A tool for Monitoring of big borrwal accounts
The Govt. of India has introduced several governance reforms,in order to keep a watch on fraudulent activities and to prevent diversion of funds, has introduced the Agencies for specialized monitoring mechanism, under the ASM banks will now appoint specialized monitoring agencies to closely track the activities of the borrower including purchases, invoices,actual production vis-à-vis projection, high value transaction,payments, cash inflow and cash outflow.The move to appoint an external agency to monitor loans comes in the backdrop of banks reporting a 72 per cent year-on-year jump in frauds at ₹41,168 crore in FY2018, against ₹23,934 crore in FY2017 and cases of fraud at banks and financial institutions increased 28% in volume terms during financial year 2020 as per RBI’s annual report. According to the RBI, frauds have emerged as the most-serious concern in the management of operational risk, with 90 per cent of them located in the credit portfolio of banks.Most of PSBs have deployed IT based Early Warning Signals leveraging third party data, which have enabled early, time bound action in stressed accounts.Monitoring has also been strengthened by developing agencies for specialized monitoring.
Credit monitoring is one of the vital activities in banking industry particularly in present scenario.Banks lend money for purpose of earning interest fee,common etc. which are generated mainly productive use of money collected from depositor. Thus, it is important on part of banks to develop a mechanism to track the performance of the business for which it has been lend the money and ensure proper end use of funds and bank needs to maintain a watch on the happening inside as well as outside of the entity which has borrowed money.
A prudent banker must be able to ascertain the stress in any of its asset well in advance so that timely corrective steps are taken and banks interest is safeguarded. It is observed that, stress assets of Indian banks in general and public sector banks in particular has increased manifold in recent years. Some of the common activity that a bank needs to monitor may be broadly categorized like ensuring compliance of terms and condition along with legal enforceability of documents. In this connection banks have started appointing external agencies for continuous monitoring of loans account of Rs.250.00 crore and above. Lead bank in a consortium of bank will select any particular agency and give the assignment to it for monitoring of account.
Need of ASM:
To keep a tab on the increasing cases of frauds in the banking space the IBA in March 2018 had setup a committee of senior banker to shortlist the agencies which are having expertise in monitoring of big borrowal and complex nature of transaction. By appointing ASM it’s not necessary that we will only focus on stressed loans but all type of accounts above threshold will be looked after by monitoring agency.IBA has prepared a list of agencies for specialized monitoring which may help banks to monitor stressed loan accounts. With the help of ASM we can came to know the problem in advance like inventory buildup, delay in receivables and diversion of funds.With the help of specialized monitoring agency, all the transaction will be under a strict vigilance. Asemployees of the banking industry don’t have such expertise in all the sectors and related business transaction the services of ASM to closely track the activity of complex nature of transaction of borrower is to be tracked on each stage. The activities that a bank needs to monitor may be broadly as under:
- Ensuring compliance of terms and condition of sanction
- Ensuring legal enforceability of documents
- Ensuring end use of funds for the purpose they are disbursed
- Ensuring the safety of Primary and collateral security offered to the bank
- Studying Early warning signals which are emitted at each stage
- Initiating preventive steps for resolution of the stress in the borrowal account
- Ensuring proactive monitoring of loan account to ascertain that income generation capacity and future cash flow are not impeded.
All these activities together constitute credit monitoring and to safeguard Banks interest .ASM is and entity having professionals with good domain knowledge, experience and skill in different sectors,industries etc.In case of large exposure or exposure of specialized nature, such agency provides services of inspection, stock audit, cash flow monitoring and end use verification etc.
Purpose of Empanelment of ASM:
Under given disruptive situation like recession, pandemic etc. banks needs to have special monitoring capability to effectively monitor loans with large credit exposures and exposures of specialized nature.ASM which are better equipped in this regard and it would be prudent to engage ASM for following purpose.
- To have onsite presence at the place of business and a timely, fair and transparent monitoring of borrowal account is expected.
- To monitor the borrowal account in Technical as well as Financial matters and guide the bank for further course of corrective action.
