Banking Defaults

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The widespread culture of fraud, unethical behaviour and lawlessness is blowing in our faces in the form of rising non-performing assets (NPAs) in the banking system. The RBI recently released a discussion paper, outlining a framework for revitalising the distressed assets in the economy. The focus of the paper is on strengthening bank balance sheets by revamping the prudential norms that apply to them. It has to be seen how banks respond to the suggestion when the business environment is competitive and capital is hard to find. The rising default by borrowers is not only due to the economic slowdown, but also due to the wilful acts of those who hope to get away with it.

It is common for businesses in India to set up multiple companies. There is a huge web of cross-ownership, directorships and intercompany activities, including transfer pricing and borrowings. The Ministry of Company Affairs (MCA) has been trying to digitise these records and impose compliance. There are 13.5 lakh registered companies, many of whom do not submit annual returns, accounts, or data about their directors, as required by law. The objective is to create and keep multiple, opaque entities, which are tough to track or correlate in terms of their ownership, performance or management. Therefore, it is easy for an entity to borrow and siphon it off to another, use one company's funds to buy assets for another, or deliberately let one of the many entities to fail, while the others continue to do well. This is the dark side of corporate borrowers.

 
It is also not easy to track the owners of these businesses. To ensure that directors are tracked even as they set up and close businesses, and reappear, the MCA has mandated a director identification number (DIN), but not all registered companies are compliant. According to the RBI paper, even standard accounts should be subject to a 5% provisioning if the directors also hold this position in a company that has been defaulting wilfully. If these loans become NPAs, accelerated provisioning will apply. Independent directors and government nominees have been excluded. The RBI is hoping to make a list of such directors and provide it to the lenders. However, the task may be complex if one were to go by the MCA's experience.

Credit bureaus enable sharing of data among lenders and are an effective mechanism for identifying wilful defaulters. While the bureaus and lenders have been enthusiastic about capturing the data of individual borrowers and providing credit scores, there is no sharing of data for institutional borrowers. Only those cases, in which a default has led to the filing of a suit in a court of law by the lender, are currently being shared. The others are being treated as confidential and not being shared. This means that a wilful borrower could be defaulting with one bank and can still borrow from others.
A high percentage of wilful defaulters is guilty of siphoning off the borrowed funds, misusing money, providing false records of stocks or assets, or deliberately misrepresenting the facts to bankers. The only redressal available to bankers, who find that the audited numbers they have been relying on are false, is to represent the case to the Institute of Chartered Accountants of India (ICAI). The ICAI is expected to investigate, penalise and take action against its registered members, who certify the accounts, records and books. This process also works slowly and inefficiently. The RBI has proposed that the names of these auditors be made available to ICAI, MCA and CAG, apart from the RBI and lenders. It's not clear if this will serve any useful purpose. The central bank also mentions advocates, who wrongly certify assets and securities as having a clear title, and valuers who may overvalue a security. It has asked for their names to be reported to the IBA so that banks know before using their services. There is no real protection for the banker from unscrupulous support services which are used by wilful defaulters.

So, we have an unethical web of operators calling themselves businessmen who are setting up companies, and directors who are common to many firms, approaching banks and lenders to borrow money, and wilfully diverting the funds or misusing them, abetted by accountants, auditors, valuers and advocates. This is the problem that the Indian banking system is dealing with. It's not a simplistic issue of a bank giving out loans because a politician or someone in power asks it to do so; this only makes an existing problem worse.

This is the perpetuation of the entitlement culture, where Indian business entities believe they can access public money from banks and be nonchalant about not using it efficiently or scrupulously. For several years, the access was to budgetary funds available through public financial institutions. When this tap dried, it left in its wake several sick and bankrupt state- and national-level financial institutions. In spreading its roots to the banking system, this evil has damaged the credit delivery process and is now threatening the vulnerable segment of banking—public-sector banks. These institutions are weakened by playing along with well-entrenched fraudsters masquerading as businessmen. By threatening them with prudential norms that will make it unprofitable for them to keep defaulters on their books, the RBI will either push them towards better lending practices, or supervise their demise if they fail to match up. The next few years will tell us how this story pans out.

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