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Thursday, Jul 08, 2004

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Dither not at wilful default

Mohan R. Lavi

Identification of wilful defaulters plays a key role in tracking errant borrowers, says Mohan R. Lavi

WILFUL default is a term that has been born out of the experience of banks and financial institutions with errant borrowers. The significance of this term can be deciphered from the fact that borrowers were clamouring that the draconian provision of the SARFAESI Act are to be implemented only against wilful defaulters. The Reserve Bank of India (RBI), in its Circular (No. DBOD.No.DL(W) BC/110/20.16.003(1)/2001-02) dated May 30, 2002, ruled that the title would be conferred on a unit that:

Has defaulted in meeting its payment/repayment obligations to the lender even when it has the capacity to honour the said obligations;

Has defaulted in meeting its payment/repayment obligations to the lender and has not utilised the finance from the lender for the specific purposes for which finance was availed of; or

Has defaulted in meeting its payment/repayment obligations to the lender and has siphoned off the funds.

Diversion of funds would be said to have occurred if short-term working capital funds have been used for long-term purposes, funds have been used to create assets other than those for which the loan was sanctioned, funds have been transferred to subsidiary/group companies, funds have been routed through other banks, funds have been invested in other companies without the approval of the lenders and there is a gap between amounts disbursed and deployed that has not been explained.

Siphoning off funds would be said to have occurred if funds have been used for purposes totally unrelated to the operations of the company. However, the notification rightly says that detecting siphoning would be purely judgmental. For the sake of convenience, a benchmark of Rs 25 lakh has been fixed to identify and list wilful defaulters.

At times, sheer gut-feel helps. One has been witness to a chronic NPA account with a consortium of banks. The company had sponsored the India-West Indies test match at the Wankhede stadium a couple of years back.

The RBI has defined the term quite comprehensively. Almost all banks and financial institutions restructure loans when they go sour and give breathing time to the borrower to get his act together and pay the dues. It has been seen in numerous instances that many borrowers underestimate their industry and the market as well as the requirement of funds in their eagerness to get the loan and kick-start operations.

The first restructuring would probably be the litmus test for the borrower to prove that his intentions are genuine. It would make sense to label a borrower `wilful defaulter' after the first restructuring.

The new Companies Auditors' (Report) Order 2003 asks auditors to highlight utilisation of short-term loans for long-term purposes in their report. This could turn out to be a source of information to classify a borrower as wilful defaulter.

In the case of project finance, banks and financial institutions rely on certificates issued by chartered accountants to ensure end-use of funds. The RBI seems to be placing limited reliance on these certificates. The 2002 circular asks banks and financial institutions to strengthen their internal controls credit risk management system to enhance the quality of their loan portfolio. An illustrative to-do list is also given — meaningful scrutiny of quarterly progress reports/balance-sheets, regular inspection of borrowers assets. Periodical visits to the units, implementation of stock audit system and a management audit of the credit function.

If at the end of this exercise, the borrower earns the sobriquet wilful defaulter, banks are supposed to swing into action. The RBI would forward a list of all wilful defaulters to SEBI. Banks, on their part, are to bar sanctioning of any additional facilities, the legal process to be initiated as soon as possible, attempt to change the management of the unit and prevent directors of wilfully defaulting companies to be directors in other companies too.

In case the letter of comfort given by a group company turns out to be uncomfortable or the guarantee given in invoked, the group companies too become wilful defaulters.

In case the auditors are found to have participated in the falsification of the accounts of the borrowers, the banks are to inform their governing body- the Institute of Chartered Accountants of India. One clause in the 2002 circular regarding specific certification from auditors for siphoning off funds would not be needed now in view of CARO 2003.

Procedurally, banks were labelling borrowers as wilful defaulters and then informing them about their not-so-desired status. Borrowers have represented to the RBI that this does not do justice to the genuine among them.

The RBI has issued a Circular on June 17, 2003, that asks banks to form a committee headed by the executive director of the Bank to identify wilful defaulters. On identification, the borrower is to be informed of this and a fortnight's time is to be given to him to convince the bank that such identification is erroneous.

(The author is a Hyderabad-based chartered accountant.)

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