Jump in bank frauds: Risk control systems need urgent strengthening

More than a year after Punjab National Bank admitted to the mega-fraud perpetrated by diamantaire Nirav Modi, the furore over corporate borrowers gaming gaps in Indian banks’ lending systems appears to have died down. But data on bank frauds disclosed in the RBI’s latest annual report reveal that the Nirav Modi affair was not an isolated instance of a rogue borrower making away with bank funds using Letters of Undertaking. In FY19, domestic banks reported frauds valued at ₹71,543 crore, a 74 per cent jump over the FY18 number of ₹41,147 crore. Public sector banks (PSBs) were the main victims, accounting for over 90 per cent of these frauds by value. Frauds relating to advances dominated in FY19 as against those involving off-balance sheet items in FY18. Given the inordinately long time that banks take to detect and report frauds, the spike in the FY19 numbers does not reflect recent developments. But large-value frauds cropping up across different business verticals raise concerns that the RBI’s regulatory fixes after the PNB scam do not address the root causes of bank fraud, which lie in governance and risk control lapses at PSBs.

Details from past frauds hint at three problem areas with banks’ lending practices that fraudsters have exploited. One, lending decisions by bank employees at all levels — from the branch-level executive to the sanctioning authority in top management — ignoring obvious flaws in collateral or project contours suggest that many frauds are perpetrated with the active collusion of bank employees. Yet, it is the lower- or middle-level employees who often face the heat for fraud, while bank boards and lending committees face little scrutiny for lax oversight. The fleeting tenures and poor compensation structures of top managers at PSBs actively abets negligence. This can only be fixed through pay structures that directly link their compensation to bank asset quality. Two, long delays between the occurrence of a fraud and its detection (the average time taken by banks to report large frauds was 55 months) point to yawning gaps in banks’ post-disbursement monitoring of funds. Here, whistle-blower protection laws may help bank insiders red-flag frauds at an early stage. Three, the window-dressing and misappropriation that accompany large loan frauds cannot be perpetrated without the co-operation of statutory auditors or valuers who vet projects. It is therefore critical that they are brought to book when bank frauds surface.

Overall, rather than attempt piecemeal fixes to individual cases of fraud, the RBI needs to undertake system-level interventions to improve risk management at PSBs. The PSBs also need to step up technology-related investments to effectively monitor end-use of their loans. Information sharing through a common credit registry, as mooted by the RBI, can help. The Centre, if it is keen to ward off future bad loan build-ups at PSBs, needs to empower the RBI to effectively supervise PSBs and to allow an independent entity like the Bank Boards Bureau to fill key management positions.

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