Diversion of Funds and Siphoning of Funds

What is Diversion of Funds?

Diversion of Funds means (mis)utilization of Funds for a purpose for which loan was not sanctioned. Most common example is buying immovable property out of the Cash Credit Limit, which is being sanctioned for working capital purposes.

• Utilisation of short-term working capital funds for long-term purposes not in conformity with the terms of sanction;

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

• Transferring borrowed funds to the subsidiaries / Group companies or other corporates by whatever modalities;

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

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

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

What is Siphoning of Funds?

If any funds borrowed from banks are utilised 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 amounts to siphoning of funds would have to be a judgment of the lenders based on objective facts and circumstances of the case.

How to monitor/ verify of End-Use of Funds

Diversion of funds or siphoning of funds can be detected if end use of funds is being monitored/ verified periodically. Following are some of the illustrative measures that could be taken by the lenders for monitoring and ensuring end-use of funds:

• Meaningful scrutiny of quarterly progress reports / operating statements / balance sheets of the borrowers;

• Regular inspection of borrowers’ assets charged to the lenders as security;

• Periodical scrutiny of borrowers’ books of accounts and the ‘no-lien’ accounts maintained with other banks;

• Periodical visits to the assisted units;

• System of periodical stock audit, in case of working capital finance;

• Periodical comprehensive management audit of the ‘credit’ function of the lenders, so as to identify the systemic-weaknesses in their credit administration.

This list of measures is only illustrative and not exhaustive. The same depends on the nature of finance, nature of business and other internal and external factors.

RBI has suggested that banks should not depend entirely on the certificates issued by the Chartered Accountants but strengthen their internal controls and the credit risk management system to enhance the quality of their loan portfolio.