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EDITORIAL ANALYSIS : The scam faultline is damaging Indian banking

Source: The Hindu

  • Prelims: Monetary Policy, Banking system, RBI, NPA
  • Mains GS Paper III: Fiscal policy, Monetary policy, Issues with NPA, Issues related to planning etc.

ARTICLE HIGHLIGHTS

  • The biggest banking scam in India has come to the forefront, Dewan Housing Finance Corporation Limited(DHFL) has hoodwinked a consortium of banks driven by the Union Bank of India to the tune of ₹35,000 crore through financial misrepresentation.
  • The DHFL case was not an isolated case. In February this year, ABG Shipyard Limited of Surat had already taken aloan of about ₹23,000 crore in a fake manner.
  • On February 1, 2019, a consortium of banks had held a meeting to take cognisance of the serious allegations of loan repayment default against the DHFL.

 

INSIGHTS ON THE ISSUE

Context

Non-Performing Asset(NPA)

  • NPA refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest.
  • In most cases, debt is classified as non-performing, when the loan payments have not been made for a minimum period of 90 days.
  • Gross non-performing assets are the sum of all the loans that have been defaulted by the individuals who have acquired loans from the financial institution.
  • Net non-performing assets are the amount that is realized after provision amount has been deducted from the gross non-performing assets.

 

Classification of Non-Performing Assets (NPA) Criteria
Substandard Assets These are the assets which have remained NPA for a period of less than or equal to 12 months
Doubtful Assets If the asset is in the substandard category for a period of 12 months
Loss Assets These assets are of little value, it can no longer continue as a bankable asset, there could be some recovery value.
 

Reasons behind the rise of Non Performing Assets:

 

 

 

Impact of NPAs:

  • Negative impact to economy: Stress in the banking sector causes less money available to fund other projects, therefore, negatively impacting the larger national economy.
  • Higher introductory rates: Higher interest rates by the banks to maintain the profit margin.
  • Redirecting of funds: Redirecting funds from the good projects to the bad ones.
  • Less money dividends to government: In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that the government of India gets less money as a dividend.
    • Therefore it may impact easy deployment of money for social and infrastructure development and results in social and political cost.
  • Balance sheet syndrome: It is of Indian characteristics that both the banks and the corporate sector have stressed balance sheets and cause halting of the investment-led development process.
  • Litigations: NPAs related cases add more pressure to already pending cases with the judiciary.

 

Current Issues with the banking system:

  • Inside workers and poor lending process: Data by the Reserve Bank of India (RBI) show that around 34% of scams in the banking industry are on account of inside work and due to poor lending practices by and the involvement of the junior and mid level management.
  • Rising bank scams: The data by the RBI also show that one of the fundamental problems in the way of the development of banking in India is on account of rising bank scams and the costs consequently forced on the framework.
    • Strangely, as in a Global Banking Fraud survey (KPMG), the issue is not just for India alone, it is a worldwide issue.
  • Rise in gross NPAs: In a Financial Stability Report released by the RBI in December 2021, there is a projection of the gross NPAs of banks rising from 6.9% in September 2021 to 8.1% of total assets by September 2022(under a baseline scenario) and to 9.5% under a severe stress scenario.
  • Operational failures: All scams, whether interior or outside, are results of operational failures.
  • Limited asset monitoring: Research by Deloitte has shown that limited asset monitoring after disbursement (38%) was the foremost reason behind stressed assets and insufficient due diligence before disbursement (21%) was among the major factors for these NPAs.
  • High NPA reduces net interest margin: A high NPA also reduces the net interest margin of banks besides increasing their operating cost, these banks meet this cost by increasing the convenience fee from their small customers on a day to day basis.
  • High bad loans of corporates: According to the RBI data, corporate loans account for nearly 70% of these bad loans, while retail loans, which include car loans, home loans and personal loans, account for only 4%.
    • A study by the IIM Bangalore has shown that poor bank corporate governance is the cause behind rising bankscams and NPAs.

 

Some recent Bank scams:

 

Steps taken:

 

Bad Bank

●    The bad bank is an ARC or an Asset Management Company (AMC) that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.

●    The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.

●    The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

India Debt Resolution Company Limited (IDRCL)

●    It will provide management and resolution of assets and also help in the operational aspects, relating to price discovery and aim at evolving the best possible recovery and the resolution process.

●    PSBs and Public Financial Institutes (FIs) will hold a maximum of 49% stake in IDRCL. The remaining 51% stake will be with private-sector lenders.

●    The NARCL is majorly owned by public sector banks with 51% ownership but in the case of the IDRCL, 51% shares are in private hands.


 

Way Forward

  • Due diligence and caution: Over time, bad loans lead to higher NPAs. So, banks have to exercise due diligence and caution while offering funds.
    • The regulation and the control of chartered accountants is a very important step to reduce non performing assets of banks.
    • Banks should be cautious while lending to Indian companies that have taken huge loans abroad.
    • There is also an urgent need to tighten the internal and external audit systems of banks.
  • Rotation of employees: The fast rotation of employees of a bank’s loan department is very important.
  • Internal rating agency: Public sector banks should set up an internal rating agency for rigorous evaluation of large projects before sanctioning loans.
  • Effective management information system(MIS): There is a need to implement an effective Management Information System (MIS) to monitor early warning signals about business projects.
  • Evaluating CIBIL score: The CIBIL score of the borrower (formerly the Credit Information Bureau India Limited) should be evaluated by the bank concerned and RBI officials.
    • This must also include the classification and responsibilities of the lending and recovery departments.
  • Use of AI: Financial fraud can be reduced to a great extent by the use of artificial intelligence (AI) to monitor financial transactions.
  • Improve in loan recovery process: Rather than having to continuously write off the bad loans of large corporations, India has to improve its loan recovery processes and establish an early warning system in the post disbursement phase.
    • Banks need to carry out fraud risk assessments every quarter.

 

QUESTION FOR PRACTICE

  1. Tightening the internal and external audit systems of banks can prevent the prevailing bank fraud. Do you agree with the statement? Give illustrations.

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