{"id":360,"date":"2020-06-22T07:48:46","date_gmt":"2020-06-22T07:48:46","guid":{"rendered":"https:\/\/www.competitionreview.in\/blogs\/?p=360"},"modified":"2020-06-22T07:48:46","modified_gmt":"2020-06-22T07:48:46","slug":"tackling-bank-frauds","status":"publish","type":"post","link":"https:\/\/www.competitionreview.in\/blogs\/2020\/06\/22\/tackling-bank-frauds\/","title":{"rendered":"TACKLING BANK FRAUDS"},"content":{"rendered":"\n

Prof. V.P. Gupta<\/strong>, Director, Rau\u2019s IAS Study Circle, New Delhi \u2013 Jaipur \u2013 Bengaluru<\/strong><\/em><\/h4>\n\n\n\n

The recent news pertaining to bank fraud by\nNirav Modi in Punjab National Bank and the loan default by Rotomac has shaken\nIndia\u2019s financial sector, leading to a government and central bank crackdown on\nlenders\u2019 systems and practices. Alleged fraud cases have been unearthed in\nother banks as well such as Oriental Bank of Commerce, Bank of Baroda, Andhra\nBank etc. In light of these events, it is clear that internal control\nmechanisms and supervisory mechanisms in banks are not satisfactory.<\/p>\n\n\n\n

This article talks about how bank rules were\nflouted, the supervisory failure of banks in the country, its impact on the\nfinancial sector and measures that should be adopted to improve banking sector\nregulation. <\/p>\n\n\n\n

HOW BANK RULES WERE FLOUTED?<\/strong><\/p>\n\n\n\n

Bank rules were flouted by the issue of\nunauthorised Letters of Undertaking (LoUs) and misuse of the SWIFT framework.\nLoU is a bank guarantee that enables a bank\u2019s customer to raise short term\ncredit\/buyers\u2019 credit from another Indian bank\u2019s foreign branch. It has to be\nanother Indian bank because LoU is not recognised by foreign banks. This\ninstrument was created by the Reserve Bank of India to help importers obtain\ncredit on easy terms. However, these LoUs were misused by not recording them as\ncontingent liabilities in bank\u2019s books thus leading to excessive issue of LoUs\nand misuse of funds by transferring them to shell companies.  Shell\ncompanies are companies that include multiple layers of firms which are created\nfor the purpose of money laundering. Most shell companies do not deal in any\nproduct or render any service. These companies hold assets only on paper and\nnot in reality. <\/p>\n\n\n\n

The SWIFT (Society for Worldwide Interbank\nFinancial Telecommunications) system, akin to a closed group using an instant\nmessaging platform, is used by banks worldwide to securely transmit coded\ninformation and instructions on financial transactions. In its complaints, PNB\nalleged that the SWIFT system that was used to authorise the illicit\ntransactions bypassed its internal systems (core banking solution). Thus misuse\nof SWIFT system resulted in the frauds.<\/p>\n\n\n\n

These incidents reflect limited capability of\nbanks to undertake risk management. There are various types of risks faced by\nbanks such as credit risk and operational risk among others. Credit risk is the\npotential of a counterparty to fail to meet its loan obligations. It is the\nmost significant risk in Indian scenario as the level of non-performing assets\n(NPAs) is very high. Operational risk is the risk of loss resulting from\ninadequate or failed internal processes, people and systems. It is due to these\nrisks that such events have happened.<\/p>\n\n\n\n

IMPACT ON THE FINANCIAL SECTOR<\/strong><\/p>\n\n\n\n

Negative impact on buyers\u2019\ncredit<\/strong><\/p>\n\n\n\n

The bank frauds have created negative\nimplications on other sectors of banking. One of them is buyers\u2019 credit used\nfor trade financing. In the aftermath of such frauds, banks have become\nreluctant to issue guarantees through LOUs. This has resulted in increasing the\ninterest rates on buyers\u2019 credit and has adversely affected trade financing. It\nis mainly impacting small traders.<\/p>\n\n\n\n

Buyers\u2019 credit is short term credit available to\nan importer (buyer) from overseas lenders such as banks for goods that they are\nimporting. It helps local importers obtain access to cheaper foreign funds that\nmay be closer to London Interbank Offered Rate (LIBOR) as against local sources\nof funding which are costly. LIBOR is a benchmark rate which some of the\nworld\u2019s leading banks charge each other for short-term loans. It serves as\nthe first step to calculating interest rates on various loans throughout the\nworld. LIBOR is administered by the ICE Benchmark Administration (IBA), and is\nbased on five currencies: US dollar (USD), Euro (EUR), pound sterling\n(GBP), Japanese yen (JPY), and Swiss franc (CHF). It is the world\u2019s most\nwidely used benchmarks for short-term interest rates. Buyers\u2019 credit interest\nrates are amongst the lowest in credit products. It allows importers to manage\ntheir cash flows. This credit facility is available for 90 days, 180 days and 1\nyear. <\/p>\n\n\n\n

The process of obtaining buyers\u2019 credit is\nsimple. For example: Person A whose bank is PNB, is an importer. He asks PNB to\nissue an LOU on his behalf so that he can obtain overseas credit to buy\nimports. Hence, PNB issues an LOU to another Indian bank located overseas with\na guarantee to pay back on the due date. Hence the overseas bank deposits this\namount in the NOSTRO account of PNB. Nostro account refers to an account that a\nbank holds in a foreign currency in another bank. For example, Bank X has an\naccount with Bank Y, in Bank Y\u2019s home currency. To Bank X, that is a Nostro\naccount, meaning \u201cour account on your books\u201d.<\/p>\n\n\n\n