- Timely reporting to the lenders on the borrower business situation on real time basis
- ASMs are also expected to look into other aspects like Government notifications which may have material impact on borrowal company, all approvals and clearance.
- ASM is required to analyze, supervise, monitor and suggest on the business activities of the borrower.
- To monitor end use of funds on account of their on-site presence as well as off site.
Source of Information for credit monitoring:
In order to achieve effective credit monitoring, it is essential to examine monitoring tools. At the ground level we should periodically receive a certified statement of actual cost of the project from the borrower. The actual cost as per the certified statement submitted by the borrower should be compared with the projected statement of project cost to be incurred at each stage of the project. For cost over-run, ifnoticed,close monitoring is called for to prevent the account from turning into a NPA. In addition, site inspection of securities report is very useful source to get the early warning signal. Any erosion in the value of securities or negligence noticed on the part of the borrower to keep securities in order would be a matter of concern.
The project loans should be disbursed as per the periodical progress reports submitted by the borrower and subsequent site inspection done by the bank official.in big projects report from auditor on capital expenditure incurred at each stage of the project to ensure the end use of funds.Periodical returns and statement and book debt statement, stock statement,credit audit report and concurrent audit reports are good source of information for credit monitoring.One such reason for poor turnover may be that the borrower has opened a current account with another bank wherein the sales proceeds are deposited .similarly, the bank should receive a list of major suppliers of raw materials to ensure the end use of bank funds.Similarly while calculating drawing power based on stock statement or book debt statement and stock inspection, we should ensure whether advances received against orders for goods are deducted to arrive drawing power. More importantly, month wise purchases and sales should reasonably be reflected in the borrowers ledger statement of account to prevent diversion of funds.in this regard, banks should insist on the auditor of the borrower firm to certify, among other items,sources of funds, funds brought in and end use of funds.
Main Reasons for stress built up in Borrowal accounts:
Buildup ofStress in borrowal/loan account could be on account of various factors and also on the type of loan viz., Working Capital or Term Loan. An analysis indicates that list of major reasons for stress can be broadly classified as under:
- In most of the instances, end use of fund was limitedly ensured and instances were observed when funds are used for the purpose other than that meant for. This lead to shortage of fund in the system sooner than later thus resulting into stress.
- Projects/Units where Foreign Currency is involved, a steep volatility in exchange rate also caused stress in the borrowal account.
- If product is more vulnerable to Government Policies, change in policy attracted stress in the account.
- Less involvement of Promoter/Top Management of the company and lack of strategies/financial planning and its execution has also led to deterioration in asset quality. Sometimes lack of capital infusion capacity of the promoters is also observed for stress building.
- Labor unrest in certain cases has led to building up of stress in borrowal account
- Danger of technology used becoming obsolete or fast changing technology or invention of cheaper replacement product are also observed as reasons impacting performance of borrowal accounts.
- Competition in the industry and major market players’ strategy towards the same impacted health of a borrowal account.
- Under financing or over financing is also seen as one of the reason for funds shortage/diversion and building up of stress in borrowal account.
- Timely and adequate insurance is not obtained/taken which led to loss and subsequently building stress.
- Lack of Ongoing/Regular monitoring the borrowal account & its operations closely & taking/initiating corrective actions at the first instance of observance of incipient weakness/stress.
- Tax incidence/Tax Laws/Litigations etc. resulting into attachment of cash flows, Units, Assets, Properties etc. of the borrowal account.
- Lack of Timely & adequate corrective action by Promoter as well as lenders jointly, to cope up the disruptive circumstances / economic conditions.
- Cancellation of Government orders / Bulk orders resulted in jamming the cash flow of the borrowal/loan account leading to stress.
- It is also observed that in case where the major Debtors of a borrower face stress, the same resultantly creeps into the borrowal/loan account also.
- Production of defective or substandard product leading to rejection of bulk order giving rise to unwarranted inventory being locked.
