The Reserve Bank of India (RBI) has recently raised concerns regarding the prevalence of fraudulent accounts and the practice of loan evergreening within the banking sector. During an interaction with chief financial officers (CFOs) and auditors of banks and financial institutions on Tuesday, RBI Deputy Governor Swaminathan J highlighted the issue, stressing the need for urgent corrective measures.
RBI’s concerns
Swaminathan’s address focused on the alarming number of internal accounts identified in certain banks, describing them as “lakhs” of accounts with no apparent valid purpose. “One area that has come into sharper focus in the last couple of years is the control and management of internal accounts,” Swaminathan noted. He pointed out that many of these accounts are used as conduits for fraudulent transactions and for evergreening loans—an illicit practice where new loans are issued to pay off old ones, thus masking the true state of a borrower’s financial health.
The Deputy Governor urged CFOs to rationalize the number of internal accounts and bring them down to a necessary minimum. He emphasized that internal accounts carry high risk due to their potential for misuse and advised banks to implement more stringent controls through regular reconciliation and comprehensive reporting to the audit committee of the board.
Recent RBI directions and emphasis
The concerns raised by Swaminathan follow similar issues highlighted by RBI Governor Shaktikanta Das last week. Das had emphasized the need to curb digital frauds and address the issue of “mule accounts,” which are illegal accounts used for fraudulent financial activities.
Swaminathan also stressed the importance of maintaining the integrity of financial reporting. He advised CFOs to avoid any creative interpretations of regulations or accounting standards and to ensure transparent communication with the Managing Director & CEO and other senior management members. He further recommended keeping an open channel of escalation to the Chair of the Audit Committee of the Board (ACB) for higher-level guidance when needed.
Challenges with regulatory frameworks
Deputy Governor M. Rajeshwar Rao also expressed concerns about the application of principle-based regulation frameworks, particularly the impairment framework under Ind AS (Indian Accounting Standards). Rao noted that while this framework is intended to be forward-looking, some non-banking financial companies (NBFCs) have relied heavily on the 30 days-past-due (DPD) criteria for loan loss. Rao pointed out that DPD, being a lagging indicator, may not always align with the expected credit loss (ECL) approach, which is forward-looking.
Rao also highlighted issues with Asset Reconstruction Companies (ARCs), noting that some had failed to create provisions for management fees and expenses that remained unrecoverable for over 180 days. This situation led the RBI to issue guidelines requiring such unrealized management fees to be deducted from regulatory capital when calculating capital adequacy ratios.
Impact of emerging technologies
Emerging technologies are also posing new challenges for the banking and financial sector. Rao pointed out that the exponential growth in digital channels has increased reliance on third-party service providers, which in turn has exposed institutions to operational risks, including cyber and outsourcing risks. He urged auditors to assess whether management is adequately evaluating the impact of these technologies on internal controls and financial reporting.
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Expectations from CFOs and auditors
Swaminathan outlined several expectations for CFOs, emphasizing the need for:
- Leading institutions towards sustainable growth and resilience.
- Maintaining open and honest communication with auditors and bank supervisors.
- Ensuring the integrity of financial reporting and avoiding creative interpretations of regulations.
- Investing in technology and data analytics to enhance operational efficiency.
For auditors, the RBI’s expectations include:
- Applying rigorous audit processes to prevent divergence, under-provisioning, and non-compliance.
- Holistically assessing material risks posed by businesses.
- Demanding robust sustainability reporting from both financial and non-financial entities.
- Evaluating if management is properly assessing the impact of emerging technologies on internal controls and financial reporting.
The RBI’s latest directives underscore a critical need for banks and financial institutions to tighten their controls, enhance transparency, and adopt best practices to mitigate risks associated with fraudulent activities and regulatory non-compliance.
