New Delhi: The Reserve Bank of India (RBI) has laid to rest the confusion and controversy surrounding the rules it had released in June 2023 on “compromise settlements”, which opposition parties at the time had said were aimed at letting wilful defaulters off the hook.
The central bank Thursday released a consolidated set of draft rules on how banks and other regulated financial institutions must deal with wilful defaulters. These rules now bring together various different directions issued by the central bank, and provide clarity on each aspect of a wilful default.
ThePrint dives into the matter to explain what the compromise settlement rules are, how they apply to wilful defaulters, and whether the new rules dilute the stringency with which such wilful defaulters are to be treated by the law and the lenders.
What is a wilful default?
According to the RBI’s draft guidelines issued on 21 September, a wilful default is when a borrower defaults on loan repayment obligations and if any of the following behaviours are noticed: The borrower has the capacity to repay, the borrower has diverted or siphoned off the loan funds for some other purpose, the borrower has disposed of the assets that were provided as security for the loan without informing the lender, or the borrower has failed to infuse equity despite having the ability to do so.
The rules further say that a borrower would be designated a wilful defaulter if a wilful default has occurred, and the outstanding amount is more than an amount set by the RBI from time to time — currently Rs 25 lakh or more.
How can banks get money back from defaulters?
When it comes to normal (non-wilful) defaults, the banks have the option of restructuring the loan, or engaging in a compromise settlement with the borrower.
Restructuring involves extending the duration of the loan, reducing the amount to be paid back in each instalment, or the lenders taking a “haircut”, which is when they reduce the amount that needs to be paid back.
This process is distinct from a settlement because it keeps the loan open and prolongs the relationship between the lender and the borrower.
A settlement is when the lender agrees to recover what it can from the borrower at that point in time, and then closes the loan. That is, the relationship between the lender and borrower is over once the settlement is completed.
The RBI has made clear where it stands on the issue of restructuring versus settlement when it comes to wilful defaulters.
“Restructuring in general entails the lenders having a continuing exposure to the borrower entity even after restructuring and hence, in case of borrowers classified as fraud or wilful defaulter, permitting lenders to continue their credit relationship with the borrower entity would be fraught with moral hazard,” the central bank said in a June 2023 FAQ document.
It added that, on the other hand, a compromise settlement involves a complete de-linking of the lender and the borrower.
“Therefore, permitting lenders to settle with the borrowers as per their commercial judgement would enhance recovery prospects,” it said.
What is a compromise settlement and is it new?
When the RBI had in June issued rules on compromise settlements, the Congress had issued a statement saying that the central bank must withdraw the rules since they now “allowed” banks to enter into compromise settlements with wilful defaulters, which was a step down from its stance in 2019 when it had barred wilful defaulters from accessing capital markets or taking fresh loans.
According to the June notification, a compromise settlement is “any negotiated arrangement with the borrower to fully settle the claims of the RE (registered entity) against the borrower in cash; it may entail some sacrifice of the amount due from the borrower on the part of the REs with corresponding waiver of claims of the RE against the borrower to that extent”.
In other words, a compromise settlement is when the lender enters into an agreement with the borrower where the latter pays back the loan, or as much as possible of the loan, following which the lender settles all claims on the borrower.
The rules also say that the lenders can engage in compromise settlements with wilful defaulters, but added that this would not stop criminal proceedings against such defaulters from continuing. The first part of this provision is what created controversy.
However, it is important to note that the provision to allow lenders to enter into compromise settlements with wilful defaulters is not new.
The RBI had in 2007 written to the Indian Banks’ Association (IBA) saying that “banks may enter into compromise settlements with wilful defaulters/fraudulent borrowers without prejudice to the criminal case against the borrower” and that all such cases must be approved by the boards of the banks.
This is nearly identical to what the June 2023 notification by the RBI stated.
Also Read: ‘Rehabilitation path for Nirav, Mallya’ — Congress attacks PM over RBI’s ‘compromise settlements’
Is June notification a dilution of what RBI said earlier?
This is where the difference between restructuring and settlement becomes even more important.
In 2019, the RBI had said that borrowers who have committed fraud or wilful defaults would be ineligible for the restructuring process except in cases where the existing promoters of the defaulter are entirely replaced by new promoters, and the borrower company is totally delinked from the erstwhile promoters or management.
Even in such cases, the RBI said, lenders can take a call on whether to restructure the loan based on viability, and added that even this restructuring would not impact the criminal proceedings initiated against the wilful defaulters.
The June 2023 notification on compromise settlements does not deal with restructuring at all, and hence does not dilute any of the existing restructuring-related provisions.
Further, the RBI’s 21 September consolidated guidelines reiterate its stance on restructuring related to wilful defaulters, with no changes from the previous policy.
Do rules go easy on wilful defaulters?
The new guidelines say any account that has been included in the List of Wilful Defaulters (LWD) will be removed from the list only when the borrower has fully paid the compromise amount.
In fact, the rules add that the name of the wilful defaulter will not be removed from the LWD even if the outstanding amount falls below the Rs 25 lakh limit — it would have to be paid completely.
Further, as laid out in previous versions of the rules, the latest guidelines also state that the financial aspects of the compromise settlement will run parallel to the criminal proceedings against wilful defaulters and will not affect them.
The latest guidelines empower banks to pursue legal action against wilful defaulters on a case-by-case basis, if it is warranted. Each lender has also been tasked to come up with a board-approved policy for the publication of photographs of wilful defaulters.
The rules also lay out several penal measures against wilful defaulters, such as mandating that no additional loans will be granted to a wilful defaulter or any entity with which a wilful defaulter is associated. This bar on access to credit will hold for a period of one year after the wilful defaulter’s name has been removed from the list.
Further, no loans will be given to wilful defaulters for the purpose of floating a new venture for five years after their name has been removed from the list.
So, , a wilful defaulter must repay all dues to the lender, and then wait for a minimum of one year and a maximum of five years before which they can access bank credit again.
From now on, lenders are also meant to incorporate a provision in their agreements with borrowers saying that the borrower must not have a board member whose name appears in the LWD. If a wilful defaulter is found on the board of directors, they must be removed within 90 days of receiving a notice from the lender.
“Under no circumstances shall a lender renew/enhance/provide fresh credit facilities to such a borrower so long as the director whose name appears in the LWD continues on its board,” the rules state.
(Edited by Nida Fatima Siddiqui)
Also Read: RBI ban on 3rd-party loan recovery agents not a fix. It’s like AP’s microfinance ban mistake