Despite Spending More on Audits, State Banks Worst Hit By Fraud

India's government-owned banks have a problem: they spend much more money on audit checks compared to private lenders. Yet, they account for most of the banking frauds in the country, led by Bank of Maharashtra.

That's according to a new report by proxy advisory firm Institutional Investors Advisory Services. The high audit fees in public sector banks are a function of large number of branches, multiple auditors, higher number of physical audits and Reserve Bank of India prescribed rates, IiAS said in its report. "Despite paying high audit fees, the quantum of fraud in public sector banks tend to be much higher."

The median number of auditors at state banks is six, according to the report that collated data for the year ended March 2017. For their private peers, the median is one.

Another reason is the high amount of physical auditing at PSU banks. Private banks have a higher level of automation, hence, the advances are only given from the head office. These can be scrutinised without having to visit a bank branch physically. On the other hand, PSU bank have decentralised branches that give loans and require physical audits.

India's banking sector has been most recently hit by a near Rs 12,700 crore where firms linked to billionnaire jeweller Nirav Modi and his firms allegedly got fraudulent loan guarantees from Punjab National Bank Ltd, without the lender knowing. The Central Bureau of Investigation has filed two money laundering cases against Modi and his uncle, Mehul Choksi. A global arrest warrant against the two has also been notified to the Interpol.

The scam has reignited debate about the governance standards and quality checks at state-owned lenders in the country.

The Worst-Hit Banks

Despite paying higher fees, audit quality at PSU banks has failed to improve, IiAS said. The Indian banking sector reported 12,533 frauds in financial year 2017 – the largest contribution coming from Bank of Maharashtra, a state-owned bank.

Even the quantum of frauds is higher. The 12,533 frauds were worth Rs 18,170 crore. More than 75 percent of those were at government banks, excluding India's largest public lender State Bank of India.

The focus now needs to shift towards strengthening the audit quality by plugging process gaps and streamlining the checks and balances.

IiAS report 

(This article was first published on BloombergQuint)