[Analysis] Understanding RBI’s Stance on Compromise Settlements & Write-offs

Table of Contents

1. Background
2. Compromise settlement with wilful defaulters is a longstanding regulatory stance for over 15 years
3. Framework doesn’t dilute the penal measures applicable to borrowers classified as wilful defaulters or fraud
4. 12-month cooling period in ‘Framework for Compromise Settlements’ doesn’t allow fraud/wilful defaulters to borrow
5. RBI prescribes key safeguards to ensure that the provisions of compromise settlement with borrowers are not mis-utilized
6. Rationale behind permitting lenders to enter into compromise settlement with borrowers
7. RBI clarifies w.r.t exceptional treatment for permission to restructure borrower accounts, in case of change in ownership
8. Technical write-off is a normal banking practice undertaken by the lenders, doesn’t encourage default behaviour
9. Key objectives of the present circular
10. Conclusion

1. Background

Earlier on June 8, 2023, the RBI issued a framework for compromise settlements¹ and technical write-offs². One of the provisions in the said framework allowed the Regulated Entities (REs) to undertake compromise settlements or technical write-offs in respect of accounts categorised as wilful defaulters or fraud, without affecting the criminal proceedings against such debtors³.

The term ‘Compromise settlements’ refers to fully settling borrower claims in cash, which may require REs to sacrifice some portion of the amount due with a corresponding waiver of claims against the borrower.

The framework also outlined the reporting mechanism, a cooling period for borrowers subject to compromise settlements, and the treatment of accounts categorized as fraud and wilful defaulters. Further, the framework mandated the Regulated entities to establish board-approved policies for undertaking such settlements with the borrowers.

Now, on June 20, the RBI released an informative document addressing frequently asked questions (FAQs) regarding the ‘Framework for Compromise Settlements and Technical Write-offs’ circular, issued on June 8, 2023. Let’s explore the key coverage of the FAQs.

2. Compromise settlement with wilful defaulters is a longstanding regulatory stance for over 15 years

The RBI clarified that the said provision enabling banks to enter into compromise settlement in respect of borrowers categorised as fraud or wilful defaulter is not a new regulatory instruction and has been the settled regulatory stance for more than 15 years.

This enabler is already available to banks as per the extant instructions, as given under:

(a) RBI advised IBA in May 10, 2007, that banks can enter into compromise settlement with wilful defaulters/fraudulent borrowers while criminal proceedings are ongoing. The compromise settlements should be reviewed by the bank’s Management Committee/Board of banks.

(b) Master Circular on Wilful Defaulters dated July 1, 2015 envisages lenders agreeing to compromise settlement with borrowers classified as wilful defaulters and states that such cases need not be reported to Credit Information Companies provided inter alia that, “the borrower has fully paid the compromised amount.”

(c) Master Directions on Frauds dated July 1, 2016 provides for compromise settlement with borrowers classified as fraud, subject to the condition that,

“No compromise settlement involving a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued.”

Comments

The objective of this clarification is to bring clarity and reassurance to banks regarding their authority to engage in compromise settlements with fraud or wilful defaulter borrowers.

It aims to facilitate the efficient resolution of cases while ensuring that necessary due diligence and oversight are in place to protect the interests of the banks and the financial system as a whole.

3. Framework doesn’t dilute the penal measures applicable to borrowers classified as wilful defaulters or fraud

The RBI clarified that the penal measures currently applicable to borrowers classified as fraud or wilful defaulter remain unchanged and shall continue to be applicable in cases where the banks enter into compromise settlement with such borrowers.

The penal measures include, among others, the prohibition of any bank or financial institution from granting further additional facilities to borrowers identified as wilful defaulters.

Furthermore, borrowers classified as fraudsters will be ineligible for bank financing for a duration of five years starting from the date when the defrauded amount has been fully repaid.

Comments

The RBI stand in the form of specific FAQs reaffirms the seriousness of the consequences for borrowers engaged in fraudulent activities or wilful defaults. Further, it reinforces & continues the consequences faced by defaulters and fraudsters. Thus, the RBI aims to deter fraudulent behavior and maintain integrity of the banking system.

4. 12-month cooling period in ‘Framework for Compromise Settlements’ doesn’t allow fraud/wilful defaulters to borrow

The RBI, through its FAQs clarified that the minimum cooling period of 12 months prescribed in the circular doesn’t imply that even borrowers classified as fraud or wilful defaulters will be able to borrow fresh funds from the lenders after the cooling period.

Comments

With the present clarification, RBI will be likely to serve as a deterrent to potential fraudsters and wilful defaulters, as it makes it clear that their actions will have long-lasting consequences beyond the cooling period.

Further, Lenders will also be more cautious in extending credit to such borrowers, knowing that the cooling period does not grant them a clean slate.

5. RBI prescribes key safeguards to ensure that the provisions of compromise settlement with borrowers are not mis-utilized

Compromise settlement is not available to borrowers as a matter of right; rather it is a discretion to be exercised by the lenders based on their commercial judgement. The prudential guidelines provide sufficient safeguards with regard to such settlements considered by the lenders including:

(a) The circular further strengthens the regulatory guidance by mandating that all such cases of compromise settlement must be approved by the Board;

(b) Such settlements shall be without prejudice to the criminal proceeding underway or to be initiated, if under consideration of the lenders against such borrowers;

(c) As already mentioned, the extant penal provisions continue to remain applicable in such cases.

