A Fair Settlement: On Defaulters RBI Prioritises Public Interest

Why in News?

• Recently, the Reserve Bank of India (RBI) set out a framework for bank settlements with defaulters.
• This circular has attracted widespread criticism because it covers settlements with fraudulent and wilful defaulters implying to some that the RBI is condoning their crimes.
• Contrary to the criticism, the point of the circular is to establish safeguards so that public interest is protected when banks make such settlements. 

 

Compromise Settlement for Bank Defaulters and RBI Framework

• 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.
• RBI Framework
  • The 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.

 

The Correct Interpretation of RBI Circular

• Not something unusual
  • When there is a default, the primary objective of a bank is to recover as much of the loan as possible. Various options might be available to the bank for recovering the loan.
  • The bank decides which strategy would work best, based purely on commercial judgement.
  • For instance, the bank may want to trigger the Insolvency and Bankruptcy Code (IBC, 2016) against the borrower.
  • Alternatively, in some other cases, it may decide to pursue a “compromise settlement”. Hence, it is wrong to think that the RBI has permitted something unusual.
  • One-time settlements are part and parcel of the business of banking. The RBI has simply given a formal regulatory structure to a standard banking practice.
• The sole motive is to maximise recovery
  • When trying to recover a loan, a bank should not make any distinction between whether the default is wilful, fraudulent, or otherwise.
  • Irrespective of the nature of the default, it is up to the bank to decide whether a settlement is a better and quicker option instead of triggering the IBC or pursuing some other strategy.
  • The sole motivation behind such a decision should be to maximise recovery, as speedily as possible.
  • This will help unlock banking capital that is stuck in the wilful default or fraud categories.
• The banks are free to file case against wilful defaulters
  • The RBI circular makes it clear that banks should feel free to file cases against fraudulent or wilful defaulters.
  • It states that banks will undertake settlements “without prejudice to the criminal proceeding underway against such debtors.”
  • This separates the criminality of a particular default case from the commercial aspect of it. In other words, the circular does not condone any crime.
  • But the pursuit of criminal action against a defaulter should not necessitate suspending commercial judgement. This distinction is important.

 

Some Valid Concerns Regarding the Circular

• Government control over the boards of public sector banks: This creates a risk that the settlement process might be misused to favour politically connected defaulters at the cost of the banks’ commercial interests. 
• What was the need for this circular?
  • Two-thirds of the Indian banking system is owned by the government and public sector banks are more likely to come under the scrutiny of investigative agencies for any action they take.
  • The RBI circular gives these banks regulatory cover for settlement-related decisions. Therefore, the circular merely levels the playing field.
  • But from a wider perspective, the fact that a circular needed to be issued underscores the distortions that the Indian banking system suffers from owing to the government ownership of banks.
  • In a fully privately-owned banking system, there would be no need for such a circular and the ensuing controversy could have been avoided.
• Circular not in public domain
  • A year ago, the RBI’s Regulations Review Authority 2.0 recommended that the RBI place all draft instructions on its website for stakeholder comments and finalise them after considering the feedback.
  • Exceptions should be made only in special circumstances. Despite having no issues related to financial stability, or fiduciary duty, or confidentiality, the draft circular was not uploaded on RBI’s website for public consultation.

 

What should have been done to avoid unnecessary criticism?

• There do not appear to have been any special circumstances/ pressing urgency surrounding the June 8 circular.
• At the same time, the circular is of great public interest since it applies to entities against whom criminal proceedings are underway.
• Hence, the draft circular could and should have been placed on the RBI’s website for public consultation along with a discussion paper clearly explaining its rationale.
• Concerned stakeholders could have expressed their concerns and the RBI would have had the opportunity to assuage their misgivings by making suitable clarifications to the draft circular before notifying it.
• That would have saved the central bank and the government much trouble.

 

Conclusion

• Banks are commercial enterprises and should be allowed to operate accordingly.
• In principle, separating a commercial decision such as loan recovery from criminal proceedings against wilful defaulters is a step in the right direction.

 

 

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Q1) Who are wilful defaulters?

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.

 

Q2) Why is loan recovery important?

Recovery of debts 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. One of the reasons for the high interest rates in India is the high level of NPAs in the banking system.

 

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Source: The Indian Express