Strategies for Reducing Scams in the Banking Sector
Scams and irregularities in the banking sector pose significant risks to the overall health and stability of a nation's economy. Such malpractices, as seen in cases like the one involving Diwan Housing Finance Limited (DHFL), highlight the urgent need for robust measures to prevent and tackle such frauds.
Understanding the Impact of Scams on the Banking Sector
Recently, in the case of Diwan Housing Finance Limited (DHFL), the Central Bureau of Investigation (CBI) uncovered irregularities related to debt issues. DHFL's banking fraud involved a staggering amount of 35,000 crores (approximately $4.4 billion) transferred to a consortium of banks led by the Union Bank of India. This fraud was audited by the prestigious firm KPMG. Such cases underscore the vulnerability of banking systems and the severe consequences that accompany financial irregularities.
The Backbone of the Economy: Banks and Non-Performing Assets
A resilient banking system is crucial for the sustainable growth of any , the rise of Non-Performing Assets (NPAs) due to loan defaults has become a major concern. A spike in NPAs not only cripples the operational efficiency of banks but also inflates the overall cost of operations. According to a report by the Reserve Bank of India (RBI), the net NPAs of banks might increase up to 10 percent by September 2022.
Root Causes of Bank Scams
Bank scams are not merely isolated incidents; they are systemic failures that occur due to a combination of factors. A survey by Deloitte revealed that about 40 percent of NPAs arise due to inadequate attention being paid to loan recovery. On average, out of every 100 rupees given as a loan to industries, only 30 rupees are recovered, highlighting the inefficiencies in the loan recovery process. Among the causes, 35 percent of scams identified by RBI are internal, often the result of collusion between junior and middle-level management.
Mitigation Strategies for Reducing Scams
To address these issues effectively, a multi-faceted approach is needed. Firstly, there should be stricter regulation and control by Chartered Accountants. Internal and external audit systems must be reinforced to detect discrepancies before they escalate into major issues.
Secondly, placing greater accountability on senior officers is crucial to prevent internal conflicts and maintain transparency. Constructing an internal rating agency can help public sector banks conduct detailed risk analyses of large projects before approving loans. This would help mitigate the risks associated with high-credibility but risky ventures.
Thirdly, strengthening the supervisory capacity of the RBI is imperative. An enhanced forensic audit capability, complemented by robust technical resources, can help uncover fraudulent activities when auditors conduct investigations. It is vital for the branch officials to give due importance to the inputs they receive from borrowers, as these can significantly impact the risk assessment.
Improving Recycling of Bad Loans
Instead of accepting bad loans from big corporates and shunting them into discount accounts, there is an urgent need to improve the loan recovery process. Banking institutions should conduct periodic fraud risk assessments—quarterly or even more frequently— to proactively identify and address any red flags.
By implementing these strategies, the banking system can be made more robust, thereby reducing the incidence of scams and ensuring that the financial sector remains a reliable backbone of the economy.