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Compromise and technical write-offs of defaulted accounts- A review based on the new RBI framework

A wilful defaulter is a borrower who refuses to repay loans despite having the capacity to pay up,” as per the definition. And, “A fraudster is one who intentionally cheats the bank with false documents/information and misappropriates the money.” Both are criminal offences. This article analyses whether the new framework issued by RBI is an easy route for fraudsters and wilful defaulters to escape from the rigours of law.


The word that is very often used in the common parlance of banks is stressed assets. Much has been done to solve this perennial headache concerned with the coagulation of stressed assets in the banks by both banks and government alike and as a result of their combined incessant efforts a positive beacon of light is reflected in the recent Financial Stability Report (FSR) released by RBI on 28th of June 2023 which stated that “Scheduled Commercial Bank’s Gross Non-Performing Assets (GNPA) ratio continued its downtrend and fell to a 10-year low of 3.9 per cent in March 2023 and the net non-performing assets (NNPA) ratio declined to 1.0 per cent.”[1] However, it is still too premature to heave a sigh of relief as the stressed assets are still a crisis that is jeopardizing the Indian economy.


What are stressed assets?

The Stressed assets are financial assets that have fallen behind on debt payments or are in danger of defaulting. The presence of stressed assets can have significant implications on financial institutions as the accumulation of non-performing loans can lead to a decline in the quality of a bank’s loan portfolio with far-reaching consequences that can even pose a threat to the stability of the economy. In simpler terms, the non-performing assets, written-off assets and restructured loans are grouped together as stressed assets.


As the menace of stressed assets increased in the banks and other financial organizations like NBFCs, the RBI devised the mechanism of compromise settlements with defaulters to enable the lenders to get back at least some money owed to them instead of writing it off. Prudential Framework for Resolution of Stressed Assets (PFRSA) was one such framework issued by RBI which recognises compromise settlements as a valid resolution plan for resolving the issue of Stressed Assets. Since the applicability of PFRSA was limited only to major financial organizations the RBI on June 08, 2023, issued the Framework on Compromise Settlement and Technical write–off with a view to providing further impetus to the resolution of stressed assets in the systems as well as to rationalize and harmonise the instructions across all Regulated Entity’s (RE) by widening the scope of Prudential Framework of Resolution of Stressed Assets.


The Compromise Settlement according to the framework is a negotiated arrangement with the borrower to fully settle the claims of the RE’s which would entail some sacrifice of the amount due from the borrower on the part of RE’s with corresponding waiver of claims of RE against the borrower. The aim of the RBI is to ensure a better recovery for lenders without any legal action being taken against the defaulter, by enabling multiple avenues for lenders to recover the money due to them without delay. This is very evident from the proviso of the framework which clearly states that “the objective shall be to maximise the possible recovery from a distressed borrower at minimum expense, in the best interest of the RE.” The RBI opined that “Apart from the time value loss, inordinate delays result in asset value deterioration which hampers ultimate recoveries, the Compromise Settlement can be considered as a valid resolution mechanism under the Prudential Framework of Resolution of Stressed Assets” and through this framework they intend to achieve this.


Unlike the guidelines or frameworks which existed before, the applicability of this framework is also very wide as it is applicable even to non-systemically important NBFC’s like housing finance corporations. Though the vision of RBI is very insightful, the framework is not immune from certain oversights which led to the stirring up of a hornet’s nest in the banking sector.


Point of concern

Immediately post the issuance of the framework it created a huge uproar in the banking sector with respect to the Framework’s treatment of accounts categorized as fraud and wilful defaulter. The provision of the framework states that “REs may undertake compromise settlements or technical write-offs in respect of accounts categorized as wilful defaulters or fraud without prejudice to the criminal proceeding underway against such debtors”. The All-India Bank Officers Confederation (AIBOC) and All India Bank Employees Association (AIBEA) criticized this move of RBI to enter into a compromise settlement with wilful defaulters and Frauds and issued a joint statement stating “that allowing compromise settlement for accounts classified as fraud or wilful defaulters is an affront to the principles of justice and accountability. It not only rewards unscrupulous borrowers but also sends a distressing message to the honest borrowers who strive to meet their financial obligations”.


