Fund diversion: Ticking time-bomb for banks

Even as commercial banks face the uphill task of recovering mounting non-performing assets, there is another time-bomb in the form of fund diversion by corporates waiting to explode.

The banks have been sitting on a pile of working capital advances that constitute 30% of their total lending. There has been diversion towards the capital expenditure by the businesses in a bid to grow faster.

The situation, if unchecked, might become unmanageable just like the shadow banking crisis – the issues pertaining to the asset-liability mismatch. The mismatch takes place when an entity deploys funds borrowed for short term in long term assets -- thereby putting stress over the payment cycle.

Sources in the know say that the management of the central bank has been worried over the issue for some time. It was evident from Governor Shaktikanta Das’ recent address at National Institute of Bank Management (NIBM), Pune – where he tried to school the banks on the importance of risk management.

“Governance issues in private sector banks originate from an altogether different set of concerns. The issues here mainly relate to the incentive structure of their managements, quality of audits and compliance and also efficient functioning of Audit and Risk Management Committees,” Das had said.

He had also emphasised on the need of appointing chief risk officers and giving importance to the compliance issues within the set-up.

A highly-placed source told DH, this advice on risk mitigation, was directed at the diversion of working capital. “There was a clear message for the banks in that,” sources said.

In fact, the importance that the central bank has been giving to the issue can be ascertained from the fact that in last December, the Reserve Bank came up with “Guidelines on Loan System for Delivery of Bank Credit” – fully focussed on the working capital.

In respect of borrowers having an aggregate fund-based working capital limit of Rs 150 crore and above from the banking system, a minimum level of ‘loan component’ of 40% came into effect from April 1, 2019.

In its December 2018 circular, the Reserve Bank had issued a guideline, advising banks to keep a minimum of 40% as term component, in case the working capital exposure of any account exceeds Rs 150 crore.

The bank had issued the circular all the commercial banks and small finance banks.

“Hence, for such borrowers, drawings up to 40% of the total fund-based working capital limits shall only be allowed from the ‘loan component’,” it added.

This limit was slated to be hiked to 60%, with effect from July 1, 2019. However, this, according to the multiple sources in the central bank, hasn’t been implemented, owing to the resistance shown by the banks.

“This was supposed to be implemented, but then it didn’t get implemented. Banks came up with excuses that it is impossible to implement them,” sources in the know told DH.

Banking sources, on the other hand, suggest that it is very difficult to implement such guidelines, as their fund usage can’t be tracked by the bank.

However, experts don’t exonerate the banks over the issue. It would be prudent for the banks to disburse every loan into a separate account so as to enable appropriate correlation between the source and application of such loans, says Khushroo Panthaky, Director, Grant Thornton Advisory.

“In the event that the short term loans in the nature of working capital or overdraft are utilised by the borrowers to fund their capital expansion plans, the borrowers would be in a difficult situation to pay off such short term loans, as such amounts get invested for long term purposes, where cash inflows are expected at a much later date. Such situations generally put banks into a very difficult situation and result into financial stress,” he adds.

The industry sources said that they have been using bridge capital to finance the working capital in such cases. Bridge capital is temporary funding that helps a business cover its costs.

According to the data available with the central bank, working capital exposure of all the banks stands at whopping Rs 26.3 lakh crore, spread across 19.98 million accounts.

Banking industry insiders say that almost 20-30% of this amount has been diverted towards the capex.

Many market observers are worried that this might lead to a bigger crisis in the debt market. Indian debt market, on the back of over-leveraging by the corporates, has seen multiple defaults on short term-loans along with big hiccups in the refinancing.

“It might lead to stopping all the credit lines to the companies, if the crisis intensifies,” a banker added.