Compromise settlement for wilful defaulters: How RBI’s controversial move impacts the banking sector

In the last two decades, banks have approved several compromise settlements, running into hundreds of crores with huge haircuts – or the reduction of outstanding payment or loans that will not be repaid by the borrowers – leading to huge losses for banks.

What did RBI say?

Banks can undertake compromise settlements or technical write-offs in respect of accounts categorised as wilful defaulters or fraud without prejudice to the criminal proceeding underway against such debtors, the RBI said in a circular on June 8, 2023.

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?

The RBI’s latest ‘Framework for compromise settlements and technical write-offs’ is considered as a “detrimental step that 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.

“We firmly believe that allowing compromise settlement for accounts classified as fraud or wilful defaulters is an affront to the principles of justice and accountability,” said All India Bank Officers’ Confederation (AIBOC) and All India Bank Employees Association (AIBEA), representing 6 lakh bank employees.

It is worth noting that 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 and hardworking bank employees, bank unions said.

Does this mark a policy reversal?

The central bank has virtually reversed its earlier policy of keeping wilful defaulters out of compromise settlements.

On June 7, 2019, the RBI, in its ‘Prudential Framework for Resolution of Stressed Assets’, made it clear that borrowers who committed fraud/ malfeasance/ wilful default would remain ineligible for restructuring. Now, this sudden change by the central bank to grant compromise settlements to wilful defaulters comes as a shocker to the banking sector as it will not only lead to erosion of public trust in the sector but also undermines the confidence of depositors.

According to bankers, there is sufficient evidence, anecdotal and otherwise, that restructuring is often misused by banks and corporates for ‘evergreening’ problem accounts to keep the reported NPA levels low. Corporates were allowed to opt for the liberal restructuring route between 2000 and 2014 when a host of companies used fresh loans from banks to evergreen their loan books. However, with the enactment of the bankruptcy code, evergreening declined even though recovery has remained abysmally low.

Who are wilful defaulters?

As per the Reserve Bank of India’s classification, a ‘wilful default’ would be deemed to have occurred if the borrower has defaulted in meeting their repayment obligations to the lender even when they have the capacity to honour the said obligations. There were 15,778 wilful default accounts involving an amount of Rs 340,570 crore as of December 2022 as against 14,206 accounts involving Rs 285,583 crore a year ago in December 2021 and 12,911 accounts for Rs 245,888 crore in December 2020, according to Transunion Cibil, a credit information company registered with the RBI.

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, Union Bank of India Rs 35,266 crore, IDBI Bank Rs 23,601 crore and Bank of Baroda Rs 23,879 crore, according to data from Cibil website. Public sector banks account for 85 per cent of the wilful defaults at Rs 292,666 crore, indicating the reluctance of borrowers to repay bank loans despite having the capacity to make the payment.

A wilful default happens when the borrower has not utilised the finance from the lender for the specific purpose for which finance was availed, and has diverted the funds for other purposes, siphoned off funds, or disposed of or removed the movable fixed assets or immovable property given for the purpose of securing a term loan without the knowledge of the bank.

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.

“Therefore, 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,” said a Union Bank of India note on compromise settlements.

“While negotiating compromise settlements, it should be appreciated that the bank is public sector entity and the stakeholders are taxpaying general public. Therefore, more than interest of the Borrowers, the interest of public at large should be kept in mind,” the note said.

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