Exclusive: RBI Reports Show HDFC Cleaner than Others, but Regular Lapses in KYC and AML Control
In the fourth and last instalment in our series on inspection reports of the Reserve Bank of India (RBI), called risk assessment reports (RARs), we take a look at the HDFC Bank. Our previous reports were focused on State Bank of India, Axis Bank and ICICI Bank. These reports were procured by Right to Information (RTI) activist Girish Mittal, who doggedly pursued RBI right up to the Supreme Court. 
 
HDFC Bank is by far the most consistent when it comes to performance and has been the highest value creator, over the past two decades, not only among banks but also among all listed companies. The market expects its operations to be clean and efficient. 
 
 
RBI classified the Bank as medium risk and its reports certainly show HDFC Bank in much better light than its competitors. Here are some reasons: 
  • The FY12-13 RAR mentions that HDFC Bank has a very aggressive record in the write off of non-performing assets (NPAs).
  • There were virtually no deviations in the provisions required to be held and the provisions actually held by the bank (in FY13-14, the deviation is around Rs4.7 million which is negligible for its size). In FY14-15 there is no divergence. 
  • No divergence in assessed profits and reported profits.
  • In all the years, RBI has specifically mentioned that considering the capital adequacy to aggregate risk score, no capital add-on is prescribed.
  • In the FY13-14 RAR, RBI mentions that there is no major variance in the past three years' projected and actual figures for HDFC Bank. 
  • RBI notes that a large number of customers of current account (90% in FY14-15) do not have borrower relationship with the Bank. This is greatly beneficial to the bank because its no-risk free money, since banks pay no interest on current accounts and there are no borrowing. 
 
Serious Lapses in Know-your-customer (KYC) and Anti-Money Laundering (AML) Process: Laxity in compliance with KYC and anti-money laundering provisions reflected in all three years. 
  • In fact, in FY13-14, RBI had imposed a fine of around Rs4.5 crore on the Bank and had also issued a caution notice. There was a fine of Rs2.6 million too by the financial intelligence unit (FIU) subsequent to Cobrapost revelations for which an appeal is pending. This is one of the key areas where the oversight of the board is found wanting, reflecting in higher risk score for governance and oversight in FY14-15.
  • In FY14-15, more than 11,000 accounts were opened under Jan Dhan Yojana in which substantial cash transactions were observed for which HDFC Bank has not exercised the requisite due diligence in monitoring such accounts. 
  • There was delay in updation of risk categorisation in AML tracking system compared to core banking software system of the Bank.
  • The alert generation for suspicious transactions reporting (STR) needs improvement as in many cases the Bank did not file STR or filed it with considerable delay. RBI noticed that there were delays between 10 and 70 days in the filing of STR with FIU after it was approved as a suspicious transaction by a principal officer of the Bank.
  • In FY14-15, RBI specifically comments that the internal audit of the Bank detected a large number of violations in KYC and AML instructions by the branches. 
  • In FY14-15, 32,134 cases were detected for KYC and AML exceptions, reflecting noticeable non-adherence to laid down KYC and AML processes. In 2,124 instances, treasury deals were cancelled or modified due to errors which included those ratified by higher authorities, adding to process risk.
  • Out of 1.92 million accounts that are due for re-KYC, nearly for 64.5% accounts the exercise is not yet completed.
  • A large number of newly opened current accounts in FY14-15 recorded huge high value transfers that had no correlation to business profile and declared turnover. The audit did not flag such sudden spurt in transactions.
 
Rampant Mis-selling 
Customer complaints revealed that they were charged with premium towards insurance policies of group entities HDFC Ergo and HDFC Life without consent. The charges were reversed only after receipt of the complaint from customers. 
 
High Attrition Rate 
One of the interesting reasons for a high percentage of operational (non-IT) risk is surprisingly high staff attrition rate. Indeed, in FY14-15, HDFC Bank suffered an attrition rate of as high as 32.75%. The Bank also relies heavily on outsourced or contracted employees. As many as 48% of the employees outsourced or contracted are not on its rolls. The attrition rate of sales and front office employees of the Bank was significantly high at 53.66%. The levels of attrition at HDFC are 93%, of HBL Global Pvt Ltd  at 65% and HDB Financial Services Ltd (HDBFS) at 73%.
 
