Why frauds are increasing in Indian banks


Cases of fraud of Rs 1 lakh or more, reported by banks and financial institutions, increased by 28% (in volume terms) and 159% (in value terms) during 2019-20, according to the Reserve Bank of India annual report.

A disclaimer though: this does not necessarily mean that all these frauds took place during the last year alone. They are spread over several previous years but were detected during the last year.

Majority of the frauds (99%) have been occurring in the loans and advances portfolio, both in terms of number and value. The top 50 accounts constitute 76% of the total frauds in value terms reported during 2019-20, highlighting concentration risk.

Despite the RBI tightening the framework for prevention, early detection and prompt reporting of frauds, the time taken to detect frauds is quite long.

The average lag between the date of occurrence of frauds and their detection by banks/FIs was 24 months during 2019-20. For frauds of Rs 100 crore and above, the average lag is much higher at 63 months!

The RBI says weak implementation of early warning signals (EWS) by banks, non-detection of EWS during internal audits, non-cooperation of borrowers during forensic audits, inconclusive audit reports and lack of decision making are the major reasons for the delay in detection of frauds.

There are two basic elements of fraud cases:

  • Criminal intent of the promoter with or without the connivance of staff
  • Lack of adherence to systems

Criminal intent cases are difficult to prevent. This may happen with or without the connivance of the bank staff. In cases, such as Winsome Diamonds and Nirav Modi, it appears that the promoters intentionally defrauded the bank. Sometimes the borrower has good intentions, but later is enticed into committing fraud, taking advantage of the vulnerability of systems.

Frauds also take place because of lack of systems or non-adherence to existing systems. Most of the time the control from banks is lacking, the end use of funds is not monitored, the documentation is not perfect, and the covenants are not tested vigorously.

Often banks do not have the technical expertise to evaluate a project. They lack industrial knowledge. Third-party evaluation of projects is missing. In some cases the bank’s investment banking arm does the project report where the concerned bank is participating in the financing. This mechanism suffers from a clear conflict of interest.

Corruption among bank’s rank and file has emerged as one of the big reasons for the increase in the number of frauds. A case in point is the sacking of ICICI Bank CEO Chanda Kochhar over allegations of violating the bank’s code of conduct in the Videocon case.

A few years ago, Bhushan Steel vice chairman Neeraj Singhal was arrested on charges of allegedly bribing the Syndicate Bank chairman to ensure that a Rs 100-crore loan was not declared as a non-performing asset.

In another case, the Central Vigilance Commissioner recommended action against officials of 26 banks, which together provided Rs 2,650 crore to Zoom Developers.

The nexus of promoters with top officials of private and public sector banks is quite sinister. It impacts credit decisions from disbursing loans to classifying them as NPAs. 

Banks place excessive reliance on rating agencies while evaluating a client’s credit worthiness rather than their own rating models. Agencies often do not access real time data of corporates.

While banks seek recourse to the security offered by borrowers, it is seen that security is overvalued, not perfected (is not free of claims) and does not fetch the outstanding amount owed to banks. Few bank officials treat security as the first recourse rather than assessing the cash flow generating ability of the borrower.

Siphoning-off of funds is not uncommon. Due to less control over end use of funds, buying-selling within group firms is rampant. Related party transactions are carried out not at an arm’s length as is prescribed. Lenders to DHFL have approached the National Company Law Tribunal to tag Rs 14,046 crores to 87 related parties in retail loans as ‘fraudulent’.

In a highly globalized environment where companies set up subsidiaries across the world and enjoy bank limits from global banks, domestic institutions tend to rely heavily on information provided by the borrowers. 

So how many companies does the promoter own, what are the bank limits of the company and group? All this information is difficult to cross verify.

In India, name lending culture is quite prevalent. The credit analyst and risk teams in banks are not empowered to take on relationship/coverage teams and they don’t always ask the pertinent questions. Smaller banks rely on assessment done by bigger banks in the consortium.

It has also come to light that banks have a much lenient process in granting off balance sheet lines like guarantees versus loans and advances.

The RBI is engaged in interlinking various databases and information systems to improve fraud monitoring and detection. Online reporting of frauds by NBFCs and the CFR portal of SCBs, augmented with new features, are likely to be operational by January 2021. 

