Compromise Settlement for Wilful Defaulter: RBI | 14 Jun 2023

Why in News?

Recently, The Reserve Bank of India (RBI) has introduced a circular allowing wilful defaulters and companies involved in fraud to opt for compromise settlements or technical write-offs.

• The circular provides guidelines for banks and finance companies in handling such cases.

What are the Key Points Related to Circular?

• About the Circular:
  • Compromise Settlements and Technical Write-Offs:
    • Banks and finance companies can undertake compromise settlements or technical write-offs for accounts categorized as wilful defaulters or fraud, irrespective of ongoing criminal proceedings against the debtors.
    • The RBI's circular enables these settlements while ensuring that criminal proceedings remain unaffected.
  • Cooling Period for Fresh Loans:
    • Banks are required to impose a minimum cooling period of 12 months before granting fresh loans to borrowers who have undergone compromise settlements.
    • The cooling period also applies to exposures other than farm credit, with regulated entities having the authority to set longer cooling periods based on their board-approved policies.
• Concerns:
  • Potential Loss of Public Money:
    • Banks have previously approved compromise settlements resulting in significant losses due to substantial haircuts on outstanding payments.
    • There are concerns that allowing compromise settlements may encourage big fraudsters and defaulters.
    • Allowing compromise settlements will bring low NPA artificially, even though financial policies are unstable.
    • The Public sector banks account for a major share of the total Gross NPAs. The NPAs of Public sector banks constitute around 72% of the total, with the Private Sector Banks, Foreign Banks & Small Financial Institutions accounting for the rest.
      • PSBs are recapitalised by Govt. Which leads to loss of public money.
  • Issues with Debt Recovery Tribunals (DRTs):
    • Instances have been reported where banks entered into compromise settlements without informing Debt Recovery Tribunals (DRTs).
    • The DRT, Ernakulam observed a case where a settlement was reached, but the bank failed to obtain the consent decree and concealed the settlement from the DRT for an extended period.
  • It is also diluting importance of both Asset Reconstruction Company and IBC.
• Benefits of Compromise Settlements:
  • Reduces Cost:
    • Compromise settlements facilitate early recovery of dues and save costs for banks by reducing legal expenses and other associated costs.
    • The underlying objective is to recover dues to the maximum extent possible within a shorter time frame.
  • Technical Write-Offs and NPA Reduction:
    • Banks have utilized write-offs to reduce non-performing assets (NPAs) over the past decade, resulting in lower reported NPA levels.
      • Write-offs were used for accounting and tax purposes, but concerns exist that this practice allowed banks and corporates to "evergreen" their loan books.
  • Compromise Settlements aims to provide vital humanitarian assistance to financially burdened companies facing Non-Performing Assets (NPA) resulting from unforeseen market risks.

What is a Non-Performing Asset?

• About:
  • NPA refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest.
    • In most cases, debt is classified as non-performing, when the loan payments have not been made for a minimum period of 90 days.
    • For agriculture, if principle and interest is not paid for two cropping seasons, the loan is classified as NPA.
  • Gross NPA:
    • Gross NPAs are the sum of all the loans that have been defaulted by the individuals
  • Net NPA:
    • Net NPAs are the amount that is realised after provision amount has been deducted from the gross non-performing assets.
• Laws and provisions related to NPAs:
  • Bad Bank:
    • The bad bank in India is called National Asset Reconstruction Ltd (NARC).
      • This NARC will work as an asset reconstruction company.
      • It will buy bad loans from the banks, relieving them of the NPA. NARC will then attempt to sell the stressed loans to distressed debt buyers.
    • The government has already set up India Debt Resolution Company Ltd (IDRCL) to sell these stressed assets in the market. Accordingly, IDRCL will attempt to sell them in the market.
  • The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002:
    • The SARFAESI Act allows banks and financial institutions to take possession of collateral assets and sell them to recover outstanding dues without the intervention of the court.
    • It provides provisions for the enforcement of security interests and allows banks to issue demand notices to defaulting borrowers.
  • The Insolvency and Bankruptcy Code (IBC), 2016:
    • The IBC provides a comprehensive framework for the insolvency and bankruptcy resolution process in India.
    • It aims to facilitate the time-bound resolution of stressed assets and promote a creditor-friendly environment.
    • Under the IBC, a debtor or creditor can initiate insolvency proceedings against a defaulting borrower.
    • It establishes the National Company Law Tribunal (NCLT) and the Insolvency and Bankruptcy Board of India (IBBI) to oversee the process.
  • The Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993:
    • The RDDBFI Act establishes Debt Recovery Tribunals (DRTs) for the expeditious adjudication and recovery of debts due to banks and financial institutions.
    • DRTs have the power to hear and decide cases related to the recovery of defaulted loans exceeding a specified threshold.
  • The Indian Contract Act, 1872:
    • The Indian Contract Act governs the contractual relationship between lenders and borrowers.
    • It establishes the legal framework for loan agreements, terms and conditions, default, and remedies available to lenders in case of non-payment.

Way Forward

• Recovery Proceedings and Consent Decree:
  • Banks must consider ongoing recovery proceedings under judicial forums while negotiating compromise settlements.
  • Settlements should be subject to obtaining a consent decree from the relevant judicial authorities.
• Importance of NPA Recovery:
  • The recovery of NPAs is crucial to protect the interests of depositors and stakeholders.
  • Compromise settlements should prioritize the maximum recovery of dues with minimal expense and within a shorter timeframe.
• Consideration of Public Interest:
  • During compromise settlements, banks, being public sector entities, should consider the interests of the tax-paying public over the borrowers' interests.

Source: IE