Relationship with HDFC 
HDFC Bank has the option to buy up to 70% of the loans sourced for its parent, i.e., HDFC Ltd. While recognising that adequate disclosures are made, RBI has specifically mentioned the need to have a board-approved 'Conflicts of Interest policy'. 
 
Tricks To Meet the Rulebook 
In March 2014, it accepted a deposit of Rs100 crore from a rural bank and sanctioned a loan with zero mark up over fixed deposit (FD) rate. This resulted in increase in deposits, advances and priority sector advance close to the balance sheet date. The utilisation of loan reduced drastically by 17 April 2014.
 
Complaint-handling
  • More than 50% of complaints received at branches were not addressed in the stipulated time, while in 23% of the cases it did not issue an acknowledgement to the customer
  • The largest number of complaints were on account of the mis-selling of insurance products including debit of premium from account without the consent of customers. The complaints related to insurance were closed at the branch without escalation to the head office and also not forwarded to vigilance or fraud for investigation. The Bank needs to step up its efforts to identify and address the causes, which lead to complaints that are recurring in nature.
  • There were instances of mis-selling of third-party insurance products where the amount of premium is not in synchronisation with the income of the customer. The Bank was not adhering to the code of commitment by not providing post sale services to customers, non-specified employees of the banks are engaged in lead generation or solicitation of third-party insurance products in contravention of IRDAI (Insurance Regulatory and Development Authority of India) guidelines.
Audit Lapses 
In FY13-14, certain areas and activities were not covered under concurrent audit. Though the branches were required to respond promptly regarding the bonafides of transactions on the Rs1 crore portal, the same was not being covered by concurrent auditors as they have not been provided access rights
 
Operational Issues
While the RARs have flagged a number of operational issues, these have reduced over the years.
 
Issues in FY14-15
  • Considering the thrust in digital banking and risks due to system failures, RBI has remarked that there is no director with an IT background.
  • One of the key reasons for increase in score for senior management as reflected above is that the Bank had reported incorrect exposure data to the central repository of information on large credits (CRILC) and did not take steps to integrate the CRILC data in credit risk framework, i.e., it is not incorporated as a part of standard credit approval memorandum appraisal, review and renewal.
  • The internal audit staff seemed over stretched considering the number of staff and number of audit assignments undertaken.
 
Issues in FY13-14
 
Systems and IT
  • System integration tests and user acceptance tests are not conducted stringently. There are a high number of bugs detected.
  • High unscheduled downtime for core banking and internet banking.
  • Manual intervention existed while uploading files in 23 critical systems.
  • Out of 20 sample laptops, 17 had unauthorised software installed on them. This risk was highlighted in previous audits as well but seems to be not addressed.
  • The Bank is yet to address issues pertaining to 72 gaps identified by an external consultant with regard to recommendations of working group on technology risk management and cyber frauds.
  • The capital adequacy computation was not entirely system driven. There were manual interventions required due to system deficiencies.
  • The Bank provided intra-day credit facilities to certain corporates and MF. However these exposures were not reckoned for the purposes of calculating single borrower / group borrower limits.
 
Credit Risk Issues 
  • The rating of borrowers is supposed to be independent of credit function. However the rating approvers were also part of credit & market risk group and in some cases were credit approvers as well. Thus they are not truly independent of the credit function. 
  • The Bank has multiple systems for different exposures. Therefore, in some cases, even though the account is classified as a non-performing asset (NPA), it may continue to be standard in different sub-systems. There was no process note for the system-driven NPA identification procedure.
  • The retail asset product pricing framework gave a leeway to business to operate within a band of (+)/(-) 3% from the rack rates. This resulted in pricing offered below base rate, which is not permissible.
  • In certain cases, e.g., construction equipment / commercial vehicles the Bank charged interest at a rate lower than the base rate factoring for the incentive received from the manufacturer. However this was not uniform. There was no computation of the interest rate applicable and discounts passed on, which lacks transparency and does not give clear picture to the customer on the applicable interest rate
 
