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If there is one single theme that dominates the Central Vigilance Commission (CVC) analysis of the top 100 bank frauds in India, it is the lax credit culture at banks, especially state-owned lenders.
Yes, borrowers have resorted to a host of fraudulent activities such as inflating the value of goods, fudging financial statements, diverting money to shell companies and so on, but the CVC analysis shows that most of these threw up enough red flags. That suggests willful ignorance of such red flags either owing to incompetence, laziness or corruption.
These are the same reasons why banks are sitting on almost Rs 10 lakh crore of bad loans. As for frauds, Reserve Bank of India showed that there were 5835 frauds reported in 2017-18 worth Rs 41,000 crore. There was a significant number in both the volume and value of frauds. Public sector banks accounted for 85 percent of frauds, higher than their business share of 65-75 percent.
That frauds and the bad loan crisis owe a lot to mismanagement can be seen from the fact that frauds reported by those banks under RBI’s prompt corrective action (PCA) framework were “well in excess of their relative share in credit,” according to the central bank.
The CVC analysis shows the lacunae in the credit appraisal and monitoring process. In many cases, banks did not do proper due diligence on borrowers. In case of consortium lending, members banks failed to carry out due diligence independently and relied on the lead bank entirely.
The CVC report is scathing about some of these arrangements. In one example, it said that the “exchange of information was more a ceremonial formality rather than to sift the data. The lead bank did not share the areas of concern.”
In yet other cases, banks and their credit officers did not have the necessary competence and skills to appraise the technical aspects of projects and blindly accepted whatever was stated by the borrower.
One example is the case, where banks financed a company based on brand valuation, which was done by a private company. Later this brand value was found to be inflated; whether it is incompetence or corruption is another question altogether.
Forget specialist knowledge, in some cases, basic red flags were ignored. For instance, branches failed to get confirmation from debtors of their customer. In one case, they did not see that working capital exceeded the sales in an account by a large margin and was much higher than that of industry peers. In another case, a company produced a use-of-funds certificate that was signed by an auditor other than the one who audited the company’s balance sheet. Regional and controlling offices failed to notice that their reporting branches discounted cheques beyond their delegated powers on several occasions without obtaining permission/ approval.
The CVC’s suggestions to plug these gaps is just common sense for the most part. It suggested that banks delist third-party experts such as auditors with questionable credentials. It has asked banks to pay more attention to internal control systems and improve oversight, and have proper working capital assessment.
It has asked new members in a consortium lending framework to check with other banks before advancing and enhancing credit limits. In sum, these recommendations say that banks should do proper diligence and monitoring.
Banks would do well to improve the use of information technology in improving oversight too. In the case of Punjab National Bank, the failure to connect its core banking system to the SWIFT messaging system was one key reason why a $2-billion fraud went undetected for several years.
Secondly, as this column has argued earlier, there needs to be better utilisation of human resources, especially in state-owned banks. They need to move to a system where merit is rewarded, and specialist/professional skills are recognised. Banks can improve their credit assessment capabilities by hiring specialists and having flexible compensation policies.
The government and the regulator should seriously consider the CVC report and implement the suggestions to improve governance. Frauds are a big bottleneck to the flow of credit and should be tackled quickly in a country where bank finance is still the dominant source of funding.