Context

The biggest banking scam in India has come to the forefront; in this case, DHFL has hoodwinked a consortium of banks driven by the Union Bank of India to the tune of ₹35,000 crore through financial misrepresentation.

How scams affect economy

• The banking system of any country is the backbone of its economy.
• Excessive losses to banks affect every person in the country because the amounts deposited in banks belong to the citizens of the country.
• The NPAs that banks incur are mainly due to bad loans and 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.

Reasons for scams

•  Frauds in the banking industry can be grouped under four classifications: ‘Management’, ‘Outsider’, ‘Insider’ and ‘Insider and Outsider’ (jointly).
• 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.
• Poor bank corporate governance: A study by the Indian Institute of Management Bangalore has shown that poor bank corporate governance is the cause behind rising bank scams and NPAs.

The problems of high NPA

• 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.
• 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.

Suggestions

• Banks have to exercise due diligence and caution while offering funds.
• Regulation and control of CAs: 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.
• Tightening audit system: There is also an urgent need to tighten the internal and external audit systems of banks.
• Fast rotation of employees: The fast rotation of employees of a bank’s loan department is very important.
• Public sector banks should set up an internal rating agency for rigorous evaluation of large projects before sanctioning loans.
• Effective MIS: Further, there is a need to implement an effective Management Information System (MIS) to monitor early warning signals about business projects.
• CIBIL score of the borrower: The CIBIL score of the borrower (formerly the Credit Information Bureau (India) Limited) should be evaluated by the bank concerned and RBI officials.
• Use of AI: Financial fraud can be reduced to a great extent by the use of artificial intelligence (AI) to monitor financial transactions.
• Improve loan recovery process: Rather than having to continuously write off the bad loans of large corporates, India has to improve its loan recovery processes and establish an early warning system in the post-disbursement phase.
• Risk assessment: Banks need to carry out fraud risk assessments every quarter.
• Only establishment of National Asset Reconstruction Company Ltd. (NARCL) or the ‘bad bank’ is not a real solution.
• These measures can help only after a loan is bad but not the process of a loan going bad.

Conclusion

While the Government of India and the RBI have taken several measures to try and resolve the issue of scams in the banking industry, the fact is that there is still a long way to go.

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