Save Yourselves; Bank is Protected

 Loan Frauds in Banks
Bankers: Protect yourselves; Bank interest safeguarded

Some of the newspaper headlines last week: 

"Former ICICI Bank MD&CEO and her spouse were arrested by CBI in connection with alleged irregularities in loans sanctioned by the bank to the Videocon Group in the period 2005-2012."

"CBI has booked the Abhijeet Group promoted company Corporate Power Ltd and its directors for cheating a consortium of banks to the tune of Rs.4,000 cr."

"Fifty major wilful defaulters have defrauded the banking system of Rs.92.000 cr., the Minister of State for Finance informed Lok Sabha."

Greedy Pulls down everyone: It is not that the above headlines appear now only. Every now and then, we do hear frauds of huge magnitude, hitting the banking system in India. While the fraudsters, internal or external, will have to suffer for their sins, quite a innocent lot within the banks also suffer, as they were part of the appraisal, sanction and disbursing process involved in these fraud accounts. As rightly said in Sai Satcharita (Shirdi Sai)  "the greedy, aiming to achieve greater heights through wrong means, when he falls, brings down not only his empire and family, but also the persons and organisations who were not part of the crime, but just pawns in the process" (Chapter 47). The classic example, one can remember is the collapse of Barings Bank of England in 1995, due to rogue derivative trades (aggregating USD 1.3 billion) entered into by its employee Leeson. In the Indian context, parallel can be drawn to the frauds committed by Nirav Modi and Mehul Choksi on Punjab National Bank in collusion with the bank's staff and PNB became poorer by more than Rs.20,000 cr. overnight. I do not intend to comment on the fraudsters, who fell from zenith to nadir. I dedicate a few tips to the honest, sincere, hardworking employees, as to how to save themselves from the effects of fraud on them and the organisation they serve.

Follow bank rules, comply with terms and conditions of sanction and Bank is Protected automatically: My colleague (retired as CGM) in SBI used to say "Protect yourselves, Bank is saved automatically". This statement was an eye opener to people like me, who worked in smaller banks and felt that timely assistance to a customer not only saves the customer but the bank as well; And in the process, at times,  acted in anticipation of ratification from higher ups, forgetting for a moment that we try to take risks much higher than the sanctioning authority. Let me take-up a few causes, which results in a loan becoming bad, outstanding ballooning up, resultant insufficient security to cover loan amount, bolting the gate after the horse left the stable, etc.

a. Sanction/Disbursals based on oral instructions from the top: In the banks I served in the State Bank Group, I never encountered any interference from the top/outside for considering sanction/disbursal of loans. I always felt that even if any genuine  references/suggestions  come from an insider/outsider, if one takes the pain and courage to go back to the 'referees' and tell his frank opinion, things will fall in place in course of time. Please remember that any oral instruction/suggestion from the top/influential outsider is similar to the act of a mother monkey extending the hand of its baby on a substance to find out whether it is hot or not. The baby monkey only suffers and not the mother. While refusing/conveying inability, it is worthwhile to remember that the baby monkey will survive its mother in age. Persons at the top or at places, which matter to-day, have a short term, but you have a long career ahead.

b. Disbursing Loans before perfection of security: Quite often, one comes across instances, where disbursals preceded perfection of security. Significant number of bank loans given to infrastructure and turned bad subsequently, belong to this category. There were cases, where even before legal approvals/ environment clearances/ promoters' contributions were in place, partial disbursals had taken place. Even if the terms of sanction permitted disbursals prior to obtention/perfection of security, a time period for perfection will be part of such sanctions. Any disbursal made after the stipulated period, needs the approval from the said sanctioning authority, if the perfection of security is not completed by that time. Pressure (self/higher up) also mounts to disburse a loan sanctioned by having a second charge on an asset already charged to another lender. The golden rule is, insist on security creation, promoters' contribution and covenants of similar nature before disbursal of a loan, as that will secure the outstanding. (Imperfect security is one of the main reasons for the substantial hair-cut one experience in recovery of bad loans). 

c. Sanctioning a higher limit, but restricting the drawings: Recently I came across  a case, where officers of the bank concerned were charged along with the borrower firm/its directors that defaulted in paying its dues to the bank. One of the credit committees at the administrative office sanctioned a loan to the said firm, which was already enjoying facilities with some other banks. The sanction was conveyed to the branch and a control return (CR) was put up to the next higher credit committee for noting. The higher committee, while noting the CR restricted the drawings till a review of the account is conducted after three months. But prior to the noting of the higher credit committee, the branch extended the limit and drawings, in excess of the restriction placed by the higher credit committee, was already permitted. Though charges relating to the case are not known, it came to my mind that (i) why the higher committee did not enquire on the status of disbursal before placing the restrictions and (ii) why the credit committee, which sanctioned the limit or the branch, which extended the facility did not advise the higher credit committee about the status prior to the higher credit committee's decision or immediately after the restrictions on drawings was communicated.  Unless the branch/the credit committee, which sanctioned the limit, had reported the status to the higher credit committee and requested for appropriate corrections in its noting,  charges, if any, framed on this score for non-compliance of terms and conditions by the officials concerned, will be difficult to disprove.

