Non-performing assets (NPAs) is a well-known menace in the banking industry. These NPAs, simply known as bad loans, have been an integral part of the banks’ balance sheets and its soaring percentage, when uncontrollable, has wiped out many banks from the banking scene. These bad loans don’t take much time to behave as termite on any lending institution to eat-up its fundamentals when left unattended.
Banks, under the guidance of their regulator – RBI, have been continuously engaged in tailoring and devising strategies to control their level of NPAs and they regularly come up with schemes containing some relief measures to lure the defaulting borrowers to go for settlement of their bad loan accounts. However, defaulting borrowers categorised as wilful and fraud borrowers were not included under the ambit of these compromise and settlement schemes till few weeks back.
It was on June 8, 2023, when the Reserve Bank of India (RBI) created ripples in the market by announcing a major relief to the wilful defaulters and also to those borrowers whose loan accounts have been declared fraud. The RBI issued a framework for compromise settlements and technical write-offs. One of the provisions in the said framework allowed the Regulated Entities (REs) to undertake compromise settlements or technical write-offs in respect of accounts categorised as wilful defaulters or fraud. However, the directions don’t exonerate these kinds of borrowers from the criminal proceedings initiated against them.
The historical announcement by the RBI has ignited debate in the market, particularly in the banking circles and got a mixed reaction. A section of experts in the industry hailed the RBI’s boldness to allow banks to enter into a settlement with the wilful and fraud defaulters to unlock thousands of crore of rupees blocked in such accounts. There is also a strong section of experts who have criticised the move and called it “not only rewarding to unscrupulous borrowers but also sending a distressing message to honest borrowers who strive to meet their financial obligations.”
Remarkably, All India Bank Officers’ Confederation (AIBOC) and the All India Bank Employees’ Association (AIBEA) in a joint statement released for public consumption stated that “the compromise settlement for fraud accounts is an affront to the principles of justice and accountability, and the RBI’s move came as a “shocker.”
However, the apex bank states that the said provision enabling banks to enter into compromise settlement in respect of borrowers categorised as fraud or wilful defaulter is not a new regulation. It’s a long-standing regulatory stance for more than 15 years. It was in May 10, 2007, that banks were allowed to enter into compromise settlement with wilful defaulters/fraudulent borrowers while criminal proceedings are ongoing.
The RBI’s Master Directions on Frauds dated July 1, 2016 provides for compromise settlement with borrowers classified as fraud, subject to the condition, “No compromise settlement involving a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued.”
Meanwhile, the RBI’s framework to recover money from these wilful and fraudulent borrowers would bring significant benefits to the banks and other lenders in the country’s financial system. The recoveries will help the lenders to free up their capital for more productive use and make their balance sheets strong.
What are the exact RBI guidelines permitting banks to undertake compromise settlement of wilful defaults and fraud accounts?
The term ‘Compromise settlements’ refers to fully settling borrower claims in cash, which may require Registered Entities(REs) such as banks to sacrifice some portion of the amount due with a corresponding waiver of claims against the borrower. However, the REs may undertake compromise settlements or technical write-offs in respect of these accounts without prejudice to the criminal proceeding underway against such debtors.
The framework outlines the reporting mechanism, a cooling period for borrowers subject to compromise settlements, and the treatment of accounts categorized as fraud and wilful defaulters. Further, the framework has mandated the REs to establish board-approved policies for undertaking such settlements with the borrowers.
After the initial reaction of the market players to the framework for Compromise Settlements and Technical Write-offs circular, issued on June 8, 2023, the RBI has now explicitly explained the contours of the schemes.
The objective would be to maximise the possible recovery from a distressed borrower at minimum expense, in the best interest of the Regulated Entity (RE).
The scheme envisages a cooling period to be determined by the respective board-approved policies before the REs can assume fresh exposures to such borrowers.
The cooling period in respect of exposures other than farm credit exposures would be subject to a floor of 12 months. However, the REs are free to stipulate higher cooling periods in terms of their Board approved policies. The cooling period for farm credit exposures would be determined by the REs as per their respective Board approved policies.
Notably, the framework doesn’t dilute the penal measures applicable to borrowers classified as wilful defaulters or fraud and shall continue to be applicable in cases where the banks enter into compromise settlement with such borrowers.
The penal measures include, among others, the prohibition of any bank or financial institution from granting further additional facilities to borrowers identified as wilful defaulters.
Furthermore, borrowers classified as fraudsters will be ineligible for bank financing for a duration of five years starting from the date when the defrauded amount has been fully repaid.
There are also key safeguards to ensure that the provisions of compromise settlement with borrowers are not mis-utilized. It’s worth mentioning that the compromise settlement is not available to borrowers as a matter of right; rather it is a discretion to be exercised by the lenders based on their commercial judgement.
Precisely, the main objective of this framework, as stated by the RBI, is to facilitate prompt recovery of defaulted money to minimize time value loss and prevent asset value deterioration. Compromise settlement is acknowledged as a valid resolution mechanism for stressed assets, including those involving fraud or wilful default.
Precisely, the scheme aims to facilitate the efficient resolution of cases while ensuring that necessary due diligence and oversight are in place to protect the interests of the banks and the financial system as a whole.
Who is a wilful defaulter?
Basically, the defaulters are categorised into “wilful” and “non-wilful” defaulters. The Reserve Bank of India has already made differentiation between the two to delineate those who were deliberately using the banking system to defer paying back dues from those who genuinely fell into the debt trap. Those who defer paying back their loans despite having financial capability to repay are wilful defaulters. The borrowers who suffer on a financial front due to unavoidable circumstances and are genuinely unable to repay their dues on time are non-wilful defaulters.
So, wilful defaulters are the entities that do not pay back money despite the ability to do so. As per the RBI’s Master Circular , a borrower is a Wilful Defaulter when he does not meet his obligations even when he can do so; does not utilise funds for the specific purpose they were availed, nor has it in another form of assets, siphons the funds, disposes of the property or assets which were given for securing the loan without the knowledge of the lender, misrepresents and falsified reports and fraudulent transactions.
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The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.