Banking Efficiency (version 2016) – Uniform formats for Assessment

Banks in India follow practice of financing under Multiple Banking Arrangement (MBA) or under Consortium for Working Capital (WC) finance. Similar practice is followed for project/term loans on achievement of financial closures. Borrowers approach the lead bank in WC Consortium every year for assessment/renewal of WC limits. This process takes on an average 2-3 months time for a mid/large scale corporate borrower. After detailed appraisal/assessment, the lead bank shares its assessment note with the other member banks in the Consortium. The member banks use this note for renewal/enhancement assessment at their end. But when? If the note is received say in January, when will the member banks use it for assessment at their end? The answer is : in normal circumstances, they will use it only when the limits are due for renewal at their end, and if such due date is say in May, then it will be May only when the note will be used. Surprisingly the renewal exercise at each member bank, takes average 1-2 months time even after assessment by lead bank, and lead bank shares its assessment note! But why? The first reason being of course is that all member banks do not maintain a common date for renewal, which leads to information in lead bank note becoming obsolete or requires updation by the time limits are due for renewal at their end. The second issue is that all banks individually also undertake the same full assessment exercise i.e. management study, analysis of financials, ratios, industry/market research, limits assessment, risk, mitigants, KYC etc, however in different formats. Each bank has its own devised formats which more or less contain similar information. But since the formats are not uniform and there is no written unanimous guideline for computation of ratios etc., each bank takes the support of lead bank note and prepares it own assessment/appraisal note.

In case of term loans the appraisal note is shared by bank if borrower pays a huge appraisal fee for such sharing. As mentioned above, even if it shared, it is of limited use in terms of efficiency in swiftly completing the assessment by other banks due to the issue of different formats prevailing in each bank. This applies even to the Syndicated/Underwritten deals, where the Information Memorandums (IMs) are of limited use as long as efficiency is concerned.

Think of the enormous time, energy, resources, systems, people, etc. invested by each bank in undertaking the same exercise which is already done by leader of the consortium, and even shared the assessment/appraisal note. Whether this meets the efficiency levels we expect in this challenging business environment?

In a time when Government is focusing on improving the system efficiencies in financial sector, formed the Banks Board Bureau (BBB) for improving the working of public sector banks, is it not time to address this issue of not having uniform formats in banks? If this is rectified, imagine how faster it would be to achieve financial closures for the WC/project finance. The Corporates will be able to use the saved time and resources in addressing the other issues. Banks will be also able to save their huge time which they can devote for processing additional proposals. Hence, addressing this small issue can hugely benefit India Incorporation, and its indirect effect would support the overall productivity in economy which is struggling to keep growth rate high.    

The above issue can be easily addressed by IBA/RBI by initiating dialogues with banks in drafting the uniform formats, uniform definitions of ratios, covers etc. for WC and project assessment. They can also initially conduct workshops for adopting the uniform formats. There could be need for addressing sector specific formats which can be also facilitated. There can be some information like industry exposures etc. specific to each bank which cannot be covered by lead bank in its uniform assessment note. Such limited information and the commercials pricing etc. can be prepared and topped up by each bank over the lead bank’s uniform assessment.

As a long term solution and efficiency building exercise, they can facilitate software which can generate industry specific templates having required assessment fields and formulas. This will standardize the assessment practices in banks without tempering with the templates/formulas. They can keep on improving/developing this software in consultation with banks over time.

There is thrust by RBI that each bank should undertake its own due diligence for exposures taken. To this effect, lead bank can share copies of supporting back up papers to enable the other members individually verify critical data.

Banks will be able to address the other issue i.e. of not having common due dates for renewals, once the uniform formats are adopted. Since the uniform formats will significantly reduce the assessment time, member banks will be also able to immediately take up the assessment exercise.  

Time to set New Normal : Adopting Cash Flow Based Monitoring

The rising NPAs have given sleepless nights to the bankers. The gross NPAs of Indian banks increased from Rs.83,000 crore (USD 13 billion) in FY 2010 to Rs.3,23,000 crore (USD 48 billion) in FY 2015, and this figure increased to Rs.5,72,000 crore (USD 86 billion) at the end of Q3 FY 2016. In many of the cases diversion of funds is reported to be one of the key areas of ongoing investigations. The existing banking system is based more on sharing of data among the lenders for their common borrowers. The bankers exchange of information of borrowers on regular basis. Generally such sharing is frequently and timely when account has already turned NPA or almost reached to become an NPA !!

