HOW TO PREVENT FRAUD IN MSME LENDING WITH CASE STUDY:

Introduction

Generally, fraud can be commonly defined as any action deliberately and

dishonestly committed to obtain an advantage, which causes a loss to another
party. The cost of fraud to Small and Medium-sized Enterprises (SMEs) is not
easy to quantify, as many cases are either undetected or unreported.

MSME loans are defined by the Indian Government and RBI as loans for
business enterprises for support in terms of finance, infrastructure and other
areas. Micro Small and Medium Enterprises (MSMEs) play a critical role in
creating momentum to the growth of the Indian economy. It contributes to over
28 per cent of the overall GDP, 45 per cent of the manufacturing output and 48
per cent of the total exports. It has a vast network of about 63 million enterprises
and provides employment to over 111 million people. MSMEs not only play
crucial role in providing large employment opportunities at comparatively lower
capital cost than large industries but also help in industrialization of rural &
backward areas, thereby, reducing regional imbalances, assuring more
equitable distribution of national income and wealth. MSMEs are complementary
to large industries as ancillary units and this sector contributes enormously to
the socio-economic development of the country. MSME plays an important role
in the Indian Economy in terms of their contributions to industrial production,
trade and services, exports employment creation and creation of entrepreneurial
base.

In order to enable identification and facilitate development of MSMEs,

Government of India had enacted the Micro, Small and Medium Enterprises
Development (MSMED) Act, 2006.

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  Registration in “Udyam Registration Portal” mandatory w e f July 1, 2020.
 Existing Enterprises registered with Enterpreneur Memorandum and
Udyog Aadhaar Memorandum should register in Udyam Registration
Portal before 31st March 2021. (Existing registration valid till 31st March
2021)
 All enterprises registered till 30th June, 2020, shall be reclassified in
accordance with revised definition.

Common Guidelines on lending:

 Credit facilities are extended by the Bank for financing genuine

commercial activities. The Bank does not lend money for speculative
purposes and/or for any unlawful activity.
 All credit proposals are subjected to due diligence processes with regard
to the credentials of the borrower, purpose of the loan, financial position
of the borrower, need based requirement of credit facilities for working
capital and capital expenditure, capability to service the loans and
security offered.
 Bank has developed robust internal credit rating and scoring models.
These models are used to assess risk associated with a credit proposal,
thereby enabling evaluation of its acceptability. The rating models also
take cognizance of the Business risk, industry risks, and financial risk and
management risk aspects of the borrowing entities. The pricing decisions
are linked to internal risk rating. In addition, overall value of relationship
and competition in the market would also guide pricing decisions.
 The Bank has a well-defined system of delegation of powers to
sanction/approve credit facilities. The terms and conditions/covenants
governing any lending arrangement are also well defined. No credit

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 facility can be extended to any borrower unless duly sanctioned by the
designated sanctioning authority/committee.
 No credit facility can be disbursed unless the standard loan documents in
the specified form have been executed

Selection of Borrowers
Careful selection of borrowers is essential to maintain asset quality. No violation
of Know Your Customer (KYC)/Anti Money Laundering (AML) guidelines under
the Prevention of Money Laundering Act (PMLA 2012) is permitted. Scrutiny of
past credit history of all borrowers/promoters/guarantors must be carried out..
A Comprehensive assessment of the profile of the borrower has to be made on
the following aspects while appraising the credit needs of the borrower:

 Purpose / need for credit,

 Types of facilities required,
 Due diligence on the Borrower(s) /Guarantor(s)/Group(s)
 Borrower’s business expertise, status of his economic activity,
 Current risk profile and its sensitivity to changes,
 Internal Credit rating,
 External credit rating, wherever applicable,
 Track record of repayment / cash flow projections for capacity to repay,
 Legal capacity to assume the liability,
 Adequacy and enforceability of the tangible securities / guarantees under
various scenarios.
 Verification of PAN Card details
 Verification of DIN/Father’s name
 Verification of Detect report from CRIF Highmark / CIBIL / Experian /
Equifax

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  Market information on Promoter(s)/company/firm/group companies /
partners o. Verification of CRILC

Importance of Due diligence:

The stronger credit risk management practices and higher standards of Due
Diligence are to be followed to protect and improve asset quality at both
transaction and portfolio levels. Due diligence on all
Entities/Promoters/Partners/ Trustees/ Directors/Guarantors needs to be carried
out with a view to being satisfied about their credentials, and for ensuring
compliance with the guidelines on KYC and AML under Prevention of Money
Laundering Act. Due diligence particularly in relation to promoters and
management should reckon/cover aspects like experience, professionalism,
integrity, vision, track record of meeting commitments to lenders, industry
experience, history of strategic initiatives, governance practices and record of
adherence to covenants.
Financial Statements
An additional layer of preventive actions that banks can incorporate is
the analysis of financial patterns of the entity or individual. The financial health of
the company should not be taken for granted on the sole basis of the applicant’s
words. Always insist on audited financial statements. Since it’s very easy to
fabricate the financials, you should always rely on solid data to verify the
financial statements with the bank statements. Tax filings, be it ITR or GST
filings, are a good indicator of the business health and validity of an entity. Lack
of GST or ITR data is cause for concern for any lending institution, as it can be
an indicator of fraudulent intention or activities.

