Covid underlined the need for due diligence across BFSI: Deepak Bhawnani, CEO & Founder, Alea Consulting

Deepak Bhawnani_Founder and CEO_Alea Consulting

COVID-19 has resulted in a surge in non-performing loans in India, primarily after the second wave. Delays in reporting of financial statements, wilful defaults, increased arbitrations, and litigation has made the situation more challenging. It is during this time, the need for due diligence across the financial institutions has come to the spotlight. Rashi Aditi Ghosh of Elets News Network (ENN) spoke to Deepak Bhawnani, CEO & Founder, Alea Consulting, a private global risk and investigative consulting firm, helping organizations reduce reputation and operational concerns.

1. What are the changing dynamics of Promoter Integrity Due Diligence, Investigative Monitoring and Asset Discovery in the new normal? Please share your views.

We have seen an elevated need for most of our services during and post-COVID. For example, there is a shift in the focus for due diligence. While the priority remains to have a comprehensive check on the integrity, compliance and flags related to the entity and its promoters, clients require more detail to understand the business practices of the promoters, source of capital, undisclosed related party transaction. In the current situation, investors rely more on insights into the ground operations of the target companies. This has been for two reasons – restricted personal meetings with the promoters and KMP’s, along with identification of on-ground window dressing/manipulation of data.

It has been recommended to banks that they should conduct monitoring of their key/large clients. One option is Investigative Monitoring which works as an early warning system to inform impending/soft issues not identified in a financial review. For example, attrition of senior management, significant litigation, or enforcement actions.

In terms of undisclosed Asset Tracing, COVID-19 has resulted in a surge in non-performing loans in India, more so after the second wave. Delays in reporting of financial statements, wilful defaults, increased arbitrations and litigation have worsened the situation. Early initiation of asset discovery can increase the quantum of recovery. We have the capabilities to conduct asset tracing in multiple jurisdictions.

The success rate of identifying hidden assets has been high, and this has increased the confidence of clients to conduct such focused studies.

2. Any views on the implications of critical Government committees on NPAs, Anti Money Laundering (AML) and Know Your Customer (KYC) Compliance?

The Malegam Committee was established to curb the accumulation of non-performing assets. It advises an early warning system via the establishment of a separate Market Intelligence Unit (MIU) focusing on large borrowers. Considering that financial reports can be distorted or exaggerated, the Committee, rightly, felt that FI’s needed to complement due diligence with market intelligence. Collection and processing of financial information and preventing unfavorable borrowers and sending out early warning signals of potential fraud or credit danger should be initiated at the sanctioning stage, and also during the ongoing relationship with the client.

Alea’s reviews assist FIs towards the Malegam Committee’s recommendations. Alea’s Investigative Monitoring reviews include assessing leakage of funds, conflict issues, parallel or competitive ventures by the promoters, litigation, enforcement, regulatory compliance checks, and various other flags.

For AML and KYC, the RBI has issued detailed guidelines based on the Recommendations of the Financial Action Task Force on Anti Money Laundering (AML) standards and on Combating Financing of Terrorism (CFT) and; the paper issued on Customer Due Diligence (CDD) for banks by the Basel Committee on Banking Supervision. Banks are advised to ensure that a proper policy framework on KYC and AML measures, with the approval of the Board, is formulated and implemented.Identification of customer history of repaying debts and dues plays an essential role. Determining factors include the customer’s current income and assets, verification of income, credit history, current liabilities, outstanding debts, etc.

A judicious and comprehensive background check of KMPs and Owners can also assist in mitigating operating risks.

3. How can the latest formats of independent Due Diligence assist in the Risk-Based Internal Audit (RBIA) phase of the FIs?

The RBI has consistently stressed the need for Risk-Based Internal Audit (RBIA). It is imperative to conduct independent and focused Integrity Due Diligence (IDDs) on the client entity and its promoters. This process provides a reliable and comprehensive in-depth understanding of risks.

Comprehensive IDD reports collated by Alea provide substantial and critical pre-transactional intelligence encompassing various reputation aspects.

4. How does Investigative Monitoring fit in the context of Financial Institutions (Fis)?

Analysis of risks and trends impacting operations or functioning of a FI helps assess threats, which in turn enable the FI to modify existing strategies customized to the client and industry. There are risks that are not highlighted in quarterly statements or books of accounts- examples include frequent change of auditors, senior-level management departures, rise in complaints regarding delays in payments, outdated machinery, issues with other FI’s, etc.

Investigative Monitoring provides an early warning system within a sector, group, or entity. Additionally, on-ground intelligence gathering, on an ad-hoc basis, can also be initiated to augment the process.

5. Why are some FIs choosing to change lending banks?

A number of factors may result in FIs wanting to change banks- to get better interest rates on loans, benefit from lower or no prepayment penalties and processing fees, among other benefits.

Another significant aspect is reputation. An institution’s reputation is a valuable, distinctive and non-substitutable asset that provides a sustainable advantage. Potential clients deliberately exclude a bank if it has perceived financial instability or ethically questionable practices.

6. According to you, what implementational challenges plague the financial industry?

The banking system is saddled with NPA and NPLs for years. Contributing reasons include corporate malfeasance, siphoning off funds, excess lending, etc. Despite the implementation of IBC, there are large haircuts taken against many large accounts. Strengthening integrity due diligence, monitoring and corporate governance will help mitigate such risks.

7. Any examples of steps that can help FIs to prevent NPAs from eroding their growth roadmap?

With increasing NPAs, there is constant pressure from regulators to clean up loan books and recover dues from defaulters including personal guarantees. We have been working closely with our banks clients to identify undisclosed or transferred (to family) assets, through innovative research and in-depth review of corporate filings, to identify hidden assets of substantial value.

Even after usual risk reduction procedures are undertaken, steps like Anti Conflict & Eligibility Reviews assist with background checks of Resolution Professionals, by assessing their independence. Bidders and their connected persons should be scrutinized to assess the source of funds and eligibility under Section 29A of the IBC (mitigating original promoters from control).

The NARCL initiative by the Government will also support banks to clean up legacy issues and focus on their core business of banking.The recent IBC amendment proposing Pre-Packaged Insolvency Resolution(Prepacks) as an insolvency resolution mechanism for MSMEs through a direct agreement between secured creditors and existing promoters/investors will definitely offer a faster resolution with minimal disruption of operations.

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