Dilemma of Existing Mechanism for Sharing Cash Flows

In a Working Capital arrangement of bankers, every lender requires the borrower to route its business transactions through it on proportionate basis (i.e. based on percentage share of the lender in total Working Capital Borrowing tie up). The purpose is of three folds, one it gives them some hands on experience in understanding the business transactions of the borrower, two it helps in understanding the real volume of business, and three it gives access to interest free cash flow / deposits which has probability of remaining with lender for some time. It is very common that lenders complaint / pursue the borrower for routing cash flows. Lenders generally do not come together by relying on one of the lending members for first taking all the cash flows and then passing on the proportionate share to other lenders. Of course, this is commonly done when account becomes non performing (i.e agreeing to sharing cash flow when cash flows have already dried up!!), restructured and Trust and Retention Account (TRA) is managed by lender having largest share. Projects with concession agreements (i.e. like BOT Toll Road projects or City Water Supply projects etc.) are some of the exceptions to the situation where TRA takes place by virtue of the concession agreement. 

The Big Problem

Unscrupulous borrowers take the advantage of weakness of the system. Such borrowers maintain accounts with multiple banks, route cash flow to various A/cs in the absence of any fixed set of rules and enjoy ease of diverting the funds by complex chain of transactions. Such liberty of disproportionate cash flow routing or routing to banks not part of lending consortium/ arrangement is enjoyed by the borrower on the name of all lenders pursuing for larger share of cash flows. The lender getting larger share in cash flows remains cheerful and does not complain about such indiscipline of the borrower.

Such borrowers also ensure maximum squeezing of undrawn loans/working capital lines before they disclose their deteriorated financial position to the banks.

TRA Arrangement

In today’s highly technology driven world, it is important and possible to have dynamic understanding/control of the income and major expenses of the borrower. A Trust and Retention Account (TRA) Agreement is a documented arrangement wherein rules are framed to channelize the cash flows of a borrower in a systematic manner. The agreement provides the Water-fall mechanism in which the cash inflows will be utilized. The Water-fall mechanism provides the details of various key accounts to be maintained by the borrower, like Income A/c, Critical Expense A/c, Statutory Dues A/c, Tax A/c, Debt Service Reserve A/c (DSRA), Interest Expenses A/c, Principal Payment A/c etc. and their priority order for channelling the cash flow. Generally TRA is stipulated in restructured loans while in other cases Escrow A/c is stipulated. TRA is strict mechanism of cash flow management to be maintained by the borrower. In comparison to TRA, Escrow can be considered a bit lenient mechanism which makes sure that all the cash inflows are brought into one account and transferred by the Escrow bank as per the Escrow agreement. Sometimes Escrow is followed by Supplementary Escrow Agreement stipulating the TRA Water-fall mechanism. All these arrangements of TRA / Escrow are well developed by the banking sector, and lenders are well equipped in managing TRA/Escrow.

Adopting the Technology

The point here is that with the advancement of technology and app driven convenience, these mechanisms can be further made efficient with technology support. For monitoring purpose, lenders now need to change their first focus from analysing the financial statements to hands on control on the cash flows of borrower. This needs to be adopted as a practice. Ultimately, it is the cash which matters and if cash is monitored well, rest of the things would fall in line. The need of hour is that it is not only the borrower getting SMS on his phone when his account is debited but also the lender should come to know about the utilization and details. Hence, time demands for setting standards, rule of game and as matter of basic practice & principal to adopt the cash flow focused monitoring.

It has been experienced that in restructured cases TRA arrangements, the TRA bank/agent is often accused of using the cash flows for recovery of its own overdues. The solution could be resolved by appointing any bank as TRA agent having no exposure to the borrower.  Adoptions of such practice by the banking industry would set it as market standard. As usual, adopting any new practice is faced with initial hiccups. With the adoption of TRAs at industry level, the increased business volumes and competition would bring down the TRA bank fee. Allowing benefit of retaining /maintaining some balance with the TRA agent could drastically reduce the fee for implementing TRA. Over the time borrowers will also get accustomed to managing the TRA and it will become a new normal in practice.  

The segregation of income into a separate account and routing all the sales to one single account as per TRA arrangement, would help in understanding the actual sales volume regardless of accrual accounting based income as per financial statements. Segregation of expenses and tracking of related party transactions would help in controlling diversion of funds.

The transaction monitoring can be filtered to reduce SMS volume on the phone of banker by setting  minimum transaction size, frequency, tracking related party transactions and type cap for such reporting to the banker. Instead of getting SMS alert for all the transactions, the banker may get alert only when some alert is triggered like the cheque issued by the borrower is returned/dishonoured, or when limits utilization are reaching some peak level (say 80%) or when the interest/principal is not paid on due date, etc. Depending on the category/rating of the borrower, status of the account, such triggers can be increased/reduced. Such type of filtering would hugely reduce the volume without defeating the purpose of monitoring. They app driven technology may also facilitate easy management of such triggers.

The Reserve Bank of India has already issued guidelines on Early Warning Signals (EWS) and facilitated CRILC database check, which would supplement the Cash Flow based monitoring. The use of advance predictive and prescriptive analytics can further create significant impact in monitoring the accounts.

It is not easy to identify customers before they default, however, with the advancement in technology, monitoring of cash flows can be managed in an efficient, improved and controlled way which would support in identifying the problem accounts before the damage happens.