Pre-disbursement due diligence refers to the process of conducting a comprehensive review and analysis of the potential borrower’s creditworthiness, financial health, business operations, and legal compliance before approving and disbursing a loan. This due diligence process is essential to ensure that the borrower has the ability and willingness to repay the loan and that the funds will not be used for illegal or unethical activities.
The importance of pre-disbursement due diligence lies in its ability to mitigate financial risks for lenders. By carefully assessing the borrower’s creditworthiness and financial position, lenders can make informed decisions about whether to grant a loan, how much to lend, and at what interest rate. This helps lenders to reduce the risk of default, which can result in financial losses and damage to their reputation.
Rising Non-Performing Assets (NPAs) in India have brought a myriad of challenges faced by banks and financial institutions into the spotlight. The banking and finance sector is struggling with the constant issue of inadequate due diligence regarding borrowers, which has resulted in an increase in the number of NPAs. The lack of proper due diligence has also led to a decrease in the availability of credit to deserving borrowers, causing a negative impact on the overall economy.
The issue of gathering information about the borrower can be demystified by segregating it into the various stages of the loan cycle:
Due Diligence while On-boarding
Global banks faced significant fines for violation of Anti Money Laundering provisions. Heightened Risk Professionals have played a significant role in making these banks operationally weak and identifying the Heightened Risk Individuals help the banks to tackle the risks.
Anti Money Laundering (AML) regulations are critical to preventing financial institutions from being used to facilitate illegal activities. Global banks that fail to comply with AML regulations can face significant fines, legal penalties, and reputational damage. In recent years, regulatory bodies have stepped up their enforcement of AML regulations, resulting in a number of high-profile cases where global banks have been fined for non-compliance.
By identifying Heightened Risk Individuals who pose a higher risk of involvement in money laundering or other financial crimes – companies like Riskpro help banks to more effectively target their compliance efforts and reduce the risk of non-compliance.
Due Diligence while Sanctioning
There are times when loans are sanctioned without adequate due diligence to confirm the authenticity of the promoter’s background. In the age of continuous monitoring by the regulators, it becomes important to conduct a quick review of the background of the borrowers. This becomes even more relevant for loans sanctioned especially at period ends where there is significant pressure on Turn Around Time.
In some instances, it has been observed that the ‘market value’ of the collateral is considered while preparing the sanction documents instead of taking a rather conservative approach and considering ‘book value’ which allows a ‘cushion’ to the lending institution. Information on the types of manipulations done with the value of the security can be understood while completing the Certification course in Banking Frauds offered by Indiaforensic.
Another case could be when the evaluation of collateral is often performed by independent agencies that are later identified as being linked to the borrower (being appointed by the borrower) thus defeating the purpose of independent assessments. In order to identify the nexus between the borrowers and valuers, tools like Biznexxus play a crucial role.
Loan documentation
Documents submitted by the borrower are often taken at face value without adequate diligence and skeptical review. Many of times it is essential to understand the nexus of the auditors with the borrowers. Auditor borrower nexus can prove costly to the banks. Hence auditor independence checks play a crucial role in today’s world.
Some common occurrences in this case would be the unavailability of requisite insurance cover or just photocopy of ‘no objection certificate’ obtained from other banks.
In the pre-disbursement stage if the banks perform additional due diligence checks such as the auditor independence checks, review of the nexus of the borrower with other parties, and analysis of undisclosed related parties it helps the banks to take informed decisions.