Hopefully, this will improve things going forward.

A disclaimer though: this does not necessarily mean that all these frauds took place during the last year alone. They are spread over several previous years but were detected during the last year.

Majority of the frauds (99%) have been occurring in the loans and advances portfolio, both in terms of number and value. The top 50 accounts constitute 76% of the total frauds in value terms reported during 2019-20, highlighting concentration risk.

Despite the RBI tightening the framework for prevention, early detection and prompt reporting of frauds, the time taken to detect frauds is quite long.

The average lag between the date of occurrence of frauds and their detection by banks/FIs was 24 months during 2019-20. For frauds of Rs 100 crore and above, the average lag is much higher at 63 months!

The RBI says weak implementation of early warning signals (EWS) by banks, non-detection of EWS during internal audits, non-cooperation of borrowers during forensic audits, inconclusive audit reports and lack of decision making are the major reasons for the delay in detection of frauds.

There are two basic elements of fraud cases:

  • Criminal intent of the promoter with or without the connivance of staff
  • Lack of adherence to systems

Criminal intent cases are difficult to prevent. This may happen with or without the connivance of the bank staff. In cases, such as Winsome Diamonds and Nirav Modi, it appears that the promoters intentionally defrauded the bank. Sometimes the borrower has good intentions, but later is enticed into committing fraud, taking advantage of the vulnerability of systems.

Frauds also take place because of lack of systems or non-adherence to existing systems. Most of the time the control from banks is lacking, the end use of funds is not monitored, the documentation is not perfect, and the covenants are not tested vigorously.

Often banks do not have the technical expertise to evaluate a project. They lack industrial knowledge. Third-party evaluation of projects is missing. In some cases the bank’s investment banking arm does the project report where the concerned bank is participating in the financing. This mechanism suffers from a clear conflict of interest.

Corruption among bank’s rank and file has emerged as one of the big reasons for the increase in the number of frauds. A case in point is the sacking of ICICI Bank CEO Chanda Kochhar over allegations of violating the bank’s code of conduct in the Videocon case.

A few years ago, Bhushan Steel vice chairman Neeraj Singhal was arrested on charges of allegedly bribing the Syndicate Bank chairman to ensure that a Rs 100-crore loan was not declared as a non-performing asset.

In another case, the Central Vigilance Commissioner recommended action against officials of 26 banks, which together provided Rs 2,650 crore to Zoom Developers.

The nexus of promoters with top officials of private and public sector banks is quite sinister. It impacts credit decisions from disbursing loans to classifying them as NPAs. 

Banks place excessive reliance on rating agencies while evaluating a client’s credit worthiness rather than their own rating models. Agencies often do not access real time data of corporates.

While banks seek recourse to the security offered by borrowers, it is seen that security is overvalued, not perfected (is not free of claims) and does not fetch the outstanding amount owed to banks. Few bank officials treat security as the first recourse rather than assessing the cash flow generating ability of the borrower.

Siphoning-off of funds is not uncommon. Due to less control over end use of funds, buying-selling within group firms is rampant. Related party transactions are carried out not at an arm’s length as is prescribed. Lenders to DHFL have approached the National Company Law Tribunal to tag Rs 14,046 crores to 87 related parties in retail loans as ‘fraudulent’.

In a highly globalized environment where companies set up subsidiaries across the world and enjoy bank limits from global banks, domestic institutions tend to rely heavily on information provided by the borrowers. 

So how many companies does the promoter own, what are the bank limits of the company and group? All this information is difficult to cross verify.

In India, name lending culture is quite prevalent. The credit analyst and risk teams in banks are not empowered to take on relationship/coverage teams and they don’t always ask the pertinent questions. Smaller banks rely on assessment done by bigger banks in the consortium.

It has also come to light that banks have a much lenient process in granting off balance sheet lines like guarantees versus loans and advances.

The RBI is engaged in interlinking various databases and information systems to improve fraud monitoring and detection. Online reporting of frauds by NBFCs and the CFR portal of SCBs, augmented with new features, are likely to be operational by January 2021. 

Hopefully, this will improve things going forward.

This Article has been originally published here

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