STATUS OF DUE DILIGENCE IN CORPORATE LENDING: ANJALI TRIPATHI

Introduction

 

Corporate Lending has been a part of corporate structure and business working since long. Various banks and financial institutions specialize in corporate lending and earn huge profits by lending money to corporate entities.

When we discuss corporate lending, the money lent to such corporate entities are solely for the purposes relating to operation, expansion or diversification of the business enterprise and not for any personal use. The amounts lent to corporates aren’t as small as that of the retail loans and thus, better safety solutions and stringent eligibility criteria have been undertaken to avoid losses.

In the previous years, India has witnessed a substantial growth in small and medium scale industries. The mushrooming of start-ups has also helped create job opportunities and entrepreneurial spirit amongst the youth. To ensure that such brilliant minds are not hindered by the lack of funds and that the flow of capital continue in the economy, various lucrative schemes for loans and corporate lending have been launched by the Government of India. In addition to this, various private sector banks are also making efforts to attract MSMEs and start-ups for lending.

However, the problem of bad debts and non-performing assets cannot be ruled out. The problem of NPAs has been since forever and that was one of the reasons behind the Liberalization, Privatization and Globalization policy. Thus, the concept of due diligence in corporate lending came into picture.

 

Due Diligence

 

Due Diligence refers to research and analysis which is undertaken before the acquisition, investment, business partnership and bank loans to access the risk involved and the value of subject of due diligence. These findings are then summarized in a report which is termed as due diligence report. This exercise is undertaken to analyse, foresee and minimize any possible risk that maybe involved in the transaction.

The saying that “finding the skeletons in the closet before the deal is always better than finding them after the deal” is true. This is the reason why corporate lenders and business enterprises undertake activities of due-diligence.

The due diligence reports help the financial institution understand and contemplate all the relevant information regarding the company and state of affairs in order to avoid risks which may be created by the transaction. Also, it is pertinent to note that the corporate lenders are expected to make sure that due diligence is exercised on their part before lending the amount. If it so happens that due diligence wasn’t taken into consideration and the same is proven in the court of law, the bank or financial institution’s ability to extract the unpaid amount is undermined.

 The idea of due diligence is based on 3 Ws-

1.     Who is the target audience?

2.     What is the objective?

3.     What are the aspects which will affect the decision making?

 

Corporate Lending and Due Diligence

 

In 2019, the Organization for Economic Co-operation and Development (OECD) had released a report concerning corporate lending and due diligence which was titled ‘Due Diligence for Responsible Corporate Lending and Securities Underwriting’.

In this report, the organization had compiled data and issued certain model guidelines for the multinational corporations, nation states and banks and financial institutions. According to OECD’s guidelines, the first and foremost purpose behind due diligence is to avoid causing or contributing adversely as an impact over the environment, people and society. However, it doesn’t rule out the possibility of cases whereby such impact cannot be avoided. In such cases, the need of due diligence is to mitigate any harmful effects or dire consequences which may occur and re-occur. The purpose of it is also to remediate any harmful effects of business transactions.

When discussing due-diligence in corporate lending, the aim and effort of the bank and financial institution is to identify risks and undertake a preventive approach which will caution the lenders against corporate entities which are likely to contribute and impact negatively to the growth of the bank or the lender. This helps in mitigating the mon-performing assets which may arise out of mismatched and poorly researched business lending.

In corporate lending, there are two types of due-diligence that are taken into view:-

1.     Legal Due-Diligence- Legal due-diligence mainly focuses on the legal and statutory aspects of the transaction to ensure that the legal checklist is full-filled. For a corporate organization to be eligible for corporate loan, the primary requirement of the bank is to adjudge the eligibility of the organization. These eligibility parameters are formulated by amalgamating the bank policy, the guidelines of the Reserve Bank of India and the statutory requirement. This type of due-diligence ensures the fulfilment of these requirements.

2.     Financial Due-Diligence- Financial due-diligence is to inspect and investigate about the cash flow, profitability and assets of the corporate entity to ensure that no unprecedented losses are created by the lending.

The extent of due diligence is varied in different transactions. It is dependent on the nature of bank, the nature and profitability of the organization/corporate borrower, the multitude of the deal and the objective behind the loan. The other characteristics of the deal also have bearing on the due diligence report. One of these characteristics include the duration for which the loan is granted.

The approach of different lenders also varies. These approaches are communicated the prospective borrowers through annual reporting, sustainability reports, websites or other means which may seem necessary to the bank or corporate lender.

 

Conclusion

 

It is important to understand that the banks and financial institutions may not always be in the best capacity to adjudge due-diligence. Their employees may not have the skill set which maybe required to ascertain the involved risks. Thus, the bank has the freedom to employ or collaborate with specialized organizations to promote proficiency in due-diligence and to ensure that all investigation of important facts is done in a professional and impeccable manner.

When the Indian economy is in despair due to the pandemic and NPAs are worsening, the aspect of due-diligence in corporate lending is important to ensure that the economy sails smoothly without unexpected hurdles and fall-outs.