The RBI circular allows settlement of fraudulent accounts, raising concerns about justice and accountability. Wilful defaulters may be eligible for new loans after a minimum settlement period. The circular increases banks’ NPAs as they receive only a portion of the loan balance. Stronger measures like internal rotations, a robust rating agency, and AI transaction monitoring are needed to address fraudulent loans effectively

The foundation of any nation’s economy is its banking system. The increased loss to the banks affects every citizen of the nation because the deposits in the banks belong to the citizens of the country. Banks run their business by giving loans to the money that we deposit. In the meantime, the June 8 release of a circular by the RBI titled “Framework for Compromised Settlement and Technical Write-off” has several consequences that may affect the Indian banking system because it allows compound settlement for accounts that have been deemed fraudulent, which is a violation of justice and accountability. Fraudulent businesses or wilful defaulters may be eligible for a fresh loan after completing 12 months (minimum period) of settlement.

A wilful defaulter is someone who has resources but refuses to make payments, according to the 2015 RBI Master Circular. Because a company is a separate person under the law and promoters’ personal assets cannot be seized if they have not personally guaranteed the loan, such agreements are acceptable for small loans (such as home and auto loans) and to some extent even with significant wilful defaulters.

The circular dated June 8, 2023, now addresses settlements with fraudulent borrowers, which were not addressed in the 2015 circular. How can a bank settle with someone who defrauded the bank?

The circular refers to the settlement of the loan. In such agreements, the bank receives a portion of the outstanding loan balance plus interest that is agreed upon by both parties. Its drawback is that it raises the banks’ non-performing asset (NPA) levels. On the other hand, a wilful defaulter has an advantage because he is exempt from paying back the full amount plus interest.

Neeraj Singhal, the managing director of Bhushan Steel Limited, was recently detained by the Enforcement Directorate in connection with a `56,000 crore fraud committed by defrauding more than 36 banks. It was revealed to be the biggest banking fraud in the nation in 2018. Neeraj committed this bank fraud by scam of `56,000 crore from more than three dozen banks. To show multiple entries, the loan amount was transferred from one shell company to another after creating dummy or shell companies for the loan. In the name of his company and business, Neeraj obtained loans from banks, but he used the money for himself.

The unique aspect is that Neeraj continued to take out loans without repaying the original ones, and the banks prepared for this. From 2007 to 2014, this game was ongoing. There are numerous bank frauds in front of us, including Neeraj Singhal-Bhushan Steel (`56,000 crore), DHFL (`35,000 crore), ABG Shipyard (`23,000 crore), Nirav Modi and Mehul Choksi scam in PNB scam (`11,400 crore), Liquor businessman Vijay Mallya (`10,000 crore) banks, Andhra Bank Fraud (`8,100 crore), PMC scam (`4,355 crore), Rotomac Pen Scam (`3,695 crore), Videocon Case (`3,250 crore), Allahabad Bank Fraud (`1,775 crore), Syndicate Bank Scam (`1,000 crore), Bank of Maharashtra scam (`836 crore), Kanishk Gold Bank Fraud (`824 crore), IDBI Bank Fraud (`600 crore), RP Info Systems Bank Scam (`515 crore) to name just a few.

According to Reserve Bank of India data, just 312 major defaulters account for more than 76 per cent of total bad loans. According to Banks’ reports, 16,044 borrowers had wilful defaulted on loans totaling `346,479 crore as of December 2022.

Large loan advance frauds are not common, but they do happen occasionally when large lenders, bank officials, or sometimes even third parties like lawyers or chartered accountants (CAs) are involved. The amount stuck in the wilful default category has increased by 41 per cent or over `1 lakh crore in the last two years from `2,45,767 crore. When the farmer is unable to pay back the loan, the bank sells his land at auction and makes a profit.

However, when it comes to business owners or industrialists, the same banks become paralyzed and learn about these NPAs much later.

Ironically, there are no specific skills required to become a banker in an Indian bank, despite the fact that banking is regarded as a clerical occupation in India. It is necessary to categorise the banking industry as a skill-specific industry, particularly its lending division. When providing loans to Indian businesses that have taken out sizable loans abroad, banks should exercise caution. The banks’ internal and external audit systems must be strengthened immediately.

It’s crucial that employees in the loan department rotate quickly. A rigorous internal rating agency should be established to evaluate major projects. Implementing a strong management information system (MIS) is necessary to monitor early warning signs regarding business projects.

In order to conduct a forensic audit, RBI lacks the necessary supervisory capacity, which needs to be strengthened with both human and technical resources. The use of artificial intelligence to monitor financial transactions can significantly reduce the incidence of financial fraud. Additionally, the branch’s input on the borrowers’ backgrounds and other pertinent ground realities should be given the appropriate weight. Creating a “bad bank” is not the real solution because these steps only assist when a loan defaults and do not prevent defaults in the first place.

The RBI should strengthen its loan recovery procedures rather than keeping large corporate bad loans from being written off. In order to prevent problems from occurring, the government, RBI, and banks will need to exercise more supervision over credit management.

(The writer, the author of the book ‘Changing Scenario of Indian Banking Industry,’ is Associate Professor, Atal Bihari Vajpayee School of Management and Entrepreneurship, Jawaharlal Nehru University, New Delhi. The views expressed are personal.)