Issues in FY12-13
  • The investment advisor who recommends third party products was the exclusive point of contact for customers for responding to transaction alerts generated by the AML system. 
  • The bank had sold an “interest rate cap spread” (a product which was not specifically permitted as per the guidelines) to a public sector entity. 
  • The head of internal audit is in charge of vigilance as well. Given the size of the bank it is desirable to have two different people with different reporting lines, said RBI. 
  • The head of operations risk management reported to head of operations, which was in direct conflict with the fact that the risk management function has to be independent of operations and business. 
  • The risk management function was not aggregated to a designated chief risk officer. 
  • The bank had compliance liaison officers who had dotted line reporting to the chief compliance officer while being primarily responsible for operations which was in direct conflict with the compliance role. 
  • The internal audit function was not commensurate with the high level of customer complaints and frauds that the bank was exposed to. In multiple cases, the audit was completed within a day or next day and same auditor was assigned to audit multiple branches simultaneously. In some cases the internal auditor has rated the branch as satisfactory in spite of reporting serious operational errors.
  • The process of auditing insider trading was instituted 15 years back and not reviewed thereafter. The check is limited to stock depository accounts of employees with the bank only and no internal auditing of the Chinese wall between investment banking and commercial banking functions.
  • In the wholesale portfolio, the weighted average interest rates of loans extended to relatively better credit rating grade, was higher than the rates extended to lower credit rating grades. 
  • In retail products, borrowers of products with lower expected loss were charged higher rate of interest vis-à-vis borrowers of products with higher expected loss. The bank had significant pricing power in the retail portfolio due to which it was in a position to price these loans at a rate much above the rate warranted, based on the expected loss history. This has allowed the bank to have an aggressive write off and provisioning policy.
  • In spite of a committee set up by the bank having capped the rate of interest to 24%, the bank continued to have products with interest up to 27.8%.
  • Inadequacies were observed in post disbursement monitoring in respect of gold loans portfolio. However corrective steps were taken in this regard.
  • Breaches in intra-day exposure and controls were found to be inadequate.
  • The system was not able to flag restructured accounts, which dilutes monitoring of the same.
  • The head of private banking had oversight of proprietary equity trading for the bank giving rise to conflict of interest.
 
 
Here are the inspection reports of the HDFC Bank as provided by RBI to Girish Mittal under the RTI Act..
 
 
 
 
 
 
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    COMMENTS

    Abhijit Kanjilal

    2 months ago

    I think RBI should publish these reports every year to bring in more transparency with investors. Good job Moneylife + Mr. Girish.

    While Cleaning NPAs from Balance Sheet, Public Sector Lenders Are Losing Banking Relations: Report
    India's public sector banks (PSBs) are losing valuable lead banking relationships with the country's largest companies while attempting to rid their balance sheets of huge volumes of non-performing assets (NPAs), says a report.
     
    In its 2019 study, Greenwich Associates, a market intelligence and advisory services provider, says, "...even when public sector banks do retain their status as a company's No. 1 or No. 2 credit provider, they are being cited less often as leading providers in non-credit products such as foreign exchange and cash management-roles that are being filled most often by private sector banks. The one outlier to this trend is State Bank of India (SBI), which has moved faster and made more progress than other PSU banks to address the NPA issue, actually increased its share of lead corporate banking relationships to 6% of large companies in 2018 from 4% in 2016. SBI has also posted dramatic gains in cross-selling foreign currencies and trade finance to companies for which it is a top credit provider."
     
    "Even after recent mergers, it's apparent that the PSU banks need to consolidate in order to achieve the scale needed to compete as well as ensure that banks are investing in people, platforms and technology to effectively compete in the future," says Gaurav Arora, Greenwich Associates' head of Asia.
     
    As of 2016, 20% of large Indian corporates participating in the Greenwich Associates annual Corporate Banking Study said they used at least one PSU bank as a lead corporate bank. By 2018, that share had fallen to just 15%. The bulk of those relationships went to private sector banks, Greenwich Associates says.
     
