Monitoring end-use of funds: The missing link in credit risk management–economic times

Clipped from: https://economictimes.indiatimes.com/blogs/et-commentary/monitoring-end-use-of-funds-the-missing-link-in-credit-risk-management/

Meera Aranha & Srinivas Reddy

It has been an “accepted” practice in the Indian banking sector that customers borrow money from one bank but transact with another bank, many a time with an intention of “managing the funds”. It is now clear that this route of siphoning funds was often used by the large default borrowers. RBI has been forewarning the banks regarding the misuse of the current account by borrowers. Earlier, such accounts could be opened after obtaining a NOC (no-objection certificate) from the lending bank and after the due diligence.

However, in a policy statement on August 6, RBI has placed restrictions on who can open a current account and with which bank. Hence, a borrower who has borrowed from a bank cannot open a current account with another bank. The borrower can open a current account with its lending banks under some circumstances, otherwise, it is encouraged to use the cash credit and overdraft facilities under which it has borrowed.

At the bottom of this issue is the fact that most of the lender consortia are led and filled by public sector banks. Rarely do private or small banks get a chance to make it into the big league. Small banks try to make inroads into the consortium by requesting for a current account to give the borrowers a taste of their services and products. Most of these accounts then get ‘used’ for diverting funds. This new policy will now make it impossible for borrowers to open accounts with banks with whom they do not have credit limits. But will it be effective in preventing diversions. Will it take away business from the private sector banks or from ‘less efficient’ public sector banks (PSBs)?

Let us take our first question.

Let alone diversion using current accounts in other banks, diversions take place even in the cash credit and overdraft accounts. The end (mis)use of funds is hardly noticed at the time of the transaction and detected only when accounts are reviewed, which is most often when they show stress. Mere prevention of opening of current accounts in other banks, done to prevent misuse of funds, will have a limited impact, if banks do not monitor the end-use in the overdraft account of the borrowers too. Banks have necessary systems in place to track delinquencies in a loan account and identify NPAs.

RBI has now given them the mandate to upgrade these systems by June 2021 for identification and calculation of provisioning and handling both upgrades and downgrades in a straight-through process. But there is no established system that can, on an end to end basis, provide data to the lender on the use of funds. Nothing to prevent authorizing certain types of transactions that bear the ‘stamp’ of diversion. With technology making inroads, funds can be transferred from and to bank accounts, from remote locations, in a jiffy, 24×7, and even before the banks realize, the money is siphoned off.

To offset misuse of funds, banks must therefore explore investment in infrastructure and develop information systems, (using AI and blockchain), to facilitate effective monitoring of end-use of funds in loan accounts. Investment in technologies that red flag transactions on a real-time basis will be the key to reducing diversion. So, the decision byRBI to reduce the number of current accounts being opened by business holds promise for the banking industry, hoping that it will prevent the diversion of funds. But will it?

Now coming to our second question, if a few good customers find the services and products provided by the private and foreign banks with whom they have a current account better, they may wish to continue that relationship and shift their entire business, including loans to those banks. Instead of closing the current account with private banks, they may shift their overdraft account from PSBs. While this policy is worrisome to the small private sector banks, its impact may be felt by those ‘inefficient’ PSBs as well.

For now, let’s wait and watch.

(The writers are professors, T A Pai Management Institute, Manipal)

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