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Monitoring Tools

To ensure proper credit monitoring at different levels of administration, several

tools can be made use of for taking remedial action. These tools are to be
utilized on an ongoing basis for ascertaining the deterioration in asset quality if
any, and initiation of corrective measures to arrest such deterioration, so that the
loan assets continue to be in standard asset category.

Some of the important credit monitoring tools is listed here below:

 Unit/Factory Visit Reports

 Stock Statements/Book Debts Statements
 Reports on Concurrent audit, Credit Audit, Risk Based Internal
Audit, Statutory Audit, RBI Inspection, Stock Audit, Legal Audit etc.
Quarterly Information System (QIS).
 Monthly Credit Relationship Manager Report (CRM REPORTS)
 Scrutiny of operations in the account (Poor turnover, vis-à-vis, sales
realization, overdues, frequent return of cheques/bills, issuing
cheques unconnected to main business, frequent excess drawing,
frequent devolvement of LCs/invoking of BGs etc).
 Sales Tax Return / Challan, Excise Duty Challans / Production
Report / Account Operation / Balance Sheet / Quarterly Progress
Report etc. • Audited/Provisional Financial Statements
 Annual accounts filed with Registrar of Companies – Verification
through search at Office of Registrar of Companies by empanelled
Company Secretaries / Chartered Accountants or by our own
Officers, wherever need is felt, to ascertain / compare with the
balance sheet particulars filed with Registrar of Companies.
 Exchange of information/reports with other banks in consortium meetings.
 External / Internal Credit Rating.

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Pre – Disbursement:
• Branch to ensure that all pre-release terms and conditions stipulated in the
sanction letter like, creation of mortgage formalities, registration of mortgage
documents with CERSAI and registration with Sub-registrar office wherever
required, registration of charge with Registrar of Companies (ROC), wherever
applicable, are complied with.
• In respect of consortium advances, all the formalities shall be followed. Our
role as a leader and as a member shall be followed accordingly.
• Documentation: Should be completed before disbursement and legal audit may
be obtained wherever required.

Disbursement & End-Use verification

A credit risk is assumed when an exposure is taken on a borrower. That risk is
subject to the contents of the proposal and the terms and conditions of sanction.
Sanction of limits, in itself, cannot be a commitment on the part of the Bank to
disburse and it is subject to fulfilment of various commitments on the part of the
borrower as set out in the proposal. Mode of disbursement is important for
creation of quality assets. Hence, proper care should be taken during
disbursement of credit facility sanctioned. Defective mode of disbursement will
not create a quality asset. Monitoring during disbursement is very important,
especially; to ensure that the borrower has not diverted and/or siphoned off the
loan proceeds and the amount has been used for the purpose for which it was
extended. Bank may seek verification, by way of auditor’s certificate, Board
Resolution and by way of any other acceptable means confirming end utilization
of loan proceeds.
Post Disbursement

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Post disbursement monitoring is very important to identify early warning signals
and to take remedial measures wherever warranted to monitor asset quality.
Branch Officials/Branch Head has to play major role in post disbursement
monitoring. Guidelines/policies as prescribed in various Circulars/Manual of
Instructions are to be followed meticulously at Branch/ZO/FGM level. The
efficient and effective post sanction supervision system would facilitate the Bank
to maintain high level of standard assets.
Term loan:
In respect of Term Loans, Branches shall obtain original invoices in respect of
machinery / vehicles / equipment / builders etc. to satisfy itself that the valuation
is in order and the same should be held on record along with other loan
documents. Branches shall also verify bonafide credentials of the supplier of
machinery / vehicles / equipment / builders etc. Term Loan amount shall be
made direct to the suppliers as far as possible and shall not be made to
current/cash credit accounts unless specifically approved by the sanctioning
authority.
The disbursement of the loan amount should be made after collecting the
margin money from the borrower. Where the loan is to be disbursed in
instalments, it should be done only after satisfying that the borrower has
complied with the prescribed conditions. Excessive reliance on the certificate of
Chartered Accountants both in regard to infusion of promoter’s contribution and
deployment of bank’s funds shall be avoided. The branch should ensure that
disbursement of term loans should be made in a phased manner and in
instalments according to the progress made in project implementation.
Working Capital:
• Disbursement should not be in cash or transfer to accounts of sister concern
or to unrelated Accounts or to borrower’s current / savings account, without
proper justification and shall be as per terms of sanction.

