exercise due diligence and caution when offering funds. The regulation and control of public accountants is a very important step to reduce the non-performing assets of banks. Banks need to be careful when lending to Indian companies that have taken huge loans overseas. There is also an urgent need to strengthen the internal and external audit systems of banks.

Rapid employee turnover in a bank’s loan department is very important. Public sector banks should set up an internal rating agency for rigorous assessment of major projects before sanctioning loans. In addition, there is a need to implement an effective management information system (MIS) to monitor early warning signals regarding commercial projects. The borrower’s CIBIL (formerly Credit Information Bureau (India) Limited) score should be assessed by the concerned bank and RBI officials. This should also include the classification and responsibilities of loan and collection departments.

Financial fraud can be reduced to a great extent by using artificial intelligence (AI) to monitor financial transactions. However, adoption of digitization beyond a point may have limitations as AI provides quantitative insights but does not consider qualitative aspects.

While the Indian government and the RBI have taken several steps in an attempt to address the problem of banking scams, the fact is that there is still a long way to go. Rather than having to permanently write off bad debts from large corporations, India needs to improve its loan recovery processes and put in place an early warning system in the post-disbursement phase. Banks must perform fraud risk assessments quarterly.

Only the establishment of the National Asset Reconstruction Company Ltd. (NARCL) or the “bad bank” is not a real solution. These measures can only help after a loan is delinquent, but not the process of a delinquent loan.

Brajesh Kumar Tiwari, the author of “Changing Scenario of Indian Banking Industry”, is Associate Professor, Atal Bihari Vajpayee School of Management and Entrepreneurship, Jawaharlal Nehru University, New Delhi. The opinions expressed are personal. @bkt_brajesh