Auditors Liability for Willful Default: Prudential Norms by RBI

It is often observed that the Indian management system adopts the method of defining responsibilities and punishments rather than analyzing and solving the problem.
It also continues in our banking system because it is often found that bankers do not take their responsibilities seriously and rather choose to do the official work conveniently.
This is where the concept of wilful default takes place. The article below briefly discusses the overview of recent RBI Guidelines on Willful Defaulters notified by the Reserve Bank of India with respect to the liability of auditors for willful default.

Key Abstract

A lot of times it is observed that borrowers with many years of standing are branded as a wilful defaulters eventually when their accounts are declared as Non-Performing Assets (NPA).

This declaration is done on the basis of the transactions that are conducted prior to such classification of the concerned account as NPA.

Bank Audits

Banks are subjected to several audits such as statutory audits, internal audits, Special audits, RBI audits, timely departmental inspection by the officers of the bank, and duly review of accounts, etc. Some big branches of the bank also have concurrent audits. 

Recent Notification

Reserve Bank of India (RBI), on April 1, 2022, came up with a Master circular “RBI/2022-23/15 DOR.STR.REC.4/21.04.048/2022-23”.
Through this circular RBI restated the asset classification (IRAC), income recognition, and the provisioning/prudential norms.

Outline of Notification

RBI issued this Circular to mention and define the role of the auditor in case of willful default.  This circular was reinstated by the Reserve Bank of India (RBI) in furtherance of a circular that was notified on July 1, 2014, with the title “DBR. No. CID. BC.57/20.16.003/2014-15”. 

Concerning Issues

Chartered Accountants are one of the most trusted professionals and their reports are accepted as evidence of correct figures by banks. Eventually, financial statements that are duly audited by CAs are valued for their fair view and true state of affairs.
There are cases when customers of the banks do not engage with the lenders and default in repayment of dues despite having the ability to pay.
Such cases defeat the effort of the lenders in recovering their dues because they are not provided with the necessary information.
This procedure to establish transparency is usually disturbed because of denial in giving access to financed assets, financed collateral securities, obstruction in the sale of securities, etc. 

Conclusively, customers become non-cooperative borrowers by disturbing the efforts of lenders in recovering the dues.

Responsibility of Auditors 

The circular mentions some responsibilities of Auditors against such customers that make willful default in repayment such as;

• In case banks or financial institutions observe any kind of falsification in accounts on the part of the borrowers, and
• It is noticed that the auditors were negligent in conducting the audit properly,

If the above two conditions are satisfied then such banks or financial institutions (FIs) are mandated by the circular to file a complaint against such auditors of the borrowers with ICAI (Institute of Chartered Accountants of India).

Lodging a complaint would make the ICAI responsible to intervene, examine and consider answerability from such auditors. 

Reserve Bank of India through this master circular reinstates the instructions against willful default and provides for stricter compliance with the earlier circular that was issued back in 2014.

This circular also mentions that if any disciplinary action is pending by ICAI against any auditor, then such complaints should also be forwarded to the Central Office of the Department of Banking Supervision (RBI) and IBA for the purpose of the record of such proceedings.
IBA would then take a record of such CA firms against whom complaints are registered and circulate their names to all banks so that the banks know their past record before assigning them any work and associating with them. 

RBI would also circulate such information with regulators of the financial sector, MCA (Ministry of Corporate Affairs), and CAG (Comptroller and Auditor General).

Non-Cooperative Borrower

Non-cooperative borrowers are individuals who escape their duties of constructively engaging with their lenders by making defaults in the repayment of dues.
Such borrowers do not clear the dues while being capable to pay. The circular mandates some regulations and provides some rules when the borrowers try to escape from their liability and try to fail the efforts of lenders in the recovery of dues.

Willful Default

The circular DBR.No.CID.BC.57/20.16.003/2014-15 which was issued on July 1, 2014, defines willful default as follows;

If any following events are satisfied, then in accordance with the circular, willful default would be considered to have happened-

• There is default by the borrower in discharging its obligations of payment and repayment to the lender and it is proved that such a unit capable to clear the dues and obligations,
• When the borrower does not utilize the funds for the purposes for which they were borrowed but rather use the funds for some purposes,
• If the borrower siphons off the finances and funds and uses them neither for the particular purpose for which they were availed nor to let the funds be available with the themselves in form of assets, etc.,
• When the borrower disposes of the immovable property or any fixed movable assets provided by them for securing a loan without any knowledge of the lender or the bank. 

Diversion of Funds 

The circular includes some regulations for the practice of diversion of funds. It may include any of the situations as are mentioned below;

• Utilizing funds of short-term working capital for long-term objectives that are not in accordance with the terms and conditions of sanction,
• Disposing of borrowed funds for purpose of creating assets other than the assets for which the loan was sanctioned,
• Transfer of borrowed funds to the Group companies or subsidiaries or other corporates by various modalities,
• Routing funds through a bank other than the members of the consortium or the lender bank without prior permission of the lender,
• Investing in other companies by acquiring their equities or debt instruments without any approval by the lenders,
• Defectiveness in the transfer of funds and amounts that were drawn and there is no accountability for the difference in the funds by the borrower or the auditor.

Siphoning of Funds

The master circular defines that siphoning of funds can be considered to have occurred when any finance or fund borrowed from banks or any financial institution is utilized for other purposes that were not listed by the borrower during the sanction.
The circular provides that to find out if the funds are siphoned, the lenders must analyze the facts and circumstances of the situation and then make a decision on which action can be taken.
Willful default should be identified by the past track record of the borrowers and it may not be appropriate to take pick transactions and name them siphoning of funds.
If the default in payment of dues is to be categorized as willful, the circumstances must show that it was intentionally and deliberately done, and all the possible consequences were priorly calculated by the borrower.

Identification of Willful Defaulters

The transparent structure of identifying willful defaulters should generally include;

• The evidence of willful default by the borrowers,
• Evidence of willful default by the promoters or directors at a specific duration,
• Examination of willful default by a committee led by an executive director and two other senior officers,
• If the committee concludes that wilful default occurred then the such committee would issue an SCN (show cause notice) to such borrower, director, or promoter to explain the nature of circumstances,
• After considering their submissions, an order would be issued with a record that willful default occurred, with reasons for the same,
• If the committee finds it necessary, an opportunity would be given to the promoter, director, or borrower for a personal hearing,
• Lastly, the order passed by the committee would be reviewed by one other committee that would be presided over by a chairman in addition to 2 independent directors of the Bank,
• The order shall be finalized after it is confirmed by the review committee.

Final Words

Conclusively, it is very important to make disciplinary actions effective because auditors are one of the most trusted entities. These regulations by the banks are also significant because such defaults directly affect the structure of lending and repayment.
However, for implementing these guidelines it is also important that the basis of such speculations about the auditors and the borrowers are made on valid proofs and for following a policy of expediency and not just on a distinct incident of transaction default.