Diversion of Bank money borrowed:

 

Diversion of bank money borrowed:

RBI closes one door, but other doors and windows still open: Lenders beware 

Restrictions on current/operative accounts of borrowers with banks: Reserve Bank of India (RBI) has barred banks from opening current accounts for customers who enjoy credit facilities in the form of CC/OD with other banks. The regulator has made two other stipulations:

A.   A bank, which has an exposure of less than 10 per cent of the total credit exposure of a borrower from the banking system, should not permit any debit from the CC/OD account of the borrower concerned, other than for transfer of money to the CC/OD account of the borrower with a bank which has more than 10 per cent of the total credit exposure of the borrower.

B.    In respect of borrowers who enjoy credit facilities from the banking system other than in the form of operative accounts like CC/OD, (LC/BG, term loans etc.), the restrictions are as under:

(i)                If the exposure to the banking system is Rs.50 cr. and above, current accounts are allowed to be opened/maintained with a bank, which is designated as escrow managing bank. Only collection accounts can be opened by other lenders and the debit of the collection accounts will be for credit of the account with the escrow managing bank.

(ii)             If the exposure to the banking system is Rs.5 cr. and above but up to Rs.50 cr. all lenders are permitted to open normal operative current a/cs.  However, non-lenders are not permitted to open current a/cs.

(iii)           If the exposure to the banking system is less than Rs.5 cr., the borrower is permitted to open multiple current accounts with lenders/non-lenders.

Purpose: Every banker would have experienced the issue of diversion of funds by the borrower, by opening current accounts with non-lending banks, at some point of time in his career. Dishonest borrowers always look for loopholes to divert the bank loans for purchase of land/building, luxurious cars for personal use or divert to group firms or use the working capital for capex/ acquisitions. Diversion happens because the lender never insisted for closing the existing current accounts with other banks before extending the new credit facility or the borrower silently opened current account with another bank after availing the limits with a lender bank. When a part or whole operations of the borrower is not carried out in the CC/OD account of the lender, effective monitoring or ensuring end use of funds is lost and the financial health of the borrower is understood, only when the account turns into a stressed asset. So the action of the RBI in putting a ban on banks to open current accounts for customers, who enjoy CC/OD with other banks, is laudable. The regulator appear to have had the same intent in placing restrictions on (i) CC/OD accounts of the borrower with banks, which hold less than 10 per cent of the total credit exposure of the borrower and (ii) opening of operative current accounts by borrowers, who enjoy credit facilities other than CC/OD.

Whether this will discipline the customer? The above measures are in the right direction to bring credit discipline on the part of the borrower customers. However openings to divert are still there, which might be exploited by the unscrupulous customers, unless the lenders show alertness coupled with an exercise of vigilance. Let me explain the possibilities with examples:

1.     Borrower A enjoys a consortium limit of Rs.500 cr. as Cash Credit with banks B (35%), C (25%), D (20%), E (20%) (share of limits in brackets). A may utilise the limits with B and C fully and choose to avail only the demand loan portion of the working capital with D & E (40% of the limits sanctioned by D & E).  Now as per the present circular, A will be in order if he transfers funds from the limits with B and C periodically to the limits of D & E. (as the exposure with all the banks are above 10% of total exposure). Let us assume A transfers Rs.100 cr. from the CC account maintained with bank B to bank D. B bank is happy as his limit is utilised and his monitoring ends with the debit made since the credit is to another consortium bank. Bank D, who gets the credit, is happy as he gets float funds and his account is operated. Since the working capital portion with D is unutilised and the transactions are carried out from the credit balance (due to transfer from bank B), bank D, in normal circumstances, might not monitor the end use of funds. When the account is due for renewal, debit and credit summations will show healthy turnover in the consortium accounts (Debit in bank B is matched by credit in bank D and further debits in bank D). So there is no effective monitoring of the end use of funds, which is to the advantage of any unscrupulous borrower, if he wants to divert the funds to group companies or for personal use, etc.

The above operation is possible with three or four sub-limits opened with the same bank also and the modus operandi will be utilise the main limit and keep the sub-limits idle.

2.     Borrower X enjoys Inland Usance Letter of Credit limit (90/180 days) of Rs.45 cr. with banks B, C and D in equal proportion (Rs.15 cr. each) for working capital purpose. X has an arrangement with its supplier of goods Y to supply a part of the order and pay the balance in cash or credit to the other businesses of X. (in some cases, the supplier firm might be from the same group of the borrower). Y opens a current accounts with a new bank E.  At the request of X, B opens an LC for Rs.10 cr. favouring Y. Y prepares the documents to comply with terms and conditions of LC and gets it discounted with his bank E. E bank makes the payment after it is accepted by B bank. On or before the due date of payment of the LC opened by B, an LC is opened in D bank for Rs.11 cr. favouring the supplier. The supplier prepares the required documents for complying with the LC opened by D bank and gets it discounted with his banker again. The balance in the non-monitored current account of the supplier is transferred to the current account of X with bank B for meeting the commitment on LC on the due date.  The process continues till the modus operandi is detected.

3.     Ever-greening possibility in multiple lending which includes banks, both under more than 10% category and less than 10%  category of the total exposure to the borrower:  The CC/OD limits of banks having less than 10% of exposure may be used to adjust the overdues/ interest/instalments of banks with higher exposure. And the utilised limits with smaller banks will be settled with a time lag by credit from the banks with higher share of limits.

Diversion in other ways:

ü  Diversion of funds is much easier and more witnessed in cases where the borrower enjoys working capital limits from a multiple of banks, not covered under consortium, on different terms and conditions.

ü  Sometimes, bank themselves facilitate diversion of funds unknowingly, by sanctioning limits such as “clean term loan for general purposes/shoring up of working capital etc”.

ü  A bank may also grant a facility to a firm/company outside consortium for a different project or based on other collateral security, not extended as security to the existing bankers and a part of the operations might be diverted through the new facility.

ü  Diversion of funds is difficult to detect when a working capital limit is extended to a firm/company, which belong to a group of firms/companies with forward and backward linkages. The supply will be from within the group and sales will also be within the group. Some errant borrowers float companies, maintain hundreds of bank accounts which make tracking movement of funds in real time, a big challenge. IL&FS is a classic example.

How to avoid diversion of money lent: Even if the present guidelines are reviewed for improvement/enhancements at regular intervals by RBI, unless the lenders keep their vigil, unscrupulous borrowers will always be able to divert the funds through innovative methods. Shri C.Rangarjan, former governor of RBI, in his article on “Preventing the pile up of NPAs” in Business Line on 3^rd August 2021, has suggested that the bankers need to revisit and reset their appraisal process and monitoring by probing more deeply the character, capacity and capital contribution by the borrowers on an ongoing basis. No one could have said it better as ultimately the three C’s of the borrower determine the safety return of funds lent by the banks. 

V.Viswanathan

8^th August 2021.