Since, buyers\u2019 credit is also a short term\nsource of credit, its interest rate depends on LIBOR and it is usually 20-25\nbps above LIBOR. However, in the aftermath of PNB scam, the interest rate on LOUs\/buyers\u2019\ncredit has increased to around 50-60 bps above LIBOR. This will negatively\nimpact trade financing and affect forward contracts between the importers and\nsuppliers. It has also affected the banking dealings between Indian and foreign\nbanks. <\/p>\n\n\n\n

Issue of LOUs to be\ndiscontinued <\/strong><\/p>\n\n\n\n

RBI has decided to discontinue the practice of\nproviding guarantees by issuing LOUs and letters of comfort for trade credits\nfor imports to India. The decision will be applicable to authorised dealer\ncategory-I banks. It is expected to have a negative impact on the trade\nfinancing activities of the country as importers heavily relied on LOUs as it\nis a cheap source of credit. LOUs for trade credit to importers can still be\nissued but only subject to compliance to certain provisions.<\/p>\n\n\n\n

MEASURES TO IMPROVE BANKING\nREGULATION<\/strong><\/p>\n\n\n\n

 1.   Role\nof banks:<\/strong> Repeatedly the government and RBI have said\nthat banks should operate autonomously with greater professionalism,\ntransparency and accountability. For this banks should assess the credit-worthiness\nof borrower before sanctioning loan; applying a regular evaluation and rating\nsystem of investment opportunities; fix prudential limits; enforce maximum\nlimit exposure to a single borrower; alertness on the part of staff at all\nstages of credit dispensation. Also, large exposure to a single borrower should\nbe avoided by banks.<\/p>\n\n\n\n

2.   Role\nof government :<\/strong> Since the biggest fraud has\noccurred in PNB which is a Public Sector Bank (PSB), it puts a question on the\nsovereign guarantee and trust in the public banking system. Since government is\nthe major shareholder in all public sector banks, it should take serious steps\nto improve risk management and corporate governance by banks. It should empower\nthe bank\u2019s managements, secure their independence and reduce political\ninterference in bank\u2019s managements.<\/p>\n\n\n\n

3.   Role\nof RBI :<\/strong> RBI already has a mechanism for corporate\ngovernance in banks. It undertakes disclosure and transparency measures for\nfree flow of information, off-site surveillance mechanism to monitor the movement\nof assets, its impact on capital adequacy and overall efficiency. It is also\nimplementing the Prompt Corrective Action by specifying benchmark ratios for\nCapital Adequacy Ratio, Non-Performing Assets and Return on Assets. Any breach\non these ratios is considered as a warning. However, the occurrence of these\nfrauds necessitates that RBI should focus on banking regulation by ensuring\neffective stressed asset management and ensure that the banking system\nrecognises financial distress early and takes prompt steps to resolve it. RBI\nhas also mandated banks to implement prescribed measures to strengthen SWIFT\noperating environment. <\/p>\n\n\n\n

4.   Constitution\nof Y.H. Malegam Committee :<\/strong> Further, looking\nat the rising frauds in banking system, RBI has decided to constitute an expert\ncommittee under the chairmanship of Y.H. Malegam to look into the matters of\nasset classification by banks and frauds and their prevention.   <\/p>\n\n\n\n

5.   Is\nprivatisation the answer to banking sector problems?<\/strong> Not really. This is because the problem lies in regulation and not\nownership. Poorly regulated private banks are more prone to scams. Also,\nprivate sector banks may exploit banking rules to earn higher profits. For\nexample: global financial crisis of 2008. Hence, the need of the hour is strengthening\nthe regulation of banks.  <\/p>\n\n\n\n

6.   Use of\nblockchain technology : <\/strong>Use of blockchain\ntechnology which maintains a chronologically ordered record of all actions\nand files (\u201cblocks\u201d) linked together (\u201cchain\u201d) in a distributed and\ndecentralised database can help bring efficiency and transparency in banking\ntransactions. It is based on an electronic decentralised ledger that gives\nall the participating entities, including banks, the ability to access a single\nsource of information. It also enables them to track documentation and\nauthenticate ownership of assets digitally, as an unalterable ledger in real\ntime. This technology allows easy tracking and verification of entries.<\/p>\n","protected":false},"excerpt":{"rendered":"

Prof. V.P. Gupta, Director, Rau\u2019s IAS Study Circle, New Delhi \u2013 Jaipur \u2013 Bengaluru The recent news pertaining to bank fraud by Nirav Modi in Punjab National Bank and the loan default by Rotomac has shaken India\u2019s financial sector, leading to a government and central bank crackdown on lenders\u2019 systems and practices. Alleged fraud cases […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[3],"tags":[],"_links":{"self":[{"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/posts\/360"}],"collection":[{"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/comments?post=360"}],"version-history":[{"count":1,"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/posts\/360\/revisions"}],"predecessor-version":[{"id":361,"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/posts\/360\/revisions\/361"}],"wp:attachment":[{"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/media?parent=360"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/categories?post=360"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.competitionreview.in\/blogs\/wp-json\/wp\/v2\/tags?post=360"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}