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Bank executives around the world have discerned the value of having adequate KYC controls in place to know their customers. A potent aspect of these controls is due diligence on the existing and prospective customers. The banks can become subject to operational, legal and reputational risks, without sufficient due diligence. In general terms, due diligence is a process of analysis and research that is initiated before a business partnership, acquisition, bank loan, or investment to evaluate the worthiness of the subject or identify the major issues involved. This write-up accentuates the importance of due diligence for banks.
Often, when the company wants to get the credit facilities from the Banks, they are asked to provide a due diligence report, or the bank may itself get it prepared from professionals. The Notification issued by the Reserve Bank of India dated 2nd February 2009 via Notification no. DBOD. NO. BP.BC.110/08.12.001/2008-09 prescribes about the due diligence reports from the professionals, specifically the Company Secretaries. The Notification has mandated the due diligence for lending under Multiple Banking arrangements or Consortium arrangements.
In paragraph 2(iii) of the above circular, RBI has stated the purpose of strengthening the information sharing system amidst banks in regards to the borrowers leveraging credit facilities from multiple banks. Thus, the banks are required to attain certification from a professional, preferably a Company Secretary concerning the compliances of numerous statutory prescriptions that are in vogue, as given in Annex III to the circular.
In addition to the Company Secretaries, the banks can also obtain the certification by a Cost Accountant or Chartered Accountant. The rapid pace in developments has called for a robust due diligence mechanism for Banks.
The motive of the due diligence report for banks is to scrutinize the records of a borrowing company and assess its conduct as a corporate entity from the legal perspective. Here are the ways in which the due diligence for banks is an efficient tool to truly determine the borrower entity:
Documentation plays an essential role in the process of due diligence. Banks must incorporate the approach of due diligence with professional assistance to identify and ascertain the status of compliance and governance with provisions, thus gain a fair idea of the borrower’s functions. It will not only help to evaluate the financial position of the borrower, but also know the standard of business being conducted by the borrower. If there is a lack of proper diligence, some potential risks may incur like the company not using the funds for the purpose it was borrowed, diversion of funds, legal and regulatory risks, etc.
The importance of due diligence for banks is beyond measurement, so let’s look at the right approach to make due diligence report:
As mentioned earlier, the inadequacy of due diligence for banks and other financial institutions can be a massive threat in operational, legal, and reputational terms. Bank shall have to face the following risks.
All the financial institutions and banks have to take exclusive measures to mitigate the risks mentioned above. Banks should pay special attention to all the large, complex, or unusual transactions or patterns of transactions that have no apparent lawful or economic purpose.
An ideal report of due diligence for banks must include the clauses stated below:
Financial institutions and banks are most vulnerable to external threats, so it’s better to be vigilant and take necessary measures beforehand. Due diligence for banks is crucial to know their borrowers in a better way.
You can take the assistance of Enterslice experts to prepare a due diligence report as we have competent and experienced Chartered Accountants and lawyers.
Read, Also: Financial Due Diligence / Accounting Due Diligence.
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