    The market intelligence and advisory services-provider estimates that 92% of Indian companies will make a change to their corporate banking rosters in 2019. Ït says, "That shift is having a major impact on the competitive landscape for India's leading corporate banks. The 2019 Greenwich leaders in Indian large corporate banking are navigating a stressful and volatile period of transition, as the consequences of long-needed reform ripple through the marketplace. HDFC Bank and SBI top the list of local banks. Each is used for corporate banking services by roughly three-quarters of large Indian companies. Close behind is ICICI Bank, with a market penetration score of 71%. These three banks also secure the top spots among middle market banking companies, with HDFC in first place and ICICI and SBI statistically tied in the No. 2 spot."
     
    "In terms of quality, HDFC has differentiated itself from all competitors to claim the title of 2019 Greenwich quality leader in both large corporate and middle market banking. Among foreign banks, Standard Chartered Bank and Citi are tied statistically with a market penetration of 51%-54% among large Indian corporates, followed by HSBC at 50%. In the middle market space, among foreign banks, HSBC ranks first and Standard Chartered in second and Citi a close third."
     
    Given the current dynamics of the industry and the priorities of the new government, Greenwich Associates says it is becoming increasingly clear that restoring India's banking system to health is a priority. "The potential implications could range from privatization/consolidation, to setting stronger corporate governance structures, to guidance on technology infrastructure upgrades. But weak balance sheets and other immediate challenges are preventing PSU banks from making the long-term IT investments needed to compete for wholesale banking business in the future," it concluded.
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    COMMENTS

    Shweta Shetty

    2 months ago

    Can you also give a review of hdfc life.

    Shrikant Narayan Dhekne

    2 months ago

    Can maintaining banking relations be more important than or have priority over avoiding and reducing NPAs?

    Bankruptcy Code: Needs an Indian Solution to Issues
    On 4th July, instead of a celebratory statement at successfully navigating the penultimate hurdle in its bid to acquire Essar Steel, Arcelor Mittal issued a cryptic one-line press release: “We note today’s ruling by the NCLAT (National Company Law Appellate Tribunal). We need to review the full written order to understand any implications on completion of the transaction.”
     
    The ruling is not shattering for Arcelor Mittal. Having run the gauntlet of innumerable legal challenges by the Ruia group, it is clearly prepared for the issue to go up to the Supreme Court (SC) for a final verdict. 
     
    However bankers, who have been waiting for over 530 days and counting, are preparing to challenge the order in SC.
     
    The reason? The NCLAT order has puts secured and unsecured creditors almost on par. It suggests that lenders of secured loans do not have drastically superior rights to the money from the resolution process; they will have to share it more equitably with operational creditors as well.
     
    Bankers argue that the judgement is disastrous because it calls into question how credit markets work and how risk is priced.
     
    There is, indeed, great merit in this view and I started out agreeing with it. However, applying it rigidly, without taking into account the peculiarities of the Indian situation, would also be grossly unfair to operational creditors. 
     
    The story would have been different if banks had been prudent about their lending practices, not turned a blind eye to rampant diversion of funds, giving in to ‘phone’ calls from Delhi to allow repeated debt restructuring (with no claw back), massive write-offs, permit interest outstanding to pile up and, right at the beginning, turn a Nelsons’ eye to a massive padding of project costs. 
     
    One banker told us how a Rs800-crore project had been inflated to Rs1,300 crore and then to Rs2,000 crore in a group company by one of those involved in this very litigation. Banks, usually public sector banks (PSBs), have been complicit in this mischief.
     
    We have also seen how PSBs lent over Rs15,000 crore to Prashant and Ravi Ruia in Essar Investments against personal guarantees that are not backed by any significant security.
     
    Should operational creditors, who play a critical role in keeping the businesses running, pay a bigger price when the corrupt nexus between bankers-business-politicians goes unpunished? 
     
