Reserve Bank of India (RBI) on dated January 14, 2011, issued a notification, RBI/2010-11/368 DBS.CO.PPD.BC.NO. 5/11.01.005/2010-11. As per the said notification, RBI advised the banks that the efficacy of the existing machinery in the banks for post-sanction and follow-up of advances may be evaluated and made robust, wherever considered necessary. The need for this notification arises because, as an outcome, from the RBI assessment of the practices at certain banks for ensuring the end use of funds, it was revealed that the expected level of due diligence had not been exercised in some cases facilitating “diversion of funds by the borrowers”. (Courtesy: http://www.rbi.org.in).
This blog will try to throw some light on the issue that how far the said notification is being able to impact the “post-sanction monitoring of funds” by the financial sector in India. It is almost 4 years since this notification was issued by the RBI i.e. the Central Bank that regulates the financial institutions in India. So, let me try and comprehend from a layman’s point of view the monitoring of the end use of funds by the financial institutions. Note: I have deliberately used the word ‘Financial Institutions’ in the blog instead of restricting it only to ‘Banks’ because my personal view is that monitoring of end-use of funds is not only the duty but also in the interest of every financial institution/person that grants loan, irrespective of whether it is a bank or not.
First of all, let us understand what does monitoring of “End Use of Funds” by the financial institution’s means. In this context, it means that the financial institutions need to monitor the utilization of funds, in order to ensure that the borrower had actually deployed the borrowed funds, only for the purpose for which it was sanctioned by the respective financial institution. Thus, it is one of the due diligence checks implemented by the financial institutions to ensure that there is no diversion of funds by the borrower.
Many measures have been recognized for monitoring the end use of funds like periodic scrutiny of progress reports/financial statements/books of accounts, regular visits to the units, inspections and audits of securities/stocks, obtaining of declaration/certificates from the borrowers that the funds have been utilized for the purpose it was approved for, etcetera. However, the question that arises is whether in reality, the financial institutions ensures to monitor the end use of funds, with utmost due diligence or not?
Although, the notification strikes a very important issue to curb the misuse of borrowed funds, but in reality, the same has not been taken up in the right spirit by most of the financial institutions. As far as, loans that are granted for the purchase of any fixed assets are concerned, usually the payment is made by the financial institutions in the name of the Owner/Seller/Builder etcetera. So, by and large, monitoring of end-use of funds is not a difficult task in all such cases if due diligence has been taken care of, at the time of sanction of loans. However, monitoring of end-use of funds in all the other loans i.e. personal, renovation/repair of fixed assets, etcetera is extremely important because in all such loans there is a high probability of diversion and misuse of funds by the borrower.
Anyone who closely analyse the ground realities could easily vouch for the fact that especially in personal loans and loans for renovation/repair of fixed assets, there is no monitoring of end-use of funds by most of the financial institutions. Although, the loans for renovation/repair of fixed assets is disbursed based on the completion certificates issued by the internal staff/consultants, but still the hard core reality is that the end use of funds in such cases is also prone to be misused. In personal loans and loans for renovation/repair of fixed assets, at the most, a Declaration/Certificate is obtained from the borrowers mentioning that they have utilized the funds for the purpose it has been approved for and in case of any incorrect declaration/certification, prompt action as may be warranted, shall be initiated against the borrower. Needless to mention here that the borrowers blindly ‘autograph’ this declaration along with the “set of papers” they are ‘directed’ to sign by the representative of the respective financial institutions.
But this practise somehow raises a lot of questions and doubts in the mind. Does merely by obtaining a Declaration/Certificate the very purpose of the said notification will get served or not? Whether signing of the declaration by the borrower could be taken as a confirmation that the end use of funds is appropriately done? What if the intention of the borrower is to make an illegitimate use of the borrowed funds? Taking of declaration by the borrower and solely relying on the same could no way serve the purpose and in reality, it fails to address the core issue for which this notification was being issued by the RBI. However, as a practice, “in order to comply with the RBI guidelines”, a Declaration/Certificate is obtained from the borrowers with regard to “End Use of Funds”.
We should understand the importance of monitoring the end use of funds and the implications thereof, in case we fail to monitor the same properly. The task of monitoring the end use of funds by the financial institutions is extremely essential for the soundness of any finance sector. It not only plays a major role in reducing the risk involved in the illegitimate use of funds by way of diversion of funds. But at the same time, it also confirms that the funds are being deployed for the very purpose they were meant to, and in that way safeguards the funds from getting Non-recoverable, Non-Performing Assets (NPAs) in future.
Having said that we need to come up with a practical solution for ensuring that the borrowed funds are applied for the purpose it is meant to. Well, as per my suggestion all the financial institutions should have a dedicated panel of internal staff/consultants who will “solely certify the end use of funds by the borrower i.e. End User”. This certification will be based on their inspection, rather than the current practice of merely satisfying as a ‘formality’, by obtaining a declaration from the respective borrowers.
Until the time, this activity is taken up seriously by the financial institutions, the end use of borrowed funds could not be certified with surety and it will be a loophole open for the malicious borrowers to take advantage, at their will. All the financial institutions, as well as, The Reserve Bank of India should look into this matter with utmost seriousness, which will go in the long run for the financial soundness of the financial sector, as well as, our economy, as a whole.