“ Rather fail with honour, than succeed with frauds”
Reserve Bank of India has permitted the sale of Fraudulent Loans vide circular RBI/DOR/2021-22/86 24.09.2021. These directions are called the RBI (Transfer of Loan Exposures) Directions, 2021 for Sale of Loans in Secondary Market between financial players in India. Currently, the secondary market is undertaken for the sale of stressed assets by banks to ARCs. New directions of Regulator shall facilitate the sale of loans to ARCs identified as fraud by Forensic Auditors and Law enforcing agencies.
Fraud is an intentionally deceptive action designed to provide the perpetrator with an unlawful gain or to deny a right to a victim. Fraud involves the false representation of facts for the specific purpose of gaining something that may not have been provided without deception. The purpose of fraud is monetary gain by misusing a passport, travel document, or driver’s license, to qualify for a car loan by way of spurious statements. The individual or company committing fraud takes advantage of the fact that the cost of reviewing and verifying the information is significant enough to create a disincentive to fully invest in fraud prevention.
As per the latest RBI guidelines exposures classified as fraud may be transferred “provided that the responsibilities of the transferor with respect to continuous reporting, monitoring, filing of complaints with law enforcement agencies and proceedings related to such complaints shall also be transferred to the ARC. The transfer doesn’t absolve the transferor from fixing the staff accountability as required under the extant instructions on frauds.RBI further said the entity to which fraud loans are being transferred shouldn’t belong to the promoter group of the borrower or any related party.
Lenders sell stressed loans to ARCs at a discount, either in cash or a mix of cash and security receipts. These receipts are redeemable as and when the ARC recovers the specific loan. ARCs charge an asset management fee of 2% of the asset every year. Once an account is declared fraud, banks need to set aside 100% of the outstanding loans as provision, either in one go or over four quarters. However, they were so far not permitted to sell them, thereby restricting their ability to clean up their books. The new rules will permit such a transfer even to the newly established Bad Bank (National Asset Reconstruction Company) paving the way for recovery efforts in Fraud Loans and reversal of provision.
The average time lag between the date of occurrence of frauds and the date of detection is two years in FY21. According to data from RBI’s annual report, banks have reported frauds of ₹3.95 trillion between FY19 and FY21. Banks can sell stressed loans in default for more than 60 days or classified as bad loans, including those tagged as fraudulent. The re-sale market for Fraud Loans opens up significant opportunities for banks and asset reconstruction companies who can buy these assets at a greater discount than regular bad loans.
Permitting the sale of Fraud Loans by RBI may bring in liquidity to banks at a severe cost of further frauds. Knowing well that sold fraud loans get buried and consigned to history leaving a poor trace of records of selling bankers, crucial information on frauds shall be lost, resulting in lowering of guard on such loans. What will liquidity do if fraudsters are gifted a fresh playing field to forget their sins?
A fraud violates civil law where a fraud victim bank sues the fraud perpetrator to recover a loan or criminal law where a fraud perpetrator may be prosecuted. As such loans involving fraud angle will always have law enforcing agencies chasing the counterparties Permitting the sale of such loans will rotate the dirty financial asset around innocent bankers endangering their lives.
Facing law enforcement agencies will now move from seller to new buyer of fraud loans. The ignorance of new owners of loans about reasons of fraud will make the investigation poorer. Fresh owners may not pursue vehemently treating the asset as a run of the mill loan. What is the guarantee that a fair legal trial of fraudsters will be pursued by aspirational ARCs not known for transparency.
Permitting the sale of dubious loans will indoctrinate tolerance towards frauds in the entire banking system. It may soil the lending ambiance in the medium and long term. Apart from legal hazards, the step would generate distasteful moral hazards in financial markets.
Following are the five important reasons why RBI should not permit the sale of Fraud Loans from Banks to ARCs:
1. Huge stock of unsold NPA inventory lies lazily in the vaults of ARCs. Flooding cheap fraud loans in the market shall reduce the sale of Sub Standard Loans further. ARCs with limited capital would prefer to capture cheaper fraud loans than high priced NPAs to enhance AUM and profit.
2. Most of the value time of ARC officials will now be spent with CBI, SFIO, Courts & Local Police attending hearings in fraud cases. This diversion will soil recovery of NPAs held by ARCs further, as there would not be any quality time left to resolve NPAs.
3. The recklessness in lending by banks shall jump up as fear of loss of funds through frauds will vanish due to the availability of the market to sell such loans comfortably to Bad Bank.
4. Banks will not endeavour much to convince and desist auditors from declaring accounts as frauds as the sale of such loans at a low price will be easier than distressed loans due to increased demand.
5. Fear of getting declared a fraudster by the Bank on thin and whimsical grounds shall force quality borrowers to avoid taking credit from banks further. The resultant disintermediation through IPOs will reduce the profitability and viability of banks.
Permitting the sale of fraudulent loans will demotivate the honest borrowers. It will put fraudsters on the pedestal of reverence making a mockery of banking whose four pillars stand on honesty, integrity, truth, and trust.
Legalising money plundering will demean public morality defiling public trust in the economic sense. Banks will be exposed as a soft target for frauds which no economy can subsist with. RBI may kindly stop the sale of fraud loans forthwith.
Rightly said, “If you forgive the fox for stealing your chicken, the fox will take away your sheep. Make fraud loan a banking product, then no banker will ever comfortably sleep.”
Hargovind Sachdev
About the author
Mr. Hargovind Sachdev is an Ex-Banker, GM(Retd) of State Bank of India. Has over 39 years of experience in banking, having occupied senior positions in UCO Bank, United Bank of India, State Bank of Patiala, State Bank of Travancore & State Bank of India where he headed the Central European Credit Desk at Frankfurt, Germany from 2006 to 2011 covering 15 countries of Central Europe. Has undergone International Banking Training from Asian Institute of Management, Manila, Philippines in the Year 2003 and a Multi-currency lending-technique training at the Euro Money Institute, London in 2009.
He has specialisation in Credit, Foreign Exchange,Vigilance, Monitoring & appraisal of Corporate Loans, MSME Credit,Gold Loans, Agricultural Loans & NRI Business Management in assets & liabilities. As a Forensic Auditor, he has conducted various Transaction Audits allotted by Banks.
He was felicitated by the Central Vigilance Commissioner , Sh. C.V Chowdhry for winning first prize for best article on Preventive Vigilance in 2015. He is also an accomplished Public Speaker hav-ing conducted multiple Motivational Seminars for institutions like ONGC, National Housing Bank & Bank of Baroda. He is an Inde-pendent Director & consultant to various big entities in corporate sector at present.
