On May 7, the RBI issued a circular with guidelines for all scheduled commercial banks and select financial institutions on implementing a framework to deal with loan fraud with immediate effect.

It demonstrates the RBI’s commitment to address concerns about detection, reporting, mitigating and accountability with regard to loan fraud.

The key focus areas are tracking early warning signals (EWS) and red-flagged accounts (RFA), implementing a robust credit appraisal and monitoring mechanism, staff accountability, penal measures for fraudulent borrowers, and developing a centralised fraud registry. Bankers have been urged to focus not only on quantitative aspects (such as financials) but qualitative parameters such as gathering market intelligence and monitoring databases and the public domain.

We should now see a significant expansion of the role of the fraud monitoring group (FMG) in banks.

Some ramifications There is a paradigm shift in fraud risk control with the implementation of EWS and RFA. Tracking EWS/RFA will be integrated with ongoing credit monitoring. Bankers have been given an illustrative list of EWS which could guide them. Additionally, they have been advised to study in detail documents such as annual reports and related party transactions apart from financial statements with respect to large accounts.

The prompt reporting of suspicions to the FMG is mandated with the onus on responsible individuals in case of delay in reporting.

The circular emphasises strong processes and controls around credit appraisal and monitoring mechanism so as to ensure timely detection of frauds.

With regard to pre-sanction, it highlights the importance of collecting independent information through market intelligence, the public domain, the /Registrar of Companies and defaulter list as a part of the process. Specifying certain sanction terms and conditions as ‘core’ (which cannot be diluted) is being encouraged. In case of credit monitoring, aspects related to diversion of funds, stress in group accounts, tracking of market information and monitoring databases have been stipulated as a part of annual review.

The circular also mandates individual bankers to undertake their own due diligence prior to taking any credit exposure and independently monitoring end use of funds, in case of consortium arrangements.

The circular specifies providing monthly reports to the CMD/CEO around loans above certain thresholds, where EWS are observed. There is also a deeper focus on enforcing a robust whistle-blowing policy to report genuine concerns. The FMG could potentially scrutinise whistle-blowing guidelines and may be made responsible for ‘hearing’ concerned employees under the policy. In cases where a bank is the sole lender, the circular mandates the FMG to take a call on classifying accounts as RFAs and further, also stipulating the nature and level of further investigations and/or remedial measures.

Better management In case of sole lending, a time span of six months has been mandated within which accounts tagged as RFAs would have to be either mapped as fraud or otherwise. The help of forensic experts is encouraged in such cases.

In case of consortium lending, the circular defines specific procedures and guidelines for identification and mapping of RFAs. Further, forensic audits have been made mandatory. The circular also defines clear timelines within which bankers are to identify staff responsibilities once fraud is established. Any major concerns from EWS identified by bankers need to be immediately shared with the consortium.

Borrowers who have defaulted (including promoters, directors and whole time directors) and who have committed fraud will be debarred from availing finances for a period of five years from the date of full payment of the defrauded amount.

No restructuring facilities are to be made in case of RFA or fraud accounts. The RBI has envisaged the creation of a single database which lenders can access to get information pertaining to frauds reported by banks.

With this circular, the RBI has laid a firm pathway for improving overall robustness to manage loan fraud.

However, bankers may look to prioritise focus areas for implementing the guidelines. The efficacy of the implementation and further monitoring of the guidelines would be crucial.

The writer is partner and national leader, Fraud Investigation & Dispute Services, EY India

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