    Justice SJ Mukhopadhyaya’s order on 4th July has refused to allow the committee of creditors (COC), comprising bankers and asset reconstruction companies, to corner almost the entire Rs42,000 crore offered by Arcelor Mittal. The order disposed a large number of petitions, including those of a wide spectrum of operational creditors, whose continued association with the company after the resolution process began has kept Essar Steel going.
     
    The NCLAT order, in deciding to safeguard the rights of the operational creditors (including workmen, employees, and the large number of trade- and services-related creditors) notes that they are larger in number than financial creditors and are not fully listed. It asks the COC to take help from a professional and ensure distribution based on the percentage decided by the bench. This has been provided in a tabulated form. 
     
    There was another issue which is, in fact, to the credit of operational creditors who kept the company going and even earned a profit. Financial creditors had argued that the reason why ‘operational creditors’ were not assigned any claim in the resolution process was because they had done “business worth Rs55,000 crore during the pendency of the resolution.”
     
    There was also a discussion on how the profit earned during the pendency of resolution should be distributed; both financial creditors as well as the bidder, ArcelorMittal had laid a claim to it.
     
    The NCLAT order asks the RP (resolution professional) to file an affidavit providing details of this profit and distribute it among all financial and operational creditors on a pro rata basis. 
     
    There is, however, one legitimate issue that needs to be clearly resolved. A person familiar with the resolution says, “the order has left open a path for those trade creditors, not settled by this order, to renew their claims after the deal closes and Arcelor Mittal takes over Essar Steel. That would pose a huge problem, because the aggregate number of trade creditors, by value, is large. If the order does not provide for a clean break and clear acquisition, Arcelor Mittal could end up paying a higher cost and remain engaged in endless and expensive litigation.”
     
    That would cast a huge shadow on the entire IBC (Insolvency and Bankruptcy Code) process for larger companies, especially at a time when the long delay and never-ending litigation in Essar Steel is a matter of great embarrassment for the government which had promised swift resolution. 
     
    While we wait for the Supreme Court to clarify issues raised by the NCLAT order, it is important to note that the IBC has evolved and been amended fairly quickly to plug loopholes and provide clarity on issues while taking into account the Indian reality.
     
    In November 2017, after the very first and flawed resolution of Synergies Dooray Automotive Ltd, Debashis Basu wrote in the Business Standard, “One of the many flaws of the badly drafted IBC and the whole new bankruptcy architecture is that it did not take into account the very Indian possibility that promoters (and others) will try to game the system in many obvious ways.”
     
    IBC was amended twice since then. In 2018, it was amended to safeguard home-owners, who were left in a lurch by large realty companies, although they were making regular payments and held a signed agreement promising ownership to specific properties. The legislature, as well as the SC, backed them, despite vociferous protests and lobbying by lenders and builders who had argued that it would irrevocably damage the bankruptcy process. This issue is still open. Real estate companies have filed over 140 petitions challenging constitutional validity of this amendment.
     
    Another amendment to Section 2 made the IBC applicable to personal guarantors of corporate debtors and proprietorship firms and Section 29 A was also inserted to prevent defaulters from bidding for their own assets. 
     
    In recent months, NCLAT and SC have both provided the much needed clarity with regard to statutory dues claimed by revenue agencies. In the past, exorbitant tax claims and litigation by revenue agencies had always played spoilers to any corporate resolution. 
     
    In the Monnet Ispat case, SC (August 2018) held categorically that provisions of Section 238 of IBC will override anything inconsistent contained in any other enactment, including the Income-tax Act.
     
    In the Raj Oil Mills case, NCLAT, in a combined order (March 2019), decided that all statutory dues owed to revenue agencies would be treated as operational debt. 
     
    The order said, “As the income tax, value added tax and other statutory dues arising out of the existing law arises when the company is operational, we hold such statutory dues has direct nexus with operation of the company. For the said reason also, we hold that all statutory dues including ‘income tax’, ‘value added tax’ come within the meaning of operational debt.” It, however, allowed these agencies to initiate the resolution process to recover their dues. 
     
    A final resolution of the Essar Steel case is important, not only to set at rest issues raised by the 4th July NCLAT order, but also to signal that resolution provides a better alternative to liquidation, which will entail far bigger losses to lenders. 
     
