Integrity due diligence a must exercise
Absence of a true system can lead to issues that banks face today, feels Deepak Bhawnani, CEO, Alea Consulting, which specializes in reputation risk and corporate investigations:
Absence of a true system can lead to issues that banks face today, feels Deepak Bhawnani, CEO, Alea Consulting, which specializes in reputation risk and corporate investigations
N. Mohan: What is integrity due diligence and its relevance in the banking and financial services sector?
Deepak Bhawnani: There are various types of due diligence exercises conducted prior to a business association. The three key ones are legal, financial and integrity. All three encompass a comprehensive assessment of the potential business partner or lender. Integrity due diligence focuses on reputation risks and entails investigating information regarding regulatory compliance, source of funds, corporate governance, political exposure, sanctions and blacklists, i.e. issues that, by association, can adversely impact the financial institution’s brand integrity. An integrity due diligence is imperative to the BFSI sector. One main reason ascribed to accumulation of bad loans is lack of adequate due diligence.
Do you think the concept has caught the attention of the Indian bankers?
In private sector banks, certainly. I cannot, however, say the same for public sector banks.
Is customer due diligence a norm in good banking practices? Is not KYC sufficient?
A cookie-cutter approach to KYC does not suffice to identify risks of money laundering or terrorist financing. While an enhanced KYC may not be necessary for all clients, there should be a mechanism to trigger such checks automatically for the high-exposure customers. Currently, the process is seen as a one-time exercise, ie, during the client on-boarding stage. Clients should be subject to an enhanced KYC each time the financial exposure rises above a threshold.
Other areas where banks should undertake due diligence exercises to ward off possible risks?
One major area to consider is a background screening of bank employees holding sensitive roles and managers with high limit approval authority. Validation and valuation of collateral, ie, assets of the promoters and guarantors prior to disbursement of high-ticket loans should be a core part of the due diligence.
Random and frequent screening is required for red flag checks. Prior to disbursement of loans, there must be checks for related parties, auditor independence and other conflicts.
Could the existing NPA burden be avoided had the banks adopted scientific due diligence programs?
In addition to regulatory forbearance, the `10 trillion NPA stresses in India can be attributed to lacunae in the due diligence and appraisal process prior to loan disbursement. Limited audit scope and relationship manager monitoring of an account post-sanction contributes to the losses. RBI has stipulated a Central Fraud Registry (CFR) for banks for early detection of frauds and mitigate risks. However, the bank scams indicate that either the database was insubstantial or not reviewed properly. Robust risk management practices and audits to review implementation would have certainly mitigated losses by providing an early warning.
Do you think successful corporate entities have formalized the due diligence programs?
Most, if not all, private equity funds will conduct some level of due diligence on a potential investor. Some focus on the individuals, while others on the organization. Banks have largely been reactive, ie, investigate to recover - and this is what needs to change. A proactive approach would have limited exposure in the long run. The recent RBI notification to banks, to weekly report identification of incipient stress of borrowers (with aggregate exposure of `50 million and above), to the Central Repository of Information on Large Credits is laudable.
In a bank or a financial services institution, ideally, who should have the responsibility for carrying out reputational due diligence?
The structure exists, ie, the Chief Risk Officer, Chief Security Officer, or Chief Vigilance Officer associated with the financial institution. Any of these officers can be given the mandate and budget to initiate reputational due diligence process. The report should then be reviewed by an internal ‘Green Light Committee’ before making the final decision.
Finally, what is the future of due diligence in the banking industry?
What needs to be made clear across the banking industry is that filling a compliance form does not constitute a due diligence. Independent profiling and checking against a whole host of regulatory compliance, enforcement, PEP, litigation and other databases – of the entity and its directors and shareholders – is what should be a mandatory part of the approval process. Don’t lend to the unknown. Trust, but Verify!