Compromise settlement for wilful defaulters

What’s in today’s article?

• Why in news?
• What is a compromise settlement?
• Who are wilful defaulters?
• News Summary: Compromise settlement for wilful defaulters
• What did RBI say?
• Why has this been termed as a detrimental step?
• Why is loan recovery important?

Why in news?

• The Reserve Bank of India (RBI) has allowed wilful defaulters and loans accounts involved in frauds to go in for a compromise settlement with banks to settle their dues.

What is a compromise settlement?

• A compromise settlement refers to a negotiated settlement between a borrower and a bank in which borrower offers to pay an amount that is less than the total due under the loan contract.
• The bank agrees to accept this reduced amount as a full and final settlement. 
• As part of this settlement, the bank typically writes off or waives a portion of the borrower’s dues. This write off or waiver happens only once.
• In the last two decades, banks have approved several compromise settlements, running into hundreds of crores with huge haircuts, leading to huge losses for banks.
  • Haircut is the reduction of outstanding payment or loans that will not be repaid by the borrowers.

Who are wilful defaulters?

• About
  • According to the Reserve Bank of India, a ‘wilful default’ happens when a borrower does not repay their loans even though they have the ability to do so. 
  • In other words, it occurs when borrowers can meet their repayment obligations but choose not to.
  • A wilful default occurs when a borrower does not use the funds received from the lender for the intended purpose. 
  • Instead, they divert the money for other reasons, misuse the funds, or sell off the assets provided as collateral without the knowledge of the bank.
• Statistics
  • As per a credit information company registered with the RBI, there were 15,778 wilful default accounts involving an amount of Rs 340,570 crore as of December 2022.
  • State Bank of India (SBI) leads with 1,883 wilful default accounts for Rs 79,296 crore, followed by PNB at Rs 38,360 crore.

News Summary: Compromise settlement for wilful defaulters

What did RBI say?

• According to a circular issued by the RBI, banks are allowed to negotiate compromise settlements or carry out technical write-offs for accounts belonging to wilful defaulters or fraud cases. 
• This action can be taken without affecting the ongoing criminal proceedings against these debtors.
• The central bank has also directed banks to fix a minimum cooling period of at least 12 months before making fresh exposures to borrowers who had undergone compromise settlements. 
• This means a wilful defaulter or a company involved in fraud can get fresh loans after 12 months of executing a compromise settlement.

Why has this been termed as a detrimental step?

• It may compromise the integrity of the banking system and undermine the efforts to combat wilful defaulters effectively.
• It not only rewards unscrupulous borrowers but also sends a distressing message to honest borrowers who strive to meet their financial obligations.
• Wilful defaults have a significant impact on the financial stability of banks and the overall economy. 
• By allowing them to settle their loans under compromise, the RBI is essentially condoning their wrongful actions and placing the burden of their misdeeds on the shoulders of ordinary citizens.

Why is loan recovery important?

• Recovery of debts due to a bank is an important activity that aims at protecting the interest of the depositors and other stakeholders. 
• If banks do not recover NPAs, then ultimately, depositors and other stakeholders will suffer.
  • A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
• Hence, any compromise settlement should have an underlying objective of recovery of dues to the maximum extent possible at minimum expense and within shortest possible time frame.
• One of the reasons for the high interest rates in India is the high level of NPAs in the banking system.

Q1) What is non performing asset (NPA)?

A non-performing asset (NPA), also known as a non-performing loan (NPL), refers to a classification given to a loan or advance that has stopped generating interest income or principal repayment for the lender. In simpler terms, an NPA is a loan or debt obligation that the borrower has failed to repay within the specified timeframe, leading to financial distress for the lender. The classification of an asset as an NPA is typically based on the criteria set by the regulatory authorities of a country or the policies of the lending institution. In many countries, including India, banks and financial institutions follow the guidelines issued by their respective central banks or regulatory bodies to determine NPAs.

Q2) What is a credit information company?

A credit information company (CIC), also known as a credit bureau or credit reporting agency, is an organization that collects and maintains credit-related information about individuals and businesses. Its primary function is to compile credit data from various sources and provide credit reports and scores to lenders, financial institutions, and other authorized entities. The role of a credit information company is to facilitate efficient and reliable credit assessment processes for lenders. By providing comprehensive credit reports and scores, CICs help lenders make informed decisions about granting credit, setting interest rates, and managing credit risks. This information allows lenders to assess an individual’s or a business’s creditworthiness and ability to repay loans.

Source: Compromise settlement for wilful defaulters: How RBI’s controversial move impacts the banking sector | The Wire | The Hindu