Ever since the banking regulator issued a circular named as 'framework for compromise settlements and technical write-offs' on June 8, there has been a raging debate on the compromise settlement for wilful defaulters. A wilful defaulter is a borrower who wouldn’t pay back to the bank despite having the means to do so. This is different from a regular defaulter who falls in to a genuine financial stress and defaults on his loan.
What caused the public anger? According to paragraph 13 of the framework, the RBI said banks can undertake compromise settlements or technical write-offs in respect of accounts categorised as wilful defaulters. The part concerning permitting compromise settlement of wilful defaulters in this framework agitated bank trade unions and caused public uproar among a section of experts who flagged that the RBI is going back from its earlier June, 2019 circular that prohibited restructuring of loans.
The central bank has reversed its policy on wilful defaulters, they argued, saying letting wilful defaulters get a one-time compromise settlement deal will be against the interest of the banking system as wilful defaulters will connive with bankers to get a sweet deal and thus misuse the system, they said. These rections are understandable. Wilful defaulters have been a major head ache of Indian banks over years and many such cases involve an element of criminality or fraud.
Only that the outrage surrounding the June 8 framework is largely misplaced. To understand this, let’s look at the facts of this issue:
To begin with, the RBI permission for banks to engage in compromise settlement with wilful defaulters is not new. In fact, the master circular on wilful defaulters issued in July, 2015 as well as master direction on frauds issued in July, 2016 envisage compromise settlement by banks with a borrower whose account has been categorised as wilful default or fraud. Similarly, the RBI had advised IBA vide letter dated May 10, 2007 that banks may enter into compromise settlement with wilful defaulters. So, these rules are at least 15 years old.
Two: The June, 2019 circular was about restructuring of loans of wilful defaulter accounts, which is technically different from a compromise settlements. In paragraph 34 of the June, 2019 circular, the RBI said borrowers who have committed frauds or wilful default will remain ineligible for restructuring. That prohibition stays even now. The only exception is when the existing promoters are replaced by new promoters and the borrower company is totally delinked from such erstwhile promoters and management.
In such cases, lenders can take a view on restructuring such accounts based on their viability, without prejudice to the continuance of criminal action against the erstwhile promoters and management. So technically, the RBI hasn’t reversed its policy on wilful defaulter loan restructuring.
Three: Even in cases when banks can offer a compromise settlement to the wilful defaulter, other penal measures imposed on such parties don’t vanish. This include debarring such borrowers from any form of institutional finance for a period of upto five years, remain unchanged. Also, such compromise settlement should be done after getting Board permission without prejudice to the criminal proceeding underway against such borrowers. In short, the wilful defaulter, who may get a compromise settlement offer, cannot still go back to the lender for a fresh loan for five years and get no respite from the criminal proceedings due to possible fraud.
Four: The option to settle through the compromise channel is in fact good for banks as they can recover at least some money. Typically, the legal proceedings in such instances go on for years and there won’t be much left for the banks to recover at the end of the court drama. Hence, it will make sense to the banks to enter into a compromise and recover whatever money possible.
Five: Recovery from wilful defaulter accounts is important because the amount involved is substantial. Wilful defaulters owe major private and public sector banks Rs 88,435 crore, up from Rs 75,294 crore in a year, a Moneycontrol analysis of the latest data from banks and TransUnion CIBIL, a credit information company, showed. The list includes the country’s largest private-sector lender, HDFC Bank, and public sector banks (PSBs) such as Bank of Baroda (BOB) and Punjab National Bank (PNB). There is a lot at stake for banks here.
To cut a long story short, the RBI’s compromise settlement norms aren't new and, even when used, don't change the penal measures on wilful defaulters. More importantly, restructuring of wilful defaulter accounts remain prohibited unless management changes as per 2019 circular.
(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)
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