The Forensic audit blueprint for taking NPL head-on

Illustration: TBS

Non-Performing Loans (NPL) will undoubtedly emerge as the victor among the plethora of issues plaguing the banking industry in Bangladesh. 

Several research investigations have discovered that a forensic audit might serve as a useful tool in identifying the root cause of non-performing loans (NPLs) and implementing various strategies to dissolve the issue as quickly as possible. 

With their thorough examination of financial records, transactions, and operational processes to uncover irregularities, fraud, and vulnerabilities in the lending process, forensic audits can be crucial in reducing non-performing loans (NPLs) in Bangladesh. 

Non-performing loans can greatly impact the stability of the financial system, and a forensic audit can be a proactive measure to address the underlying reasons for loan defaults. Using pertinent examples from the Bangladeshi context, we will examine how a forensic audit might accomplish this goal in this talk.

Locating fraudulent conduct
Finding fraudulent activity that contributes to non-performing loans is one of the main benefits of a forensic audit. Financial theft and loan diversion are only two examples of the many ways that fraudulent practices can occur in Bangladesh, as they do in many other nations. An example of this would be if a company obtained a loan for growth only to utilise the money for secret endeavours or personal expenses.

A forensic audit would carefully review financial accounts, transaction records, and supporting paperwork to determine how loans were used. Corrective action can be taken to recoup stolen funds and stop such incidents in the future if anomalies are found. This improves the lending process's integrity and lowers the percentage of non-performing loans.

Assessment of credit risk
The efficiency of credit risk assessment procedures used by financial organisations may be evaluated through forensic audits. The reduction of non-performing loans in Bangladesh is contingent upon guaranteeing that loans are issued to eligible borrowers. When loans are given to high-risk borrowers due to weaknesses in risk assessment, the probability of default rises. 

Through forensic auditing, weaknesses can be found, and solutions can be suggested by examining loan approval procedures, collateral appraisal techniques, and credit score models. For instance, the audit may suggest putting in place more thorough risk assessment processes if it turns out that a bank approved loans without doing a sufficient assessment of the borrower's financial stability.

Imagine that there is a spike in non-performing agricultural loans at a commercial bank in Bangladesh. It could turn out, via a forensic audit, that the bank's risk assessment overlooked things like projected crop yields and market circumstances. The bank might then amend its credit risk assessment standards to guarantee a more thorough examination that takes into account pertinent industry-specific elements.

Discovering insider collusion
One major risk factor that contributes to non-performing loans is collusion between bank personnel and borrowers. Like in other nations, insider collaboration might take the form of unapproved loans, special treatment for friends and family, or manipulated loan conditions. 

Forensic audits investigate communication logs and transactional information to find patterns suggestive of cooperation. Financial institutions can bolster internal controls, put in place checks and balances, and discipline staff members involved in fraudulent activity when they find these abnormalities.

For instance, let us assume that a bank in Bangladesh has a string of non-performing loans to companies owned by bank personnel. Evidence of preferential treatment, such as advantageous lending rates or loosened collateral restrictions, may be discovered during a forensic audit. As a reaction, the bank may fire those who were involved, tighten internal procedures, and take action to stop collaboration in the future.

Reviewing loan documentation
Forensic audits carefully review loan documentation to ensure that it complies with corporate standards and regulatory requirements. Inaccuracies or falsified documents in Bangladesh may conceal borrowers' financial situation, leading to non-performing loans. 

For example, debtors may provide fraudulent financial statements to get more loans than they can realistically repay. A forensic audit can find irregularities and suggest steps to improve the quality and dependability of loan paperwork by carefully reviewing loan agreements, financial accounts, and collateral documents.

Let us examine an instance where a Bangladeshi real estate developer secures financing using exaggerated assessments of properties. A forensic audit may uncover discrepancies between reported property valuations and their true market value. The financial institution can then introduce more stringent paperwork verification procedures, update its valuation methodologies, and independently verify property values.

Strengthening internal controls
Forensic audits assess the general efficacy of internal controls in financial organisations. Inadequate internal controls may be a factor in fraudulent reporting, unlawful activities, and other anomalies that result in non-performing loans. Internal controls must be strengthened to ensure the integrity of the loan process in Bangladesh. 

The results of a forensic audit may be used to establish strong internal control procedures, such as job separation, frequent internal audits, and the use of technology to track transactions and quickly identify irregularities.

Let's say unapproved withdrawals cause a bank in Bangladesh to suffer a string of non-performing loans. Weaknesses in the bank's internal controls, such as insufficient task segregation and transaction activity monitoring, might be uncovered by a forensic audit. After that, the bank might strengthen its internal controls by tightening access restrictions, doing frequent internal audits, and using technology to track transactions in real time.

Optimising monitoring mechanisms
Post-loan monitoring systems are essential for spotting early warning indicators of possible defaults. The efficacy of these procedures may be evaluated through forensic audits. In Bangladesh, preventing non-performing loans requires closely observing borrowers' financial situation following loan issuance. 

Weaknesses in the monitoring process, such as insufficient lines of contact with borrowers or delays in recognising declining financial situations, might be brought to light by a forensic audit. The audit's recommendations may result in the deployment of more proactive monitoring systems, such as frequent evaluations of borrowers' financial health and prompt correspondence with those who have issues.

Take a hypothetical scenario where a commercial bank in Bangladesh is dealing with a high percentage of non-performing loans from the small and medium-sized enterprises (SMEs) industry. The results of a forensic audit may indicate that the bank's monitoring systems did not sufficiently detect early warning indicators of financial hardship for SME debtors. 

The bank might then improve its monitoring procedures by putting in place frequent financial health examinations and creating a specialised staff to communicate proactively with borrowers who are having financial difficulties.

Ultimately, a forensic audit can dramatically reduce the number of non-performing loans in Bangladesh by addressing fraudulent activities, assessing credit risk assessment procedures, revealing insider collusion, examining loan documentation, fortifying internal controls, and improving monitoring mechanisms. 

Through forensic audit suggestions and real-world case studies, financial institutions in Bangladesh may enhance their lending practices, reduce risks, and enhance the overall stability of the banking industry.

SK Shamim Iqbal, a Certified Expert in Credit Management (CECM), currently serves Social Islami Bank Limited (SIBL) as a faculty member at its training institute.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.