Model Question and Answers for APSC | The scam faultline is damaging Indian banking. Discuss factors that lead to scams in the banking sector and suggest remedies.
The scam faultline is damaging Indian banking. Discuss factors that lead to scams in the banking sector and suggest remedies.
Ans: In the biggest banking scam in India, 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 crores through financial misrepresentation. The DHFL case was not an isolated case. In February this year, ABG Shipyard Limited of Surat had already taken a loan of about ₹23,000 crores in a fake manner.
Hitting citizens' deposits:
- The banking system of any country is the backbone of its 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.
- 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 junior and mid-level management.
- The data by the RBI also show that one of the fundamental problems in the way of the development of banking in India is 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.
An NPA projection, a list
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.
Reasons behind scams:
- Frauds in the banking industry can be grouped under four classifications: ‘Management’, ‘Outsider’, ‘Insider’ and ‘Insider and Outsider’ (jointly). All scams, whether interior or outside, are results of operational failures.
- 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.
- 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 Indian Institute of Management Bangalore has shown that poor bank corporate governance is the cause behind rising bank scams and NPAs.
Steps that need consideration
- 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 the 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.
- 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.
- Further, there is a need to implement an effective Management Information System (MIS) to monitor early warning signals about business projects.
- 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.
- Only the 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 during the process of a loan going bad.
- Financial fraud can be reduced to a great extent by the use of artificial intelligence (AI) to monitor financial transactions.
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. 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. Banks need to carry out fraud risk assessments every quarter.