Transforming Credit Risk Management Using AI-Powered EWS

RBI Arbitration On Credit Risk Management

RBI has introduced prudential norms for credit underwriting and associated risk management practices. A key function of the RBI is to oversee credit risk management practices, conduct regular inspections, and set guidelines. The RBI promotes credit risk management practices to mitigate financial risks, which in turn helps banks reduce non-performing assets.

Reserve Bank of India (RBI) has categorized two aspects of defaulter – “Inability to pay” or “Loan Defaulters” and “No will to pay” or “Wilful Defaulters”. RBI has mandated financial institutions and banks to incorporate Early Warning Systems (EWS) into their technology stack to identify and predict these two types of defaulters before processing the loan application. 

RBI Guidelines on Non-Performing Assets (NPA):

• The community of lenders must adhere to strict deadlines for a resolution plan.
• Lenders must provide some incentives to agree on ongoing resolution plans.
• Initiatives should be taken to improve the existing restructuring system, restructuring large values, etc.
• For non-cooperative borrowers with lenders, future loans must be more expensive in resolution.
• The sale of assets must necessarily be given more regulatory treatment that is liberal.
• If a loss is disclosed, lenders must be allowed to spread sales losses for at least two years.
• Purchasing facilities should be allowed by specialized agencies for the acquisition of ‘Stressed Company’.
• Necessary steps should be taken to facilitate the better functioning of asset restructuring companies.
• Private equity / sector-specific companies should be helped to play a very active role in the underlying asset market.

The Reserve Bank of India provided a list of Early Warning Signals (EWS) that could notify bank personnel of wrongdoings and fraud in loan accounts. In the midst of rising fraud in general and loan portfolios in particular, the Reserve Bank of India implemented a systemized framework for fraud risk management in banks. The framework also supplied banks with a list of 45 early warning signs that should instantly alert the bank to a vulnerability or wrongdoing in a loan account that may later turn out to be fraudulent.

1. Default in payment to the banks/ sundry debtors and other statutory bodies, etc., bouncing off the high-value cheques.
2. A raid by Income tax /sales tax/ central excise duty officials.
3. Frequent changes in the scope of the project to be undertaken by the borrower.
4. Underinsured or overinsured inventory.
5. Invoices devoid of TAN and other details.
6. Dispute on the title of the collateral securities.
7. Costing of the project which is in wide variance with standard cost of installation of the project.
8. Funds are coming from other banks to liquidate the outstanding loan amount.
9. Foreign bills remain outstanding for a long time and the tendency for bills to remain overdue.
10. An onerous clause in the issue of BG/LC/standby letters of credit.
11. In merchanting trade, the import leg is not revealed to the bank.
12. Request received from the borrower to postpone the inspection of the godown for flimsy reasons.
13. The delay observed in payment of outstanding dues.
14. Financing the unit far away from the branch.
15. Claims not acknowledged as debt high.
16. Frequent invocation of BGs and devolvement of LCs.
17. Funding of the interest by sanctioning additional facilities.
18. The same collateral is charged to several lenders.
19. Concealment of certain vital documents like master agreement, and insurance coverage.
20. Floating front/associate companies by investing borrowed money.
21. Reduction in the stake of promoter/director.
22. Resignation of key personnel and frequent management changes.
23. Substantial increase in unbilled revenue year after year.
24. A large number of transactions with inter-connected companies and large outstanding from such companies.
25. Significant movements in inventory, disproportionately higher than the growth in turnover.
26. Significant movements in receivables, disproportionately higher than the growth in turnover and/or increase in aging of the receivables.
27. The disproportionate increase in other current assets.
28. Significant increase in working capital borrowing as a percentage of turnover.
29. Critical issues are highlighted in the stock audit report.
30. Increase in Fixed Assets, without a corresponding increase in turnover (when the project is implemented).
31. Increase in borrowings, despite huge cash and cash equivalents in the borrower’s balance sheet.
32. Liabilities appearing in the ROC search report, are not reported by the borrower in its annual report.
33. Substantially related party transactions.
34. Material discrepancies in the annual report.
35. Significant inconsistencies within the annual report (between various sections).
36. Poor disclosure of materially adverse information and no qualification by the statutory auditors.
37. Frequent change in the accounting period and/or accounting policies.
38. Frequent requests for general-purpose loans.
39. Movement of an account from one bank to another.
40. Frequent ad hoc sanctions.
41. Not routing of sales proceeds through the bank.
42. LCs issued for local trade / related party transactions.
43. High-value RTGS payment to unrelated parties.
44. Heavy cash withdrawal in loan accounts.
45. Non-submission of original bills.
    
    

These signals help banks and other lenders to follow standard criteria to assess a vendor, supplier, and/or counterparty before starting the loan disbursement process. Evaluating businesses on these criteria provides lenders with a holistic view of the company and safeguards lenders from unforeseen credit risk. 

However, manually assessing every vendor on these parameters and cross-verifying the information is not an easy task. The process could take up to 3 months to evaluate a single vendor, resulting in a loss of time, effort, and resources for businesses if they found a red flag in the evaluation. 

Lenders now can access real-time information about a vendor or counterparty using tools like Crediwatch EWS which harnesses the power of AI and help make a “go & no-go” decision in hours, therefore saving time, effort, and money while being fully compliant with RBI norms.