Mark Twain said “a banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”. But a lot has changed since the humourist’s days – it’s bankers who are now getting drenched and none of them are singing. And the discount in the reputations involved is sought to be part-arrested with the help of forensic firms.
Banks, private equity (PE) firms, and non-banking financial companies (NBFCs) are all set to use forensics in a big way. The Reserve Bank of India’s (RBI’s) June 7, 2019, circular, which places the onus squarely on banks to get going on resolution of bad loans, the proposed amendments to the Insolvency and Bankruptcy Code (IBC), and specific sections of it on the protection of value will all play a role leading to the enhanced use of forensics. The other factor is that the central bank is working out a new set of norms to identify and set right red-flagged accounts (RFAs).
The Sherlocks
Jagvinder Brar, co-head-forensic investigation at KPMG (India) will tell you his firm employs over a 1,000, who are specifically into this. And, this summer saw over 70 firms queue up to be on the Indian Banks’ Association’s empanelled list of forensic auditors. These included the likes of Alvarez & Marsal (A&M), Kroll, Ernst and Young, BDO India, PwC, BMR Advisors, KPMG and Deloitte; that is, too, many home-bred firms which never or rarely make it to the headlines. Obviously, there is money to be made when you help out those who are out in the rain. It is also in some ways as shrouded as what it seeks to uncover – you will not be let in on these firms’ billings which can run up to be a tidy amount.
Says Tarun Bhatia, managing director (business intelligence and investigations practice) at Kroll (one of the world’s leading forensic firms): “It would not be correct to look at the professional fees charged for due diligence from a basis points perspective. A due diligence helps in lowering non-performing assets (NPAs) and conserve capital rather than use it for provisioning. Thus, the actual saving is far more significant than the initial cost.”
The current annual fee-pool is estimated to range between Rs 600 and Rs 1,000 crore (it depends on how the business is sliced and diced). It is nearly half of what the investment banking (i-banking) firms in the country carve out every year among themselves. And just like in i-banking, it is hard to get good deck-hands.
“There is a severe shortage of detective minds who are well trained, experienced and have a knowledge of finance, law, and above all, a solid presence of mind”, says Brar. Unwittingly, it is another way of putting across that it is the absence of mind by those who dole out money which has landed Bhatia’s and Brar’s brotherhood in a sweet spot – bigger the mess, bigger is the buck to be made.
RBI’s Annual Report for FY19 says the number frauds went up by 15 per cent to 6,801 cases and the amount involved by 73.8 per cent to Rs 71,542.93 crore (99.2 per cent of this was accounted for by state-run banks). The average lag between the date of occurrence and its detection was 22 months; the average lag for large frauds —Rs 1 billion and above — amounting to ₹522 billion reported in this period was 55 months. Simply put, the current amount due to frauds is more than the just announced Rs 70,000 crore recapitalisation plan for state-run banks.
The central bank’s Financial Stability Report (FSR) of June 2019 mentions that as on end-December 2018, you had 204 borrowers who had been reported as fraudulent by one or more banks, but these were not classified as such by others with an exposure to the same borrower. You have non-uniformity in the processes to identify RFAs based on early warning signals; many banks were unable to confirm RFA tagged accounts as frauds or otherwise within the prescribed period of six months.
The central bank refers to the data from its Central Repository of Information on Large Credits’ (CRILC) FY19, which shows the RFAs reported by banks exceeded the stipulated period in 176 cases – or well over two-thirds of the instances. The time lag between the date of occurrence of a fraud and its detection is also significant – the genesis of 90.6 per cent of what was reported in FY19 lay between FY01 and FY18. And the reasons cited included delays in completion or inconclusive findings of forensic audits.
It’s not elementary though
Says KV Karthik, partner-Deloitte India: “The imminent pressure to respond to instances of potential regulatory non-compliance, suspected fraud, malpractice and misconduct alone should not be the driver for parties to appoint a forensic auditor”. It’s his way of saying there is no point shutting the barn door after the equine has been bolted. “Forensic audits are beneficial if undertaken proactively to curb frauds and strengthen internal controls, which in turn can lead to better fraud risk management”, he adds.
What few will admit to is that there is still reluctance on the part of banks (largely state-run) to use these firms. While they increasingly use them for due diligence on third parties (to get a sense of vendors, customers, employees and competitors of companies), “they are still far away from doing what is actually required when taking on large financial exposure. The due diligence remains less than thorough and prone to many weaknesses which the unscrupulous borrowers are able to exploit, as many have done in the past”, points out Brar. What’s more, as Brar adds: “It is generally observed that foreign investors and PE firms perform a more deep, detailed, and thorough diligence than state-run banks”. And cost alone is not at play here; it is also a misplaced sense of urgency.
Dhruv Phophalia, managing director at A&M, concedes that “these services (forensics) come at a cost and play an important role in helping banks to identify risks and preserve capital.” But then, “in some instances, banks expect results quickly which may not be possible when you are handling large credits and significant situations”.
You have to be brave at some level too. “Banks have been working with Kroll in identifying unencumbered assets of borrowers in India while NBFCs have used our services at the pre-lending stage seeking a detailed reputation and investigative due diligence on the borrower”, says Bhatia. What he will not tell you is that there is a fear that if the forensic audit throws up something, it could lead to a sea of red faces.
After all, even within a consortium, banks had not shared credit information; or even the forensic audit report at times. It may not strike you, but Mint Road’s February 12, 2018, circular (now replaced with June 7 circular) was in great part due to the footsie played by banks on dud loans though the words “consortium” or “multiple banking” found no mention in it. Some banks treated an account as an NPAs in a quarter while others didn’t – even within the consortia. And this is despite CRILC being in place and the extant norms on RFAs.
That said, for forensic firms, the days ahead will be good. In the main, due to the IBC’s provisions on fraudulent or wrongful trading (Section 66), avoidance transactions (Sections 43 to 51), and the protection of business during the insolvency period, resolution professionals (RPs) would be expected to unearth transactions of questionable nature and report these to the adjudicating authority for clawback. “Currently, forensic professionals are called upon by the RPs to help identify these transactions. However, for an effective scrutiny, forensic professionals need timely access to all relevant data, which in our experience can be challenging at times”, says Karthik.
What can be safely concluded is that not many bankers will get an umbrella soon; that makes the business of forensics audits all the more exciting.
via Forensic audits business expected to boom as RBI prepares new norms | Business Standard News
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