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• Adequate insurance for the stocks with Bank Clause shall be ensured. •
Address mentioned in the Bank Records. i.e., godown etc. should be the same
as mentioned in the Insurance Policy and as per terms of sanction.
• Availability of Drawing Power subject to verification of stock/Book debt
statement shall be ensured and in case of new projects, releases are to be
made in proportion to achievement of sales and build-up of inventory/debtors.
• In the case of working capital advances, particularly to new borrowers,
disbursement should not be made in one lump sum and drawings should be
regulated on the basis of level of production/business activity as also scale of
operation.
• The branch shall also ensure that drawals in the account are utilized for
intended purposes and are not diverted for any other purpose.
• Utilization of large value working capital limits shall be tracked, particularly in
the corporate and export segments, to identify instances of unusual increases in
credit growth not in consonance with the regular requirements of the borrowers.
There shall be a stronger monitoring of end utilization of funds lent to borrowers
so as to spot drawals which are not need-based by fixing Operating Limits under
QIS and ensuring direct payment to the suppliers.
Pending Charge Creation
It is to be ensured that charges are created without any delay
Unit Visit:
To be conducted regularly and recorded properly.
Legal Opinion on property documents:

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 The copies of parent documents / title deeds and other relevant papers
pertaining to the property should be handed over in person to panel
Advocate by Branch Officials.
 Legal opinion must be unqualified. Opinions with qualified comments
should be got rectified before accepting such opinions.
 The advocate must make a visit to SRO / respective authorities for
verification of genuineness of the documents including EC, death
certificate, Will, Power of Attorney, etc before giving opinion and the
details of the same should also be incorporated in the opinion.
 Every page of the Document / Title Deed should be verified for
genuineness.
 The property offered should be SARFAESI compliant.
 Pre-sanction verification in the CERSAI site for any encumbrance to be
done.
 Whether any Revenue Authority attachment / Statutory Dues
Attachment / court attachment is reflected.
 Certified copy of the title deeds and parent document tracking back to at
least last 13 years from the title document are obtained from the Sub-
Registrar’s office by the panel advocate and compared with the original
one submitted by the borrower for the LSR for its correctness.
 No objection certificate and other documents issued by Competent
Authorities - builders / Society / other organizations / department/
institutions - are carefully examined for their genuineness.

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  Certificate from the advocate - that the actual search was conducted on
the date of the ‘Search Certificate’.

Engineer’s valuation on property:

 Approved engineer must visit the property, preferably with an officer of

the bank.
 Photos of the property to be attached to the valuation report.
 Boundaries of the property should be verified and certified in the report.
 Discreet enquiry to be made with neighbours regarding ownership of the
property independent of owner.
 Approval of Building Plan / Plot by the Competent Authority is to be
verified for its genuineness.
 The details of the property, photographs etc should be cross verified with
information collected, incase BM / official has conducted such visit
independently.
 Mortgaged security / property to be Geo Tagged.

Fraud indicators
Some of important fraud pointers for loan accounts are given below
1. Default in payment to the banks and other statutory bodies etc.,
2. Bouncing on the high value cheques, frequent invocation of BGs and
development of LCs
3. Request from the borrower to postpone the inspection of godown for
flimsy reasons
4. Floating associate companies by investing borrowed money from our
Bank
5. High value RTGS payment to unrelated parties

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 6. Heavy cash withdrawal in loan accounts
For preventing fraud in loan accounts, the Bank has put in place a robust
appraisal and an effective credit monitoring mechanism during the entire life-
cycle of the loan account. Any weakness that may have escaped attention at the
appraisal stage can often be mitigated in case the post disbursement monitoring
remains effective. In order to strengthen the monitoring processes, based on an
analysis of the collective experience of the bank, inclusion of the various
checks/investigations during the different stages of the loan life-cycle (Pre
sanction, Disbursement and Annual review0Should be carried out as per
directions/norms as specified in the loan policy, Risk Management policy, Credit
Risk management Policy under credit policy.
In spite of ensuring all preventive checks have been done against an
application, there is still a chance that the applicant is likely to be fraudulent,
since no process is foolproof. However, with the measure enlisted above, the
probability of onboarding a fraudulent customer is reduced significantly.
CASE STUDY

A number of large value frauds in advances portfolio were detected in one of

the branches in a metropolitan city. Investigation carried out in these borrow
accounts revealed serious lapses on the part of the Branch in not following the
systems and procedures while appraisal of these loans by flouting the guidelines
given by the Corporate Office. There was utter failure of the due diligence
exercise at the branch. The following are the lapses noticed in the frauds in the
borrowal accounts and the measures to be adopted to avoid recurrence of such
frauds:

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 Lapses on the part of the branch Measures to be adopted to avoid
noticed in the frauds such frauds

A single official was involving himself Follow a transparent process

right from the preparation of involving loans clerk, loans officer,
borrower’s application, appraisal, CMO, ABM.
filling of the documents, preparation
of vouchers, authorization of
transaction etc.

