Home / Opinion / Views /  Opinion | Indian banking - The Real Story of fraudulent loans

Recently, the media reported many high-profile bank scandals involving fraudulent loans. Between all the political rhetoric, expert commentaries and sensationalized reporting, it is hard for the casual reader to understand the real reasons behind this breakdown in the Indian banking system. As a chartered accountant, who has audited banks for nearly half a century, I believe this phenomenon is a result of the systematic breakdown of controls that has festered in the Indian banking system for decades. The loans that have been unearthed are only the tip of the iceberg and unless radical changes are made, this concerning trend will continue into the foreseeable future. This article might help the reader understand the real story behind fraudulent loans.

Let us cut through the information fog created by all the political rhetoric in the media and call this mess out for what it really is.

Governments under all ruling parties have been blamed for protecting willful defaulters. While the Congress party recently alleged that the BJP wrote off loans worth Rs. 68,697 crores of top 50 defaulters, finance minister Sitharaman claimed that between 2009-10 and 2013-14, when the UPA was in power, banks wrote off a much larger amount of 145,226 crores. She further said that “neither while in power, nor while in opposition has the Congress party shown any commitment or inclination to stop corruption and cronyism."

The fact is that, throughout the history of modern India’s banking system, there have been bank lending scams, CBI enquiries, and arrests of bank officials, politicians, defaulting borrowers and middlemen who were “fixing the system." Regardless of which party is in power, the opposition parties claim that the ruling party is a willing participant in “crony capitalism". On the other hand, the ruling party blames problem loans as a legacy of the corrupt lending practices of the past government. This pattern has been going on for so long that one is reminded of the words of the French writer Jean-Baptiste Alphonse Karr’s: “plus ça change, plus c’est la même chose," which translate to: The more things change, the more they remain the same.

The issue of fraudulent loans is not a problem of a particular political party. It is a natural product of the systematic failure of controls in the Indian banking system that is regularly aided and abetted by bad apples within every political party. One of the world’s most successful investors, Warren Buffett once wrote that it has been far safer to steal a large sum with a pen, than a small sum with a gun. Tragically, his observation has turned out to be true for the Indian banking system.

So what ails the Indian banking system and why do we have so many fraudulent loans?

During audits, I have had numerous run-ins with bank officials. These experiences have provided invaluable insights on the inner working of the Indian banking system and has laid bare some of the rot that enables both fraudulent borrowing, and lending practices.

For some context, bank auditors provide assurance on whether the financial statements of a bank are reasonably stated. To provide this reasonable assurance, one of the audit procedures is to assess the risk of fraud in the lending cycle and design appropriate procedures to assess the collectability of loans. If the loans fail certain criterion for collectability as laid out by the bank regulators, the loan is required to be classified as a non-performing asset (NPA) and a provision for loss is set up for the same in the financial statements of the bank. The results of the audit, control deficiencies identified, including adjustments made pursuant to the audit are provided to the bank, various regulators, and the public in the form of various reports.

In addition to irregularities in the performance and monitoring of loans, various issues were also identified in the initial sanction of loans including falsified collateral resulting in amounts being lent to borrowers that were never were expected to be repaid. Numerous creative practices designed to specifically avoid problems loans being classified as an NPA were also noted. These included moving moneys between various facilities/banks to show activity in dormant accounts, reduce overdrawn amounts, or to keep accounts current. In addition, there were cases where additional borrowing facilities were provided to the borrower and these additional funds were used to make an overdue account current (a practice referred to as window dressing).

Explanations offered to justify these irregularities were rarely based on merit and were on the likes of: this loan was sourced by Messer’s X, the bank will lose business if we classify this loan as a NPA, or that if this loan is classified as an NPA, the banks’ financial position will not look good. On any given day, Messer’s X could be the chairman of the bank, a member of the board of directors, an auditor, or a politician.

There exists a comprehensive machinery to oversee the quality of loans and prevent fraudulent activity in the Indian banking system. This machinery includes the top and mid-management involved in sanctioning and monitoring loans, internal inspection team of the banks, concurrent auditors, stock auditors, internal auditors, and external statutory auditors. In addition, inspectors of the RBI also review and report on sticky loans on a regular basis.

The problem is not the absence of checks and balances or a lack of tools: we have lots of that. The real problem is the lack of implementation of checks and balances. The machinery has the tools, and provides the information required to identify breakdown of controls resulting in fraudulent loans. However, due to a lack of tone at the top and lack of accountability, nothing is done with that information.

The Indian banking industry clearly suffers from challenges when it comes to ethical practices, financial distress and corporate governance. This is reflected in the cases involving a number of banks including Syndicate Bank, Canara Bank, Punjab National Bank, Indian Bank, State Bank of India, Bank of Maharashtra, United Bank of India, and UCO Bank. Chairmen of a large number of these banks were allegedly involved in providing loans for money and some of them were jailed, arrested or are still been investigated by the CBI. The investigations were confined to one or two loans during their tenure. They could have been involved in other loans for money during their tenure as chairman, or during their stint at other banks. We only hear about frauds of Nirav Modi, Mehul Choksi, Vijay Mallya, Rana Kapoor of Yes Bank, Wadhawans of DHFL, etc.

Bankers have the tools, the machinery, and the opportunity to build a good, if not spectacular business. Even if the current recession persists and even if current regulations and statutes stay in force, banks can rule their own fate, and that fate can be a good one. But for that to materialize, they have to be honest with themselves and start setting the right tone at the top. It is high time that the issue of problem loans do not become a part of politics and the country wakes up to work as a nation to reduce future occurrences. After all, large sums of public money are being lost due to these fraudulent lending practices and this has to be stopped.

In this challenging economic environment that has been exacerbated by the covid-19 pandemic, it is sometimes easy to conclude that the current spate of problem loans is a function of a tough market. Pause before making that conclusion. Is it the challenging economic environment that has resulted in these loans going bad and being revealed as fraudulent or is it that the current lockdown has inadvertently limited the ability to continue window dressing these loans.

(The author is a Delhi-based practising senior chartered accountant having vast experience in bank audits, including as central statutory auditor. The views are author's own and do not reflect Mints' editors)

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