FRAUDS IN BANKING SECTOR

Banking post-nationalization has progressed unexpectedly. With new reforms in the banking sector, more emphasis was given on lending so that economy of the nation can be improved.   But it also exposed banking to risks and frauds. Banks are the backbone of the economy. Any disruption in banking poses threat to the economy and therefore citizens.

“Reserve Bank of India defines banking fraud as an act of commission /abatement, which is intended to cause illicit gain to one person(s), entity and wrongful loss to the other, either by way of concealment of facts by deceit or by playing a confidence risk.”

The numbers and values of frauds keep on accelerating with every financial year. In the financial year 2019-20, the bank frauds (value Rs. 1.85 trillion) were more than double of the bank frauds that were reported in 2018-2019. The number of frauds was increased by 28%. The top 50 credit-related frauds constituted 76% of the total amount reported as frauds during 2019-20. Public sector banks accounted for 80% of the total value of frauds in this fiscal year. The private bank followed it by 18% and foreign banks with 2%. Although the total frauds reduced in the financial year 2020-21, frauds in private banks increased up to 21%. (Refer Table)

These frauds are spread over several years and are accounted for in the financial year they are reported. On average, banks took two years to detect fraud after it had occurred. The delay was even greater for frauds greater than Rs. 100 Crore with a time of 5 years. There have been instances in the past where banks were found not following the protocols needed while sanctioning any kind of loan. Harshad Mehta Scam was one where he got hand-in-glove with bank employees to get fake bank receipts. Satyam companies manipulated the financial statements and issued fake bank statements to purchase more land for their projects. Vijay Mallya borrowed money from 13 banks and did not pay in time. The discrepancy happened due to a lack of diligence in the process of consortium lending. The recent one is Nirav Modi PNB Scam. The bank manager sanctioned the loan without following the process.

The fraud reasons are not limited. Any mishandling of data and manipulation in process at any step can lead to the formation of higher Non-Performing Assets. Many of those take place due to the interference of corrupted third parties like auditors, controllers, and chartered accountants. Poor Internal Management also factors these frauds. When banks and employees do not follow the proper identification method and regulated assessment, it results in fraud. Due to a weaker selection process in banks, employees are not well qualified for loan assessment. RBI recently has given detailed guidelines for recruitment of employees for recovery of loans. The recruited ones will be given 100-hours training to deal with these going to be “bad debt”. Such initiatives are needed even while recruiting employees who are responsible to process the loan. In many cases, the purpose of the loan is manipulated. The loan amount received by the borrowers was not utilized for the approved project. In cases like Nirav Modi and Harshad Mehta Scam, collusion with bank officials resulted in big frauds. Weakened Business Model: Sometimes banks lend money for a project without calculating the potential of the project. Bank’s official lack in their analysis of the project. Due to this, an enterprise might go into losses and would not be in a position to pay to back its creditors. Banks at times, do not make these frauds public to prevent their goodwill in the market. In those circumstances, the amount of loan increases with negligence. When added up to a huge amount, the case is held over to Apex Court which further increases the cost on banks. With the emergence of digital banking, banks as well as the public are more at risk. RBI regularly updates customers with advertisements and guidelines to avoid these crimes. Banks have also switched to online sanctioning of the loan, so they are required to verify every document closely.

The impact of these frauds hits the financial statement of the bank first and then the economy as a whole. When an account is declared fraud, banks need to provision 100% of the outstanding loans. The provisioning is generally done in one time or four quarters. The profitability and credibility of a bank are impacted adversely. When banks face the issue of liquidity, a limit is imposed on the withdrawal of depositors. As frauds are not new in the banking context, RBI and the government has formulated many laws and acts to avoid fraud. Banks have an option to securitize the assets of the company that committed the fraud. The Debt Recovery Tribunal (DRT) was formed under “The Recovery of Debts and Bankruptcy Act,1993 to deal with loans related to the agriculture sector if the loan amount is 10 Lakhs. Banks also have Corporate Debt Restructuring framework in place to ensure a timely and transparent mechanism for restructuring the corporate debts above 20 Crore. Some of the laws against fraud are mentioned below.

  1. The Indian penal code,1860
  2. The Negotiable Instruments Act,1881
  3. The Reserve Bank of India Act,1934
  4. The Banking Regulation Act,1949
  5. Criminal procedure code,1973
  6. SARFESI Act,2002
  7. Insolvency and Bankrupt Code,2016
  8. Fugitive Economic Offenders Act,2018

RBI has taken several measures to avoid fraud and deal with fraud. Banks are required to categorize accounts for better risk assessment and to implement provisioning norms. Accounts can be classified as Special Mention Accounts (SMA), standard Accounts, substandard Accounts, doubtful accounts, and Non-Performing Accounts. Constant review of the transactions, identifying and tracking the patterns of transactions should be constantly done. RBI regularly comes up with updated frameworks that are to be followed to prevent, detect and mitigate frauds gravity.

As per RBI’s latest report, there is a list of 42 early warning signals. The presence of any of these, in any case, will mark that account as a Red Flag account. This will trigger the detailed investigation of an account which can save the bank from fraud.RBI has also put in place the three stages of the loan life cycle which should be followed for early detection. The three stages are pre-sanction Order, disbursement, and annual review

  • Pre-sanction Order  
  • – Banks should follow and track Anti Money Laundering Norms, accurate CIBIL Credit Scores, involvement in a legal dispute, due diligence on the borrower’s antecedents, set margins as per MCLR, and check whether the loan is recoverable.
  • Disbursement: While disbursement of the loan amount, banks are required to mention terms and conditions to the borrower. Borrowers and Banks should adhere to these norms so that the core purpose of the loan could not be diluted.
  • Annual Review: Monitoring EWS and reassessing the value of prime and collateral underlying.

RBI has also imposed penal measures on Fraudulent Borrowers-. In case of willful default that accounts for the high value of Frauds, RBI with CBI and Supreme Court can impose these penal provisions. Under Securitization, Banks can acquire the assets borrowers want to securitize. Banks can trade on that asset (via pass-through certificate) and recover the loan amount. Banks have also an option to repossess the asset. Banks can take control over the prime and collateral for the recovery of loans. Banks can give time to borrowers for repayment of loans. If it is not done in time, Banks can auction it to recover the loan and repay the excess amount from the auction sale to the borrower.

Although RBI updates frameworks as per the demand in banking loopholes, it has still not served the purpose to solve cases of fraud due to lack of diligence in bank employees, less transparency, less accountability, and ineffective implementation of this framework. The proof of this is the increase in the percentage of frauds associated with private sector banks. The repo rate (4 % currently) for the bank and the interest rate for the loan takers are comparatively low. This makes it attractive for people to borrow money. Banks should be cautious enough in these circumstances because some people or entities can manipulate their documents to get a loan at a cheaper rate. 

Despite the annual review, the banks should collect interim reports of the financial status of high credited accounts to get a clear picture. Credit scores need to be considered while giving any loan. Actions against Early Warning Signals should be taken strictly. The reporting of fraud cases should be done proactively so that it does not accumulate to huge losses for banks as well as the economy. Most importantly, RBI has to ensure that the guidelines issues are implemented and followed. That is where the complete banking system is lagging. Those rules and regulations have to come out from documents in action in reality.

Editor
Swati Shubham

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