    Indian PSBs’ bad loans stand at a massive Rs10 lakh crore+ and the NCLT is already bogged down with just 1,860 companies admitted for resolution so far, while an estimated 12,000 more await admission. 
     
    The task is humungous and it is important for everyone to ensure that it works at a time when several distressed asset companies from around the world remain interested in acquiring Indian companies and can provide an exit to our beleaguered lenders. 
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    COMMENTS

    vikram chinmulgund

    2 months ago

    A gentleman's word is his bond. If you borrow something- anything - you must keep your word and return it even at the cost of personal hardship.
    There is only one real way to deal with bankruptcy and losing other people's money. The borrower or business owner must work as hard and honestly as possible to repay the money by fixing the business or selling parts of it before value reduces to zero. If that is not possible the borrower must endure personal hardship to return the money he borrowed. What is borrowed must be returned or at least honest and strenuous efforts must be made to do so. Laws that are lakhs of words long to describe the same are lengthy in proportion to the vested interests and lobbies that seek to evade returning borrowings or to profit from bad borrowings in some alternate way.
    This is why business empires like the Godrej's or Tata's are trusted even though several of their businesses do flop. The family's word is it's bond.

    REPLY

    Pankaj

    In Reply to vikram chinmulgund 2 months ago

    To think like this is similar to living in fool's paradise. Indians are pathologically corrupt minded.

    vikram chinmulgund

    In Reply to Pankaj 2 months ago

    True. So how are more laws or code going to cure a pathological condition ?

    Godavari Joshi

    2 months ago

    The Operational creditors need to be taken care of because this class of creditors end up at receiving end by way of extended credit periods, forceful reductions in claim /invoice acceptances, cut throat procurement practices and so on. The Operation creditors are not as organised nor do they have the muscle power which a Secured Lender has. The Secured creditors, if they had monitored the Lending and the Recoveries in right earnest, the problems of NPAs would have not remain hidden for so long. The IBC cannot be used as a tool for injustice to Unsecured Creditors !
    The moot question is that IBC should take into account whether the Insolvency was resultant of misgovernance or was it indeed a business failure. Most of the cases coming up seem to be more of former. In that instant, let the Secured Lenders own up the responsibility and show accountability rather than ducking behind the Honest Tax Payers Umbrella! They only are wasting their depositors and the tax Payers money by endless Litigation.

    Prasanna

    2 months ago

    The issue at hand is whether Arcelor Mittal has bought "Assets" of Essar Steel under the IBC or has bought the "Business" of Essar Steel. If it is "Business" as a whole, then the terms of auction / bid under IBC would come into play to decide whether any creditors of Essar Steel follow into Arcelor Mittal. If it was "Assets" there is no question of any creditors of Essar Steel latching on to Arcelor Mittal. But by and large, our judiciary, comprising of courts and tribunals has to realise that world makes a mockery of the time required to resolve issues in India. If it continues, then what ever policies and programmes are implemented for growth, India will come a cropper unless Judiciary gets its house in Order. It was indeed sad to see time wasted in last 5 years at Supreme Court on issues which were at best unproductive.

    B. Yerram Raju

    2 months ago

    Sucheta Dalal and Debashis - both of you have flagged the right issues in IBC code. When the authors of the Law do not choose to keep the draft of such an important legislation for public views this is what would happen. Every law should be subject to Regulatory Impact Assessment in the Parliament's first session in the year to correct any aberrations as have been pointed out so that the subjects of Law get the full deal.

    SuchindranathAiyerS

    2 months ago

    Double Financing and over financing has been a standard top management Banking practice in India. Particularly in Public Sector Banks and with a wink and a nod from their masters, the Neta Babus,

    HARISH CHANDRA KOHLI

    2 months ago

    Missed Ticking the "Alert Me Box ..."

    HARISH CHANDRA KOHLI

    2 months ago

    This article brings to mind the recent news about Indigo owners and related party matter raised by Mr. Gangwal. Is it possible that some of the operational creditors of Essar Steel could be "related party" claiming money? I hope my understanding of the article is correct.

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