The RBI was quick to defend this controversial provision and tried to assuage the concerns of the banking fraternity by stating that the provision enabling banks to enter into compromise settlement in respect of borrowers categorized as fraud or wilful default is not a new regulatory instruction and has been the settled regulatory stance for more than 15 years[2], with reference to the Master Circular on Wilful Defaulters and Master Directions on Frauds issued by RBI in the years 2015 and 2016 respectively and they also made it explicitly clear that the penal measures currently applicable to borrowers classified as fraud or wilful defaulter will remain unchanged[3].


The real issue is the intention of RBI which is marred with ambiguity and is dichotomous because the RBI states that compromise settlement with wilful defaulters and fraudsters is without any prejudice to their criminal proceeding, at the same time as per the framework they are treated on par with other stressed accounts, with the same protection from any fresh exposure during the period of compromise settlement, despite their extant penal proceedings. All this shows a lack of clarity regarding the treatment of wilful defaulters and fraud accounts. Also, RBI has seemed to have overlooked the fact that wilful defaulters are not borrowers with no means to pay back the default but wilfully chose to default. As per the report of the government to the parliament, the top 50 Wilful defaulters collectively owed Rs 92,570 crore to the Indian Banks as of March 31, 2022 with fugitive Mehul Choksi Geetanjali Diamond topping the list.[4]


Further, the recent statistics also indicate an alarming situation with the amount stuck in the wilful default category which has jumped by 41 per cent, or over Rs One Lakh Crore in the last two years from Rs 245,767 crore in December 2020 with more than 16000 wilful defaulters, according to data compiled by TransUnion Cibil, India largest credit information company registered with RBI[5]. Such disturbing statistics prove that any initiative to indulge in any sort of compromise settlement with wilful defaulters will only worsen the already existing crisis. As rightfully pointed out by the bank’s union any leniency towards such unscrupulous defaulters is an absolute travesty towards the hard work of the honest borrowers who work very hard to meet their financial obligation on time.


The RBI further tried to substantiate their stand by emphasizing that “Compromise Settlement is not available to borrowers as a matter of right, rather it is the discretion to exercise by the lenders based on their commercial judgement” which is also without any merit because ultimately the aim of any lender would be to make good any losses through any means,and thereby setting a precedent that anybody could default loans and easily walk away with a compromise settlement would hamper the faith of the public in the banking sector, which would be very detrimental.


Therefore, the treatment of accounts classified as fraud and wilful default should not be treated leniently nor should they be given an easy solution like compromise settlement or technical write-offs. A separate framework or guidelines with the time-bound recovery of the defaulted amount with strict penalties should be made or the existing Master Circular on Wilful Defaulters which merely states criminal proceeding can be initiated against wilful defaulters, should be made more stringent by defining a proper time bound mechanism on how to initiate a criminal proceeding, preliminary investigation measures that can be followed by the banks against wilful defaulters and also ensuring that the collaterals given by any borrowers are scrutinized thoroughly and finally Wilful Defaulters should be completely blacklisted from procuring any finances.


Conclusion

Overall, the Framework on Compromise Settlement and Technical Write-Offs seems to be an abrupt attempt from the side of RBI to bring down the levels of Stressed Assets in the economy. Although the justification provided by RBI that continuing such exposures against the wilful defaulters on the balance sheets of the lenders without resolution due to legal proceedings would lock lenders’ funds in an unproductive asset, which would not be a desirable position may look wise, still shaking hands with wilful defaulter who has the means to pay their debts for a compromise settlement is egregious. This move by the apex bank instead of thwarting the crisis of stressed assets may have the potential to serve as fodder for wilful defaulters to continue their shenanigans. Ultimately the efforts of the honest borrowers who struggle to repay their debts would have no value which is a very undesirable position for a growing economy like India.


Adv Varsha Menon

Jr Associate, Artis Law House.

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