- Many a times, there is delay due to reasons beyond the control of borrower leading to cost as well as time overrun finally resulting into building up of stress in Borrowal Company as it requires additional capital infusion.
- Delay in securing various approvals and clearances.
- Poor Project Planning/execution/monitoring also lead to stress in borrowal/loan account in later stages.
- Lack of skilled staff was another reason which contributed to stress in the account.
- At times, delay in disbursement from lenders (due to required approvals/clearances/promoter margin etc.) also led to stress in account.
Importance of Early Warning Signals in Credit Monitoring:
Maintaining of the health of a borrowal/loan account is of paramount importance to the Bank. Increase in the stressed assets portfolio of the Bank does not augur well for the health of the Bank and may lead to a difficult situation where the bottom line is adversely affected which in turn will impact the stakeholders. We all know no advance account can turn bad overnight. The account emits sufficient signals and it is for us to constantly observe and capture such signals so that timely remedial action is initiated to avoid slippage. A careful analysis of these warning signals will throw sufficient light on the direction towards which the unit is going and the same should be used to our advantage in safeguarding the Bank’s interest.Here it is clarified that all those warning signals which are noticed in a Borrowal account primarily at the branch level and mostly during operations in the account. While building such advanced logic, the patterns / trends as well as outside data are used for generating the alert for the creeping incipient weakness in the loan account.
Scope of Work comes under ASM:
The Broad scope of work for the external agency,ASM as suggested by IBA in carrying out a clean and effective monitoring of account as under:
- Monitor the purchases /invoices of the company for procurement of raw material /spares etc. ., on periodical basis and compare vis-à-vis monthly operation budget submitted by the company as per the periodicity decided by the consortium.
- Review inventory buildup for operation of the units to verify if it is commensurate with the funds released.
- Monitor the actual operation vis-à-vis projections
- Verify the necessity of each high value payment as regards beneficiary and purpose
- Assessment of financial information that has been and that will be provided by the company to its lenders including information related to its short term and long term cash flows
- Identify key issues and submit a report along with the suggestion with regard to smooth operations of the project.
- Verification of evidence for end use of facilities by the company to confirm that utilization is as per the conditions laid down by the lenders
- Submit report on the inventory/receivables position of the company including slow moving inventory, if any, to arrive at appropriate drawing power of the company.
- Perform such other services as requested by the lenders and mutually agreed to by the company and the lenders and submit report on temporary/long term/unscheduled closure of manufacture facilities.
- Verify source of margin towards working capital/letters of credit/Bank guarantees
- Verify and ascertain quality of book debts, age-wise classification and eligible book debt for arriving at the Drawing power
- Verify substantial sales returns entries in books of the company and existence of any reciprocal receivables to be scrutinized
- Verify genuineness of supplier/debtors in addition to transaction involving merchant trade and invoice discounting under trade finance at overseas branches.
- Information/data as per monthly statement to be reconciled with account operation and published financials.
- In case of consortium lending, ASM shall monitor status of borrowing with other member banks, conduct of accounts at their end, business sharing arrangement etc.
- In case of term loan ASMs for large accounts should be engaged in order to ensure proper monitoring of project implementation and utilization of funds.
- Conduct site reviews, document reviews and study of progress reports on continuous basis especially vis-à-vis original timelines to avoid sudden shocks of overrun.
- Determine progress and appropriateness of related transactions like payment made to contractors ,vendors and others
- High value payment/dues to be clearly monitored to ensure proper utilization
- Verification related to approval/clearances/compliance in the project and analysis of Government letters/instruction/audit reports/Independent Engineers report and status of insurance.
- ASM report should also comment on the unbilled revenue,debtor’s verification vis-à-vis acceptance by the debtor based on milestones.
Monitoring aspect covered by ASMs:Broadly classified into 4 category
- Cash Inflow Monitoring:
- Sources of cash inflow based on estimates/projections
- Source of Unsecured loan/Non-convertible debentures, its tenor and rate of interest, if any sale of fixed assets or investment, interest/dividend received from investments.
