With banks blindsided by Covid-19, incidence of fraud may well have gone up

Mark Twain once said that “a banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”. A lot has changed since the humourist’s days — it is bankers who are now out in the rain, and none will be singing anytime soon. And if the spectre of a huge spike in dud-loans was not bad enough, the incidence of fraud could also headed northwards, fuelled by the pandemic.
 
Consider the following setting. Over the past 14 months, there was no way bankers could have ensured that the collateral for working capital loans was what it was claimed to be. The bandwidth of bank managements was stretched; in the case of four sets of state-run banks, merger-related issues ate up time. The exponential growth in digital banking — from the acquisition of customers to servicing them (be it in the corporate or retail areas) — may mask fraud in a system that is largely used to physical verifications.
 
The Reserve Bank of India’s (RBI’s) supervisory load has also gone up, with both non-banking financial companies and urban co-operative banks coming under closer scrutiny. Now, take a step back, and look at this data set.

 
Catch me if you can
 

In its Report on Trend and Progress of Banking in India 2019-20 (T&P 2019-20), the central bank said bank fraud rose 159 per cent to Rs 1.85 trillion. Now, think about it — that’s more than half the Rs 3.56 trillion that the Centre had pumped in as capital between 2015-16 and 2019-20 into state-run banks through direct subscription to equity shares and issuance of recapitalisation bonds.
 
The RBI’s Financial Stability Report of December 2019 referred to the huge gap between occurrence and detection of fraud between 2018-19 and H1:2019-20. Fraud between 2000-01 and 2017-18 formed about 90.6 per cent of what was reported in 2018-19 in terms of value. Similarly, 97.3 per cent of the fraud reported in H1:2019-20 occurred in the previous financial years.
 
“A fraud can’t be detected the moment it happens. If that had been the case, no fraud would have happened,” says Ajoy Nath Jha, executive director and chief risk officer at IDBI Bank. “Given the pandemic, physical verification of collateral has not been possible. There could have been cases of diversion as well.” And it may well be that during the moratorium extended on servicing of loans, banks could have taken their eye off the ball, or were indulgent towards their borrowers. Then again, there is the digital element.
 
“There are increased numbers of cyber-attacks and fraud in 2021, compared to the same time last year,” says Bharat Panchal, chief risk officer (APAC, Middle East & Africa) at FIS, a Global Fortune 500 company. “Old investigation techniques may not work effectively now. A disruptive change in investigations is needed. Speed is the key in the digital world.”
 
And, after a case of fraud is detected, there is also a due process of law that banks need to follow. There are also misgivings among a few bankers as to how quickly they should respond to restructuring proposals under the scheme announced by the central bank last week. The fear: What if the stress in some instances was caused by fraud — such as, say, fund-diversion — in the first place?
 
Information-sharing among banks even within a consortium at the best of times has been less than adequate, and the declared dud-loan figures for FY20-21 could be misleading. So, too, are the modelling tests carried out by banks on the probability of fraud in the post-pandemic world — they are based on historical data.
 
The sniffing business
 

Would it be fair to say that the Covid-19 pandemic could have led to a surge in deviant behaviour?
 
“We have seen a significant increase in employee wrongdoing. Also, desperation to save one's job, or secure a higher bonus, is resulting in compromise in sales practices,” says Tarun Bhatia, managing director and head of South Asia Business Intelligence and Investigations at Kroll. “During the pandemic, we have investigated many instances of mis-selling, or collusion between employees (or third parties) to report high or fake sales.”
 
Another way of looking at the magnitude of fraud in recent times is the fillip it has given to the forensic audits business, whose current annual fee pool is estimated at between Rs 600 and Rs 1,000 crore (it depends on how the business is sliced and diced) — nearly half of what investment banking firms in India carve out every year among themselves!
 
Two summers ago, over 70 firms queued up to be on the Indian Banks’ Association’s empanelled list of forensic auditors, which included the likes of Alvarez & Marsal, Kroll, EY, BDO India, PwC, BMR Advisors, KPMG and Deloitte. So did many home-bred firms that never, or rarely, make it to the headlines.
 

Obviously, there is money to be made when you help those who are out in the rain. The business is also as shrouded as what it seeks to uncover — you will not be let in on these firms’ billings, which can run into a tidy amount. That being the case, it has generally been observed that foreign investors and private equity firms employ these sleuths more than banks. State-run banks, which account for 80 per cent of the fraud occurring in India, simply cannot afford their services, anyway.
 
The shadow of fraud might have just got a lot longer.