(d) Wherever recovery proceedings are pending before a judicial forum, any settlement arrived at with the borrower shall be subject to obtaining a consent decree from the concerned judicial authorities.

(e) The Boards of lenders have been entrusted with the oversight of the overall trends in approvals of all compromise settlements.

Comments

By reinforcing regulatory guidance, protecting ongoing criminal proceedings, upholding penal provisions, requiring judicial consent, and establishing board oversight, this framework contributes to a more robust and responsible approach to compromise settlements in the lending industry. This instils confidence among stakeholders by promoting transparency, fairness and accountability in the process of compromise settlements.

6. Rationale behind permitting lenders to enter into compromise settlement with borrowers

The RBI’s main objective is to facilitate prompt recovery of defaulted money to minimize time value loss and prevent asset value deterioration. Compromise settlement is acknowledged as a valid resolution mechanism for stressed assets, including those involving fraud or wilful default.

The imperatives for lenders are no different when it comes to recovery from borrowers classified as fraud or wilful defaulters. Continuing such exposures 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.

The RBI is of the view that subject to safeguards, early recoveries by lenders should be preferred, with perpetrators bearing the costs of malafide actions. Criminal proceedings should continue against fraud or wilful defaulter borrowers to prevent their escape from justice.

Comments

Lenders face similar challenges in recovering funds from borrowers classified as fraud or wilful defaulters. The RBI’s emphasis on early recoveries from such borrowers brings significant benefits to lenders. By encouraging early recoveries, lenders can free up their capital for more productive use and mitigate financial risks.

This approach helps to reduce the burden of non-performing assets and potential defaults, thus minimising systemic risks. It benefits lenders by releasing their capital, discouraging fraudulent practices, preserving asset values, promoting financial system stability, and upholding the principles of justice and accountability.

7. RBI clarifies w.r.t exceptional treatment for permission to restructure borrower accounts, in case of change in ownership

Restructuring involves lenders still being exposed to the borrower even after the completion of the restructuring process. Allowing lenders to maintain a credit relationship with fraudulent or willful defaulter borrowers would create a moral hazard.

On the other hand, a compromise settlement entails a complete detachment of the lender with the borrower. Therefore, permitting lenders to settle with the borrowers as per their commercial judgement would enhance recovery prospects.

Comments

The compromise settlement involves a complete detachment of the lender from the borrower. Lenders cut their credit relationship with the borrower, eliminating any ongoing exposure or risk. Further, the Lenders can make informed decisions about accepting settlement offers, potentially recovering a larger portion of their outstanding loans.

8. Technical write-off is a normal banking practice undertaken by the lenders, doesn’t encourage default behaviour

The framework allows lenders to perform technical write-offs for the outstanding amounts owed by borrowers in default. The RBI has clarified some concerns regarding whether this practice might encourage the default behaviour , as the lenders bear the entire cost of default while the defaulting borrowers  face no consequences.

The technical write-off is a normal banking practice undertaken by the lenders to cleanse the balance sheets of bad debts which are either considered unrecoverable or whose recovery is likely to consume disproportionate resources of the lenders.

However, such technical write-offs do not entail any waiver of claims against the borrower and thus the lenders’ right to recovery is not undermined in any manner. Therefore, the defaulting borrowers do not receive any benefit and their legal obligation remains unchanged.

Comments

Through the framework, RBI allows lenders to undertake technical write-offs to address bad debts, without undermining their rights to recovery or providing any advantages to defaulting borrowers. The intention behind this is to empower lenders to efficiently manage their balance sheets while maintaining the borrowers’ obligations to repay their debts.

9. Key objectives of the present circular

The present circular is intended to achieve the following objectives:

(a) It rationalises the existing regulatory guidance to banks on compromise settlements, consolidating various instructions issued over the years.

(b) It tightens some of the related provisions and ensures greater transparency.

(c) By providing a clear regulatory framework, it enables other regulated entities, particularly cooperative banks, to undertake compromise settlements as part of the normal resolution efforts.

(d) It provides clarity on the definition of technical write-offs and provides broad guidance on the process to be followed by the regulated entities for technical write-offs, which is a normal banking practice.

10. Conclusion

The RBI’s present informative document addressing the FAQs serves to provide clarity on key aspects of the framework. It emphasizes that compromise settlements with wilful defaulters have been a longstanding regulatory stance and clarifies that the penal measures applicable to fraudsters and wilful defaulters remain unchanged.

Overall, the framework aims to rationalize regulatory guidance, enhance transparency, and provide clarity to enable compromise settlements and technical write-offs as integral part of normal resolution efforts in the banking industry.

1. Compromise settlement for this purpose shall refer to any negotiated arrangement with the borrower to fully settle the claims of the RE 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.
2. Technical write-off for this purpose shall refer to cases where the nonperforming assets remain outstanding at borrowers’ loan account level, but are written-off (fully or partially) by the RE only for accounting purposes, without involving any waiver of claims against the borrower, and without prejudice to the recovery of the same.
3. Circular No. RBI/2023-24/40 DOR.STR.REC.20/21.04.048/2023-24, Dated 08.06.2023