- Profit ploughed back and any onetime exceptional cash inflow such as profit on sale of fixed assets, tax refunds etc.
- Sources of margin to be ascertained to confirm whether it is through borrowing or through capital infusion and if it is brought in as per sanction stipulations.
- Cash Outflow Monitoring:
- Utilization in inventory buildup/acquisition of fixed assets/purchase invoices of the company about quantum and reasonableness of rates for procurement of raw material /spares/transportation etc.
- Utilization in creditors repayment/repayment of term borrowing and advance to other firms
- Capital drawing, if any, interest/dividend payouts, redemption of debentures, if any, shares by back, if any etc.
- Inter corporate transaction and /or related party transactions.
- Timely and full payment of government /statutory dues and analysis of any other kind of outflow, if observed.
- Non Cash Parameters:
- ASM is expected to keep a close watch on industry specific prevailing trends, cyclical changes, government policies affecting the company,sustainability/sensitivity in products/business and suggest precautionary measures to mitigate the risks.
- High value vendor due diligence, market values vis-à-vis invoice price
- Technological obsolescence and substitution measures.
- To report on any litigation, court cases including asset classification of associate concerns.
- Changes in shareholding pattern and voting rights
- Any contract entered into which is unrelated to business
- Implication of nay rearrangement like carve out, merger, demerger etc.
- Leveraging of single equity in multiple companies
- Other Parameters:
- Verify transaction involving substantial amount which are not of regular nature.
- Advice the bank based on monitoring based on publicity available information from various sources for initiating corrective steps to safeguard the exposure.
- Any alienation/disposal of securities.
- Verification of end use of funds deployed outside the country in respect of borrowing by offshore companies of parent entity
Documents to be referred by ASM:
- Sanction Note along with projected financials or financial model for projects
- The sanction terms and condition letter duly acknowledged by the borrower
- The statements of account of the borrower
- Details of promoter and the associate /sister/group concern of the borrower
- Details of debtors and creditors of the borrowal company
- Project and its components, project implementation schedule and its milestones
- Documents and detail of the security offered to and held by the bank
- Availability of various approvals and clearance as applicable
- Insurance details and its status
- All Inspection/regular audit/RBI audit reports etc.
- Summary of all observation and conduct of account
- Details of letter of credit/letters of Guarantee opened by bank
Expectation from ASM:
In a broader perspective ASMs is expected to monitor the account/activity onsite as well as offsite monitoring of the business/account/analyze /evaluate and monitor the borrowal account/project financially as well as technically.ASMs are also expected to look into other aspects like government notification which may have material impact on borrowal company/industry/sector, all approvals and clearance,price escalation in capital items or raw materials etc.ASMs have to look on extent of involvement of promoters/top management of the company in day to day operations/decision making as well as strategic decision making and evaluation of the same.ASM is expected to monitor the purpose of advance vis-à-vis sanction by the lender/consortium, in totality, withour any exceptions.For this post execution of non-disclosure agreement, ASM is required to analyze, supervise monitor and suggest on the business activities, sanction of advance and its usage as per sanction.
Credit monitoring starts from the moment credit is sanctioned to the borrower and ends only when the account is closed.Post sanction credit monitoring depends upon factors such as the type of credit facilities, nature of activity,purpose of loan, market dynamics and regulatory requirements and it has to be fine-tuned on a case to case basis.To make the credit monitoring more robust, the government has advised the banks to take the services of audit firms as specialized monitoring agencies for clean and effective post sanction follow up on a common engagement basis.In case of large exposure or exposure of a specialized nature, such agencies provide inspection services, stock audit,cash flow monitoring and end use of funds. These agencies would monitor all the transaction of an account on a day to day basis at the back end for loan accounts of Rs.250 crore and above and agencies are giving services by IBA approved list.Prompt identification and resolution of stress in accounts having large credit exposure and exposure of a specialized nature and leading a helping hand in reviving the stressed accounts and initiating timely corrective action to resolve the stress and maintain the accounts in stress free performing category.