Due diligence and Credit appraisal system of banks and financial institutions in India

Lot of views are expressed on mounting NPAs in the country in last 3 years. We blame lenders for their poor monitoring system or borrowers for their malpractices. Have we ever thought where else can be a problem? Monitoring and investigations come at later stage when the loan is already sanctioned and disbursed. In fact we can narrate the whole process of financing as under:

a) submission of Loan proposal;
b) appraisal and sanction of loans;
c) disbursement of loans;
d) monitoring and evaluating the loans already given;
e) recovery of the loans along with interest;
f) investigations, settlement, restructuring, if not repaid in scheduled time; and
g) concluding the chapter or litigations. 

Generally we discuss about the issue from monitoring onwards by which time, money is already disbursed and lenders are left with no option but to submerge with the plans of the borrower.

In fact, the most crucial decision is to accept the proposal of the borrower and disburse the same in planned way. Generally the proposal when submitted contains lot of information, analysis and viability support. It mostly has rosy picture prepared solely to impress the lenders to lend money and earn a lot with fully secured module. There may be some hidden or unwritten agenda which also push to lend money. The proposal travels to various layers and moves upward with strong recommendations by each concerned authority at every level. It means every mid size proposal pass through the hawk eyes of many experienced bankers. Not only this it is also scanned by outside agencies like rating agencies, TEV studies, marketing reports, government statistics etc. Then how come there is so much jump in defaults. 

Real fault lies with the appraisal system of the proposal received for financing. Indian banks have age old system where each application is submitted fitted with lot of ratio analysis and lending methods. These formats are analysed by the people working on that who are also given instructions verbally in most of the cases as to how it should be directed.  This is where the cases are manipulated. Due diligence and analysis system in our country is quite old. Except the up gradation in mode of presentation (from typewriting to computerized), the core is not yet changed. The system of due diligence and appraisal need lot of amendments mainly to sync with the economy, macro and micro factors, government policies and the expertise of the borrower. Current system is based on the security, reputation or net worth of the promoter and general business trend. There is assumption that if something going good for long it will remain as it is. No provision for the sudden change in the situation. Further the appraisal does not consider the new technology, start ups, their knowledge, professionalism, team etc. We believe that the promoter and his family has the best guts to run the business. 

Appraisal system should not only consider above factors but also the global trend of appraisal. If this is not improved, lenders may continue to loose hundreds of billions of rupees every year towards NPA accounts and Governments will fund them again and again.

More about the appraisal and due diligence in next posts.

CP Jain, FCA