NPAs linked to trade credit crisis

The RBI’s focus remains on early diagnosis of financial stress and frauds in banks’ advances and timely remedial action taken thereof. Currently, low NPA levels have come about as a result of write-offs, improved corporate financials and multiple recovery measures. Over the last five years ending FY 2022, scheduled banks’ write-offs amounted to ₹10-lakh crore.

However, potential NPA risk and surge in frauds continue to be the pain points for financial system stability. It is this apprehension that has prompted Reserve Bank Governor Shaktikanta Das recently to raise a subtle warning on the true state of banks’ health; he has urged the sector to examine whether its rosy results are a result of window-dressing.

Detection of fraud and financial stress takes a long time despite having an elaborate fraud detection and prevention framework and credit risk monitoring system. These include red flagging of accounts based on early warning signals, establishment of Central Fraud Registry, Centralised Information Management System, and fraud risk management and monitoring.

Delay in detection

Yet, the average time lag between occurrence of fraud and its detection is 23 months whereas it is 57 months for large frauds (RBI Annual Report FY2021).

Large delays in detection of incipient sickness and frauds are intriguing in the digital banking age supported by big data analytics and near real time information flows in RBI and banks. One important reason for this is our bank-centric approach, whereas the causality generally runs from disruptions in trade credit (TC)-related payables and receivables to bank working capital. Clearly, there is a network of operations that escapes the banks’ radar.

The longer the period of fraud and incipient sickness detection period, higher the losses and lower the retrieval.

Fraud Channels

TC related disruptions create liquidity challenges for firms. Some firms facing such liquidity challenges resort to delays in submitting data to banks, manipulation of accounts and financial frauds to avail bank credit facility till it is detected by the bank. Early warnings are delayed and they are inadequate and less reliable. Hence the delays in detection of stress.

The Central Vigilance Commission’s analysis of top 100 frauds in banks as end-March 2017 across a spectrum of trade and industry shows that in most fraud cases were related to working capital operations.

It involve inflated/manipulated/fabricated receivables, payables and stocks and difficulties and delays in verification of these, diversion of funds and related parties transactions. It is a fact that in these cases security value of current assets and their realisation are scanty, uncertain and time consuming.

Systemic level of TC related bad-debts and large delays in payables and receivables impact bank credit portfolio quality. Surprisingly, the TC ecosystem is hardly understood — in terms of the disruptions that it has undergone due to trust deficit and impaired confidence.

Mapping of the disruptive impacts of TC on market liquidity, payment system, financial stress and interconnected financial networks like banks are essential to identify fault lines.

Importance of Trade Credit

History of TC is as old as the evolution of trade and commerce. It is too interconnected to financial networks and the real sector to be ignored. The whole commercial infrastructure and inter-firm business activities are served by TC network. In terms of working capital volume, value, reach and inclusiveness TC is far bigger than working capital from banks. MSMEs predominantly depend on TC for their working capital.

As per IFC’s India MSME Financing Report, 2018 only 16 per cent of MSMEs credit needs are met by institutional credit. Over the years, generalised trust level and perceived creditworthiness in TC network have seen an erosion. Following demonetisation, GST and Covid, these have reached systemic proportions.

TC network’s informal institutional infrastructure and ecosystem (business conventions, discipline, moral base, reliability) have been undermined. Dysfunctional TC impacts the financial system — through interconnectivity between banks and TC networks span across supply chain financing, bank credit re-intermediation, payment flows and credit risk.

An integrated approach involving banks, NBFCs and TC network is needed to take a holistic view of NPAs. Bank-centric fragmented NPA solution strategies are less effective and less efficient.

Integrating GSTN system

Working capital operations are varied and complex, involving multi-party transactions, scrutiny of receivables, payables, stocks, diversion of funds and control returns like Stock Statements/Book Debts statements/Audit Reports etc. It is practically difficult for banks to fully and correctly analyse all these in time.

The complex web of B2B transactions and their financing are mirrored in sales, payables and receivables and their payment and settlement data. These are the real indicators of a business’s financial health. These are useful to spot liquidity problems as they develop and understand the impact on a bank’s credit portfolio.

GSTN as a Financial Information Provider under the Account Aggregator framework can provide a common platform to compile structured data on sales and purchases.

By integrating GSTN system with bank accounts operations, various financials and data points can be analysed to assess financial health and performance of a firm.

Detection of early signs of stress, will become easier and quicker with consolidation of various data points of a business with GSTN data base.

The writer is former DGM, SIDBI

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