Totally unconnected individuals were Offer of an unconnected party to

partners of borrower’s firm to mortgage securities should be
camouflage “Third Party” security. viewed with caution

Proposals sponsored by “Middlemen” / “Broker” should never

“Middlemen” / “Broker” were blindly be entertained in the process of
accepted sanction of loans.

Turnover in the account were Source of credits in CC/OD

artificially boosted by borrowers by accounts should be looked into.
Multiple Round tripping of RTGS
source

Units were not visited at the proposal Inspection of unit, godown, office,
stage. It is now revealed that certain residence, project etc. to be done
units are not in existence at all. before considering the proposal and
keep a record for the same.

The copy of statement of account of Do not accept statement of account,

some other bank branch produced by NOC etc. without verifying with the
the borrower was found to be issuing Bank.
fabricated one, on referring the same
to the said bank branch.
Scrutinize the statement of account
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 Despite the presence of negative etc. meticulously.
features in the credit history of the
proprietor, like overdue amount too
high, presence of delinquency etc,
as evident form CIBIL report, the
same were overlooked at the time
of appraisal.
The financials submitted were found to As per loan policy branches shall
be fabricated when verified with the independently take up with the
Chartered Accountants who have Auditors who have signed and keep
denied having certified the same. the confirmation in file.

In some cases, the financial statements Sales figure can be cross verified with
submitted by the borrower were found the Sales Tax Dept; Balance sheet
to be fudged. figures can be cross checked with that
filed with ROC
The collateral security was found to be Please follow all guidelines given in
overvalued to a greater extent while the Loan Policy
applying for the loan, as reveled from
the recent valuation of the property.

Copy of monthly Sales Tax returns For take over loans / new
(VAT returns) submitted by the connection/enhancement, please
borrower was found to be fabricated cross verify with Commercial Taxes
ones, on verification with Commercial Department.
Taxes Department.

The transactions in the account Cash withdrawals from the borrowal

revealed diversion of funds. Huge accounts should be allowed and also
amounts were allowed to be withdrawn any request for transfer of funds from
in cash. The end use was not ensured. OCC/OD though RTGS/ NEFT should
be processed only after verifying
purpose of withdrawal / transfer to
ensure end use of funds under
Working Capital
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In one of the mortgages, the location of For legal validity of EMs, please be
the property and the extent of land etc guided by Loan Policy
were found to be different from the one
specified in the title deed. The
mortgager is not traceable and the
property was found to be belonging to
some other person. Thus there was
impersonation leading to the EM
becoming invalid.

Quotations for machinery which were Due diligence on the suppliers of

more than 6 months old were accepted. machinery should be done by the
Due diligence on the suppliers of branch. Cost of the machinery must be
machinery was not done by the BM. In released to the supplier by way of
one case, against the quotations from a crossed Demand Draft in the name of
non existent firm as supplier of the supplier firm only.
machinery, huge amount to the extent
of Rs.1.50 crores was released and
siphoned off.

The borrower has submitted quotations Due diligence on the supplier of

from some suppliers purportedly for machinery etc. is one of the essential
purchase of machinery. But the entire processes in credit appraisal.
amount was transferred to the a/c of
the borrower company itself from where
it was diverted. There is no evidence
for purchase of machinery.

In some cases payments were made to Never deviate without the proper
vendors different from the ones who verification/ approval of the competent
gave quotations. authority.

OCC was released to the maximum OCC component must be released

extent even before the construction of only after term loan is released,
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building, shed/obtaining power machinery purchased/erected and the
connection and erection of machinery. unit is ready for manufacturing activity.
Manufacturing unit financed two years
ago is yet to start functioning though
term loan for machinery and OCC were
released.

Drawing Power marked in the system is Stock statements / auditor certified

not backed by stock statements / Book Debt statements must be
auditor certified Book Debts obtained periodically and the DP must
statements. be arrived at and accordingly marked
in the system.

Though the systems and procedures in vogue in our Bank are adequate to
prevent frauds, due to non-adherence of the same by the branches, frauds
occur exposing the Bank to huge loss. The field level functionaries are advised
to adhere to the various guidelines meticulously and prevent frauds.

References:
Circular
ADMIN-
48/2015-16

04-07-
2015

CO: INSPECTION
DEPT

Credit Policy

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Credit Monitoring Policy

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