Growing NPA is a boon in disguise for Certified Bank Forensic Auditors

Non Performing Assets and the provisions for the losses arising out of the non performing assets is taking toll on the share prices of all the major nationalized banks in 2017. Growing Non Performing assets helped Bank Forensic Audits to grow. Forensic Auditors are typically asked to look at the nature of loss to the bank and comment on whether the loss is willful default caused by the borrower or it is a genuine business problem.

Though not defined anywhere willful default is when a borrower intentionally deceives a lender by providing false information, or by omitting important information during the loan application process or during the currency of such loan. Over a period of a decade the number of willful defaulters have grown up and Reserve Bank of India was forced to announce the repository of the willful defaulters also termed as fraud borrowers.

In order to tackle the growing problem of Willful defaulters and the loan frauds, Reserve Bank of India laid down the framework to deal with the borrowers who delay the payments or avoid paying the money on the due date.

The core objective of this framework is early detection of problem in the borrower account. RBI has given a timeline with stage-wise action in the loan life cycle which would help early resolution of bad loans. It has also defined certain steps to be followed once fraud is detected. The early detection of Fraud and the necessary corrective action are important to reduce the quantum of loss which the continuance of the Fraud may entail.

Early Warning Signals (EWS) and Red Flagged Account (RFA)

Early warning signals are those triggers based on which the Core Banking System (CBS) identifies that specific account which needs special attention. RBI has given a illustrative list of EWS for the which the banks may configure their CBS. Although, each bank can form their own EWS list based upon their experience, client profile and business models

Red Flag generally in Forensic Audit means an indication which entails a probability of something being out of generic nature. As per the Framework of RBI RFA is one where a suspicion of fraudulent activity is thrown up by the presence of one or more EWS. These signals in a loan account should immediately put the bank on alert regarding a weakness or wrong doing which may ultimately turn out to be fraudulent. As soon as an EWS is triggered for an account then it must be used to launch a detailed investigation into that specific loan account.

As per the latest master circular of RBI, threshold for EWS and RFA is ₹ 50 Crores or more. This limit of ₹ 50 Crores has to be considered for irrespective of the lending agreement. i.e. Solo Banking or Consortium. As soon as EWS is triggered in any such account the same has to be immediately reported to (Central Repository of Information on Large Credits) CRILIC platform.

Each and every bank must form a Fraud Monitoring Group (FMG) or a similar committee to monitor such accounts and all of those accounts must be reported to CEO/CMD at the end of each month for review. Additionally, a report on the RFA accounts shall be put up to the Special Committee of the Board for monitoring and follow-up of Frauds (SCBF) providing, inter alia, a synopsis of the remedial action taken together with their current status.

Early Detection and Reporting

For the purpose of early detection and reporting of Fraud RBI has given following checks to be applied during the different stages of loan life-cycle.

  • Pre-Sanction: All the banks must conduct a thorough Background Check on the promoters of the company and the also collect relevant data from the industry before sanction of any loan. It should also keep a complete record of all such searches conducted.
  • Disbursement: It should be ensured that before disbursement of loan, all the terms of sanctions must be adhered to and also the sanctioning authority may specify certain specific terms and conditions which should not be diluted.
  • Annual Review: Over and above the regular credit monitoring process banks should also collect information from the grapevine, following up stock market movements, subscribing to a press clipping service, monitoring databases on a continuous basis and not confining the exercise only to the borrowing entity but to the group as a whole.

In current banking scenario, the exposure to the borrowers is divided when the loan requirement exceeds certain limits. In such cases the loans are provided on consortium basis, in cases where the bank is able to absorb the risk, bank is a sole lender.

Where Bank is the Sole Lender

In a case where Early Warning Signals are identified, it is left to the discretion of Fraud Monitoring Group to classify the account as Red Flaaged or not. Once it is classified as Red Flagged, opportunity is generated for the bank forensic audits.

Where Bank is the Consortium Lender

Certain fraudulent borrowers continue enjoying credit facilities under consortium banking even after defrauding one of the financing banks by  siphoning off funds by operating account in banks other than the one on which fraud is being perpetrated. Also at certain times same security is offered to different banks and credit is obtained on the same.

Any major concerns from the fraud perspective noticed at the time of annual reviews or through the tracking of early warning signals should be shared with other consortium / multiple banking lenders immediately.  The initial decision to classify any loan account as Red Flagged or Fraud will be at the individual bank level and it would be the responsibility of this bank to report the Red Flagged or Fraud status of the account on the CRILC platform so that other banks are alerted, after which the banks must report such fraud to RBI within 21 days of such detection.

Additionally, within 15 days of RFA classification the bank would ask the consortium leader to convene a Joint Lender’s Forum meeting of all the lenders. The same must be convened within the 15 days of the request being received.  In case there is a broad agreement, the account should be classified as a fraud; else based on the majority rule of agreement amongst banks with at least 60% share in the total lending, the account should be red flagged by all the banks and subjected to a forensic audit commissioned or initiated by the consortium leader or the largest lender under Multiple Banking Arrangements. All banks, as part of the consortium or multiple banking arrangement, shall share the costs and provide the necessary support for such an investigation.

The Forensic Audit must be completed within a maximum period of 3 months from the date of Joint Lending Forum meeting authorising the audit. Within 15 Days of the completion of Bank Forensic Audit Joint Lender’s Forum shall reconvene and decide on the status of the account, either by consensus or the majority rule. In case the decision is to classify the account as fraud, the Red Flagged Account status shall be changed to Fraud in all banks and reported to RBI and on CRILC platform within a week of the said decision. Additionally, within 30 days of the RBI reporting, the bank commissioning/ initiating the forensic audit should lodge a complaint with the Central Bureau of Investigation on behalf of all banks in the consortium.

The overall time allowed for this complete exercise is six months from the date when the first member bank reported the account as Red Flagged/Fraud on the CRILC platform.

Banks are required to lodge the complaint with the law enforcement agencies immediately on detection of fraud. There should ideally not be any delay in filing of the complaints with the law enforcement agencies since delays may result in the loss of relevant ‘relied upon’ documents, non-availability of witnesses, absconding of borrowers and also the money trail getting cold in addition to asset stripping by the fraudulent borrower.

Important Points to Ponder

  • A proper whistleblower policy must be defined in each bank so that Employees are easily to report their grievances without having any fear.
  • During the course of audit also if any major discrepancies are found then they should be immediately reported to the appropriate authority.
  • Providing various incentives for early detection and reporting of Loan Frauds.
  • RBI has also provided certain measures to be taken to make officials of the bank accountable in case there involvement is found.
  • Stringent penal measures for the Fraudulent Borrowers to discourage the loan frauds.

Even though RBI has tried to implement a robust framework for the loan frauds, every now and then one would hear the news of a company facing liquidity crunch and due to which all the major PSU facing huge losses. For a detailed study of the framework kindly refer the RBI Master Directions on Frauds – Classification and Reporting by commercial banks and select FIs.