The above example, amply demonstrates the ills in sanctioning a higher limit but restricting drawings till a review is complete or some of the terms and conditions are complied with etc. Instead of sanctioning a full limit and restricting drawings, the sanction should have been an 'in-principle' one for the whole limit and actual sanction for a certain amount till the conditions are fully complied with. No one down the line will go beyond actual sanctioned limit. 

d. Impossible terms and conditions of sanction: 

More often than not, claims made by banks with ECGC/Credit Guarantee Funds get rejected for non-compliance of terms and conditions. For example, we normally come across clean loans were extended for shoring up working capital purposes and the loan is disbursed with faith placed on the customer to comply with this condition. And if the loan had been utilised for other purposes/diverted, credit guarantee corporations find it easier to reject the proposal as the bank failed in monitoring to comply with this condition. When I encountered a few claims rejected by ECGC, I met the officials there and explained how it was not possible for a bank official to monitor certain terms of sanction. He said "Sir, We did not stipulate these conditions.  Your Bank stipulated and we have to satisfy ourselves that these are complied with.". That was revealing and the same logic holds good even for framing charges against an officer by internal disciplinary proceedings department/external agencies. In my long career, I did come across some loan sanctions (where the official concerned was not confident of viability of the project) stipulating conditions, which are not in the domain of monitoring of the disbursing official at all.  Such loan sanctions are not sanction at all. The branch/disbursing authority shall get the terms modified prior to commencing execution of loan documents itself.

e. Saving a stressed asset through improper methods: This is resorted to when the officer concerned wants to put up better results for monetary benefits (incentives for targets)/upcoming promotion opportunity/image building within the organisation. Some examples are using an unutilised working capital loan for meeting term loan instalments/interest, sanction adhoc limits for meeting repayment commitment in other loans, enhancing drawing power in working capital limit to match outstanding etc.  Any regularisation of a stressed asset with 'out of the way' methods only postpones the recognition of the impairment to the next quarter/two quarters hence. The best way is to study the prospects of the unit and do rephasement/restructuring  on merits. Here also, one finds loosened restructuring, resulting in pumping more money after a bad asset. Any restructuring/rephasement means the dues to be recovered from the borrower in future will be higher than what is the total outstanding to-day.  As the security remain the same, which value depreciates except in case of land, the percentage of recovery from the security in a restructured loan is always less, post restructuring. If this aspect is remembered while restructuring, one may not witness the huge hair-cuts that is now happening in respect of suit filed/written off loan accounts. 

f. Release of working capital limits before completion of the Project: This is similar to release of a loan without complying with the terms of sanction. Disbursal can start only after the project is complete and trial production is successful. Preliminary/ preoperative expenses and trial production expenses should be met from promoters' contribution. Extending working capital limit before commencement of production normally results in diversion of funds for capex/ meeting margin/ meet commitments on liabilities.

g. Financing against receivables: A study on the cash flows of the firms, which placed the orders on the borrower firms, their repayment culture and history, their/their bank's willingness to extend a registered power of attorney to the lending bank is a must before extending loans against receivables. Quite often loans are extended against related party receivables also. When the borrower defaults, difficulty in recovery is most experienced in respect of working capital securities more particularly that of receivables. (stocks can be diverted for other buyers, can be sold in raw material condition, etc.). In some of the loans extended to NBFCs, the EMI dues from the debtors are shown as value of receivables, which include interest portion also.

h. Diversion of Funds: Core Banking System implemented in banks ensured faster settlement of funds, much beyond what could have been perceived by a banker at the time of implementation. In the manual days, while remittance/settlements were slow, monitoring of loans was much easier, as at the end of the day, one will go through the drawings in a loan account. At that time, there was a famous saying that an account monitored properly every day in the desk is equivalent to an off-site inspection of the unit/its assets. Further on-site inspection done at monthly/quarterly intervals is only a confirmation to the judgement arrived at in the desk, by monitoring the bank loan account of the borrower. However, after computerisation, this aspect is totally lost sight of. Most of the bank staff, even now appear to learn the intricacies of computerisation on a 'need to know' basis only. Unscrupulous elements, who avail loans through fraudulent means, exploit the weakness in the system and divert funds to related parties through a series of circuit transactions. Money laundering can also be attributed to the misuse of the strength of online, without manual intervention, transactions like NEFT, RTGS, IMPS  by these fraudsters. Even if a person is involved on a day to day basis to monitor the withdrawals for ensuring end use of funds, there is an element of opacity, as he may not see the details of transfer beyond the debit effected in the loans account. 'Early sanction review' kind of inspecting tools have been introduced, but the problem is yet to be solved. The monitoring aspect, making it easier to trace the transactions on a real time basis is the need of the hour.  RBI may think of creating central data base to enable banks to track transactions end-to-end at least in respect of withdrawals beyond a certain limit, say Rs.10 cr. and above.

Regards

V.Viswanathan

26th December 2022