Diversion, Siphoning of funds Its meaning and Implementation


7th July, 2012

By Capt. Haren Mahapatra

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Considering the concerns expressed over the persistence of willful default in the financial system in the 8th report of the Parliament's standing Committee on Finance/ Financial Institutions, the Reserve Bank of India (RBI) had, in consultation with the Government of India, constituted in May 2001 a Working Group on Willful Defaulters (WGWD) under the chairmanship of SS Kohli, the then Chairman of the Indian Banks' Association, for examining same of the recommendations of the committee. The group submitted its report in November 2001. The recommendations of the WGWD were further examined by an in-house working group constituted by the RBI which advised their implementation with immediate effect.

It was decided that the terms 'diversion of funds' and 'siphoning of funds' should be considered to mean the following: Diversion of funds, referred to above, would be construed to include any one of the under-noted occurrences:

a. Utilisation of short-term working capital funds for long term purposes not in conformity with the terms of Sanction;

b. Deploying borrowed funds for purposes/activities or creation of assets other than those for which the loan was sanctioned;

c. Transferring funds to the subsidiaries/group companies or other corporate by whatever modalities;

d. Routing of funds through any bank other than the lender bank or members of consortium without prior permission of the lender;

e. Investment in other companies by way of acquiring equities/debt instruments without approval of lenders;

f. Shortfall in deployment of funds vis-a-vis the amounts disbursed/drawn and the difference not being accounted for.

Siphoning of funds, referred to at Para 3(c) of the circular dated May 30, 2002 above, should be construed to occur if any funds borrowed from banks/Fls (Financial institutions) are utiliesd for purposes unrelated to the operations of the borrower, to the detriment of the financial health of the entity or of the lender. The decision as to whether a particular instance mounts to siphoning of funds would have to be a judgment of the lenders based on objective facts and circumstances of the case.

This circular has gone through clarifications and amendments, and the relevant parts listed below: At present, banks/FIs are required to form a committee of higher functionaries headed by the bank's Executive Director for classification of borrowal accounts as willful defaulters and create a redressal mechanism in the form of a committee headed by the bank's Chairman & Managing Director for giving a hearing to borrowers who have grievances on their classification as 'willful defaulters' Representations have been received that redressal of grievances after the event is not fair in view of the damage to the reputation that cannot be easily reversed. The suggestion was that an opportunity be provided to the defaulter to be heard before being declared as such.

It is, therefore, clarified: The classification of borrowal accounts and the redressal mechanism are two distinct processes comprising (i) identification of defaults as willful with clear-cut reasons; and (ii) providing an opportunity to the borrower to make a representation before being classified as a willful defaulter.

In realization of the damage that not only affects the directors and guarantors of the company but also to its assets and the employees, the RBI has been absolutely clear in no uncertain terms that it is only meant for a willful defaulter in its true letter and spirits and not to be used as a tool to exert pressure on an innocent borrower whose account has slipped into NPA (non-performing asset) status due to reasons beyond the control of the promoters.

With special reference to routing of funds through any bank other than the lender bank of members of consortium without prior permission of the lender, when an account becomes NPA, the account is obviously over-drawn, any amount deposited thereafter in the same account is generally adjusted and no drawl is allowed. Sometimes, the banks allow 'holding on operations' thereby retaining a percentage of the deposit and allowing withdrawal of the balance amount. From our experience of our association members, this is usually not per mitted, so also opening of the account with another bank. In this regard, maximum complaints have been received against the biggest lender, the State Bank of India.

This being the case, how does the unit meet the statutory payment obligations, especially which are required to be routed through a Bank account? The borrower then has no other choice but to open an account in another bank. This is mostly relevant for the micro, small and medium enterprises (MSMEs) which operate with single banks. In consortium banking, the borrower has the liberty to route through any account which is not NPA.

The requirement of a bank account is essential for any company even after the account is NPA. Under such circumstances if transaction is carried out in another bank by opening an account due to above reasons, it should not be construed as diversion/siphoning of funds. Merely opining an account in another bank under compulsion as stated above and transacting the company business should not attract the provisions of diversion of funds or siphoning of funds.

Further, diversion/siphoning of funds should be specified in details with the occurrence mentioning the amount involved, the date, time, etc. Since this could only happen when the account is in operation, it is relevant here that the bank must identify such incidence then and not after many years of NPA when there are no operations in the account.

The RBI has also indicated in clause Nos. 7 & 8 of the circular of May 30, 2002 advising the banks that such provisions should not be misused and a solitary or isolated instant is not made the basis for imposing the penal action. The bank/Fls should also consider the track record of the individual company in such cases.

Realising the penal provisions being highly detrimental to the borrower and the company, due care must be exercised to ensure that no innocent borrower is punished through wrongful declaration of willful defaulter specially with regard to siphoning and diversification of funds by opening account in any bank other than the lender.

Suggestive measures:(a) The incidence of siphoning/diversion of funds must be specified in details with date, time, amount involved, etc; (b) The incidence must be reported within 30 days of occurrence since all accounts are monitored on daily basis by the bank/Fls; (c) After initiation of legal action when the matter is sub judice, the declaration of willful defaulter must be left to the decision of the courts and not exercised by the bank/Fls arbitrarily; (d) In case a suit/counter claim has been filed by the borrower, the declaration of willful defaulter which is a coercive measure must necessarily wait till the final verdict of the court has been pronounced; (e) The committee to decide on declaration of willful defaulter must include a senior officer of the bank/FL, an RBI officer, an officer of the MSME Department and an office-bearer of the applicable association to which the borrower belongs; (f) The final decision of the committee must be communicated to the borrower. In case of the decision of the committee to declare him as a willful defaulter, a notice of 90 days must be provided to him so that he has the liberty to appeal to the appropriate court of law.

By all means penalize a willful defaulter involved in fraudulent transactions when established. But an innocent MSME borrower, who is a part of the growth engine of the nation generally struggling for existence encountering enormous day-to-day impediments, must never be pressurized and exploited unfairly under the subject of diversion and siphoning of funds.

[The writer is the Working Chairperson of the Entrepreneurs & Finance Customers Association of India - EFCAI]