The scam faultline is damaging Indian banking

Source: The post is based on the article “The scam faultline is damaging Indian banking” published in The Hindu on 12^th July 2022.

Syllabus: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources.

Relevance: About the impacts of NPA on banking system.

News: The NPAs in banks incur mainly due to bad loans and scams. This affects the entire banking ecosystem. After the DHFL case, ABG Shipyard Limited of Surat had taken a loan of about ₹23,000 crores in a fake manner this year.

There are many examples of bank scams in India. For instance, the Nirav Modi and Mehul Choksi scam involving the Punjab National Bank, the case of businessman Vijay Mallya involves nearly 13 banks, the IDBI Bank fraud, and the R.P. Info Systems Bank scam to name just a few.

How do bad loans and scams impact the banking system?

Data by the Reserve Bank of India (RBI) show that around 34% of scams in the banking industry account for inside work and poor lending practices and the involvement of junior and mid-level management.

The RBI data also show that one of the fundamental problems in the development of banking is the rising bank scams and the costs consequently forced on the framework.

Frauds in the banking industry can be grouped under four classifications: ‘Management’, ‘Outsider’, ‘Insider’ and ‘Insider and Outsider’ (jointly). However, all scams are the result of operational failures.

According to the RBI data, corporate loans account for nearly 70% of these bad loans. On the other hand, retail loans, including car loans, home loans and personal loans, account for only 4%.

In a Global Banking Fraud survey, the KPMG highlighted that the issue is not just for India alone; it is a worldwide issue.

What are the NPA Projections?

According to the Financial Stability Report released by the RBI in December 2021, the gross NPAs of banks will be rising from 6.9% in September 2021 to 8.1% of total assets by September 2022 (under a baseline scenario) and to 9.5% under a severe stress scenario.

A study by the Indian Institute of Management Bangalore has shown that poor bank corporate governance is the cause behind rising bank scams and NPAs.

What is the impact of NPA on customers?

The banking system of any country is the backbone of its economy. Excessive losses to banks affect every person in the country because the amounts deposited in banks belong to the citizens of the country.

A high NPA also reduces the net interest margin of banks besides increasing their operating cost; these banks meet this cost by increasing the convenience fee from their small customers on a day-to-day basis.

What should be done to improve India’s banking system?

Ensure proper audit: The regulation and the control of chartered accountants is a very important step to reducing NPAs. There is also an urgent need to tighten the internal and external audit systems of banks.

Cautious approach: a) Banks should be cautious while lending to Indian companies that have taken huge loans abroad, b) Public sector banks should set up an internal rating agency for rigorous evaluation of large projects before sanctioning loans, c) There is a need to implement an effective Management Information System (MIS) to monitor early warning signals about business projects.

Use technology: Financial fraud can be reduced to a great extent by the use of artificial intelligence (AI) to monitor financial transactions.

Improve loan recovery process: India has to improve its loan recovery processes and establish an early warning system in the post-disbursement phase. Banks need to carry out fraud risk assessments every quarter.