Clipped from: https://www.thehindubusinessline.com/opinion/apex-court-googly-on-bank-fraud/article66703476.ece
Allowing the borrower to present his case may bring in the human element and delay the fraud recognition process
Exceptions should never be made examples and isolated examples must not be used to frame rules. But that is exactly what seems to have happened in the case of bank frauds.
The case in point is the recent Supreme Court’s verdict that every borrower should be given an opportunity to be heard by banks before being classified as a defaulter. Fought vigorously against two of the mighty institutions of the country — Reserve Bank of India and the State Bank of India — the verdict in this case has been quickly labelled by experts as a victory to borrowers.
The popular opinion is that borrowers, especially from small- to mid-sized businesses, barely get a chance to defend their ground with the credit teams of banks or even relationship managers. Once declared as a fraud account by a bank, these businesses find the doors pretty much shut to organised credit. Of course there are NBFCs who’d welcome these borrowers, but the cost of leaning on them is high.
But the regulations on declaring a loan account as fraudulent were tightened, not to turn the screws on small borrowers but after a slew of big-ticket loan evasions and scams hit the banking system between 2012 and 2019. Nirav Modi, Mehul Choksi, Vijay Mallya and ABG Shipyard come to mind. These cases highlighted the need to empower banks with autonomy to decide how to proceed with recovery in cases where they detected large irrevocable leakages from the system and borrowers posed a clear flight risk.
Now, the apex court ruling is seen to have taken away this freedom from banks.
At present, the process of declaring a borrower as a fraud is a routine one, with banks following a series of steps to recover a loan before doing this. The need to give the borrower an official hearing before the final step can change this.
What we need to factor in is that a loan account doesn’t turn problematic overnight. When overdue, loans are declared non-performing only after a 90-day window. During the overdue period and even after declaration as NPA, the borrower is given several heads-up to rectify deficiencies in his or her account. If the stress experienced by the borrower is genuine (except for perhaps a business model gone bad), banks usually do engage with the borrower to regularise the account and support the business.
After all, it’s not in the best interest of a bank to lose a customer. The question is if the borrower did not cooperate with the bank throughout this process of negotiation, why give him or her an opportunity to be heard at the last stage? By asking banks to do so, the apex court has brought in a layer of human intervention and judgment in an otherwise well-codified process. Experience has repeatedly taught us that human interventions leave room for (mis)judgments, bias and nepotism.
The worry is not just about delaying the process of resolution. This added step could also lead to allegations of governance compromises at the bank. ICICI Bank is perhaps a good illustration here. Even if the impact to its prevailing financials from its doubtful loan to the Videocon group was not very significant, for nearly three years (from 2018-2021) top management bandwidth was consumed in cleaning up internal systems and perception management, especially among the investor community.
If India needs to deliver on the growth front, a robust banking system should be the first priority. The system cannot afford another scam like the ones involving Nirav Modi or Mehul Choksi, that exposed gaping holes in bank lending processes.
Of course, experts are lauding the Supreme Court order as being fair to MSMEs and they can afford to do so in a favourable NPA cycle. But when the cycle turns, as it inevitably will, there may be public outrage about the quantum of NPAs and a clamour for tightening the screws on defaulters once again.
To ensure that small businesses do not receive harsh treatment from banks, perhaps a size-based dispensation could be formulated for the process on declaring an account fraudulent. For instance, proprietors and partnership firms with less than ₹50 crore turnover or MSMEs with a turnover of less than ₹100 crore could be given a chance to make a case before the banks declare them as fraud account. But given large corporate borrowers a long rope on delays and defaults could turn counterproductive for the banking system.