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RBI nudges banks to decide if red-flagged accounts are fraud


MUMBAI: Banks are in a major dilemma over a directive from the Reserve Bank of India (RBI) that lenders should decide whether loan accounts that have been ‘red-flagged’ as suspicious over six months ago are fraudulent or not.

If banks do not classify these loans as a fraud, they risk being pulled up for being lenient. If they do, they must set aside provisions for 100% of the loan amount within a year, even if a large part of the loan is recoverable. Also, the fraud tag makes it difficult to sell an otherwise sound business.

Last year, a spate of action by enforcement authorities resulted in many large borrowers being red-flagged. The RBI is now pushing banks to take a call on these loans. Of the large accounts red-flagged last year, two are DHFL and Religare. The red-flag account concept was introduced by the RBI to get banks to act on early warning signals, which include raids by regulatory and tax authorities.

Once an account is red flagged, banks are mandated to complete its forensic audit within six months and decide whether it is fraudulent or not. Classifying loans as a fraud would mean a jump in provisions and impact the bottom line of banks in the June quarter. This would belie market expectations that bad loan provisions would not spike in the April-June quarter because of the moratorium on repayments allowed because of Covid-19.

Banks fear a repeat of last year when fraud numbers jumped after all lenders were forced to classify Bhushan Power & Steel as a fraud following action by Punjab National Bank. In the case of DHFL, which has over 20 lenders in its consortium, half the banks have classified their loans to the company as a fraud, while the other half have not.

Following a forensic audit by KPMG, all the lenders had red-flagged the DHFL account last year. However, SBI had moved ahead and classified the loan as a fraud earlier this year, resulting in many other banks following suit. Earlier this month, Karnataka bank reported to the exchanges that it has classified DHFL, Religare Finvest and a couple of other borrowers as fraud accounts.

Similarly, in several other accounts, there are instances where one of the consortium members has classified it as a fraud. The red-flagging is done on an information technology platform where all banks report a large exposure to entities/individuals so that other banks can be forewarned about fraud risk. This also puts pressure on other banks in the consortium to report the fraud.

Bankers say that a revamp of norms is required for frauds. For instance, in the case of DHFL, banks say there are many buyers for the retail loan business, which is still performing well under the RBI-appointed management.

“There is a need to see the business distinctly from the promoter, particularly in the case of financial entities. The depositor’s interest is best served if action is taken against the promoters while trying to save the business,” said the CEO of a public sector bank.

However, even if this were to be done, there are laws that allow enforcement authorities to seize assets from buyers if it is established that the original promoters were involved in money laundering.


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