Mumbai: Top accounting firms have seen a surge in requests by banks to conduct forensic audits on borrowing companies that are suspected to be involved in fraud, or in cases where repayments to lenders have been consistently delayed, said three executives engaged in the process.

The increase, observed over past six months, comes against the backdrop of an increase in bad loans across the banking sector and an attempt by the Reserve Bank of India (RBI) to put processes in place to detect cases of fraud and wilful default by borrowers.

In May, RBI issued a framework for prevention, early detection and reporting of frauds.

As part of the framework, RBI introduced a concept called Red Flagged Account, an account where the suspicion of fraudulent activity is aroused by early warning signals.

These are the accounts that are now getting referred to the local units of auditors such as EY, formerly known as Ernst and Young, Deloitte Touche Tohmatsu India Llp and KPMG, all of whom have seen a rise in cases referred to them for a forensic audit.

A forensic audit entails an examination and evaluation of a firm’s, or individual’s, account to glean information and evidence of wrongdoing that could be used as evidence in court.

Of these, EY has received 55 such proposals over the last four months, according to one of the three executives mentioned above. KPMG has seen proposals double in six months through December, compared with the same period in 2014, said a second person.

These audit requests are not only for small exposures of about 500 crore and below but also involve large corporate groups where the cumulative exposure of banks through consortium lending is above 1,000 crore.

The audit firms declined to comment on the exact number of cases referred to them for forensic audit but acknowledged an increase.

“While there has been an increase, the problem is much more serious and widespread, and the rise is not in proportion to the rise in NPA (non-performing assets) or SMA (special mention accounts). It could be a function of time lag and we may see a further rise in the coming months as well," said Jagvinder Brar, partner–forensic services, KPMG India.

“It is important for banks to have a mechanism that can assist them in taking informed decisions with regards to accounts that need to be pursued or followed up for further investigation, and those that need to be written off," said Vikram Babbar, executive director, fraud investigation and dispute services, EY India.

Such audits were made compulsory for banks by RBI under the corporate debt restructuring (CDR) scheme in 2013 to distinguish between borrowers experiencing genuine financial stress from those company promoters who were siphoning off funds.

According to the first of the three executives cited above, all of whom spoke on condition of anonymity, the increase in forensic audit referrals is due to an increase in stress in the banking sector and RBI’s guidelines on detection of fraud.

“There are a couple of triggers for this (rise in audit requests). Obviously, these are stressed accounts. In some cases there may be some anonymous complaints which they may have received against the borrower. Another trigger is the RBI circular where they have said about red flagging accounts," said this executive.

In its May circular, the central bank provided an exhaustive list of 45 warning signals that bankers needed to watch for, while monitoring borrowers, to differentiate fraudulent behaviour from genuine stress.

While banks were not asked to set aside money to cover the risk of default on such accounts, RBI required them to take necessary steps towards recovering their dues.

The central bank also asked banks to give information about red flagged accounts to other lenders if the loan was extended through a consortium.

“We have seen a rise in red flags among stressed accounts. The RBI circular is very exhaustive, and if we take early warning signals like cheque bounce, etc., every second account could be red-flagged. But the spirit of the rule is to pick out serious offenders, and forensic audit helps banks to get to the details," said an executive with a mid-sized public sector bank on condition of anonymity.

The May circular was part of a larger exercise by RBI to clean up bank balance sheets.

Faced with a surge in bad loans and increasing stress on banks’ loan book, RBI in April 2015 began a campaign to clean up bank balance sheets by tweaking rules, doing away with regulatory forbearance (which allowed lenders to maintain low provisions against impaired assets) and prodding bankers to be more proactive in identifying stressed assets.

Not all forensic audit requests emerge from such red-flagged accounts, according to K.V. Karthik, partner-financial advisory services, Deloitte India.

“It is difficult to entirely attribute the rise in forensic audits at banks to prevalence of stressed loans as well as RBI’s May circular asking banks to red flag accounts. The reason is that under the CDR mechanism of restructuring, such a forensic audit was mandatory, but this window is now largely unused, and under SDR and others, an audit is not mandatory but desirable," said Karthik.

“Having said that, in cases where banks suspect fraud or there are issues in that account, they are undertaking a forensic audit proactively."

Deloitte declined to share details on the increase in forensic audits that the firm has seen over the past year.

The rise in audit requests also reflects the heightened awareness among bankers about the stressed assets, which have ballooned in recent years as an economic downturn and stalled projects made it difficult for borrowers to repay debt.

“This is definitely a serious issue. I think we would see a further rise in such cases, but we have both the regulator and the government seized of the matter now," said Ashvin Parekh, founder of Ashvin Parekh Advisory Services Llp.

According to data from RBI, stressed loans (which include restructured loans) accounted for 11.3% of total outstanding loans, as of 30 September.

The bad loan stockpile, as of 30 September, rose to about 3.5 trillion from about 3 trillion in March.

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