Wilful Defaulters/Fraud Accounts: Not untouchable

 Wilful Defaulters/Fraud Accounts:

Are the accounts untouchable?

I. Compromise settlement permitted in willful defaulters'/fraud accounts: 

Reserve Bank of India (RBI/Regulator) has come out with comprehensive regulatory framework governing compromise settlements and technical write-offs. The instructions are applicable to all the regulated entities (RES-s) (Commercial Banks, SFBs, NBFCs, etc.). The circular also covers compromise settlements, if entered into, with accounts classified as wilful defaulters or fraud.

To ensure due diligence, transparency and uniformity, RBI laid down the following for compliance by all the REs:

1. Board approved policies, which lays down the processes (with factors like minimum ageing, deterioration in collateral value, etc.) that should be in place for considering compromise settlements with the borrowers as well as for technical write-offs.

2. In respect of compromise settlements, delegation of powers for such approvals rests with an authority, which is at least one step higher in hierarchy than the authority, which sanctioned the limits and no official who was part of sanction of the loan be shall be part of approving the compromise settlement. (even if he occupies a higher level, due to promotion in between, than the level he occupied, when the loan was sanctioned by him)

3. All proposals for compromise settlements in respect of debtors classified as fraud or wilful defaulters, shall require the approval of the Board. 

4. Compromise settlements or technical write-offs in respect of (3) above shall be undertaken without prejudice to the criminal proceeding underway against such debtors.

II. Opposition to the move: Some of the bank unions including the All India Bank Employees' Association (AIBEA) have strongly condemned the move of RBI airing concerns that the new instructions may compromise the integrity of the banking system and also undermine the efforts to combat 'wilful defaulters' effectively. In this regard, the instructions by RBI can be termed only as enablers and the respective bank boards are expected to play a crucial role in framing a water-tight policy for compromise settlement and in approving proposals of compromise settlements involving wilful defaulter/ fraud accounts. However, the unions appear to apprehend that individual bank boards may be pressurised to give into compromise settlements involving wilful defaulters/fraud accounts. They still remember how the banks had circumvented in the past (2008-2014) in implementing the various restructuring schemes formulated by RBI (CDR,  SDR, 5/25, S4A, etc.), resulting in 'evergreening' of accounts, only to be unearthed through the Asset Quality Review conducted by RBI in 2016. Their fears are also strengthened by the RBI Governor, who spoke: "Despite the guidelines on corporate governance, RBI came across gaps in governance of certain banks, , with the potential to cause some degree of volatility in the banking sector. We have also come across a few examples where one method of evergreening, after being pointed out by the regulator, was replaced by another method" (In his address at the conference of Directors of Banks on May 22, 2023)

III. My views:

i. Are the accounts of wilful defaulters/ fraud accounts untouchable?

While reasoning with the concerns raised by the unions, I welcome the move of RBI as a commercial banker interested in recovering the money locked in stressed assets at an early date, without compromising anywhere in respect of speeding up the criminal proceedings initiated. In any account classified as wilful defaulter or fraud, we have usually found some innocent outsiders trapped along with the wilful/fraudulent lot. In fact, I had come across quite a few cases involving diversion of funds by the borrower firms, where innocent persons or unrelated non group firms, joined as guarantors and extended their properties as securities. In such cases, the banks leveraged on the anxiety and the desperate need of the guarantors to get out of legal proceedings and used them to force the wilful borrower to come to the table for settlements (with a token of concessions in the interest rates charged). 

ii. Is the instructions not in tune with the past?

The answer is no. RBI never stood in the way of banks in entering into a compromise settlement with a borrower, declared as wilful defaulter provided the recovery is maximum and no leeway/impression is created that the criminal proceedings initiated will be compromised. It may be noted that most of the defaulters identified by RBI (12 in the first list in June 2017 and 25 in Dec 2017) requiring banks concerned to approach NCLT for resolution under IBC,  escaped being classified as wilful defaulters by a very thin margin (as diversion of funds was very much evident). RBI still advised the resolution route, as IBC regulations closed the back door entry for promoters and usually realisation from a resolution plan, with least impact to the economy, is bigger than that realised through liquidation.

The latest instructions dated 8th June 2023 is also consistent with the stand taken by the regulator in the past. In the master circular on wilful defaulters issued in 2016 as well as in the 'resolution of stressed assets' circular issued in 2019, RBI encouraged a proactive approach on the part of banks for change of management of the wilfully defaulting borrower unit, to consider restructuring the taken over unit by the new promoters/management on merits, subject to the continuance of criminal action against the erstwhile promoters/ management. The Master circular on classification of frauds issued in 2017 stipulates "No compromise settlement involving a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued". A clear indication that RBI is not averse to any compromise settlements in fraud accounts provided continuation of the  criminal proceedings is clearly communicated. The master circular on wilful defaulter mandates a few penal measures, which includes a clause that wilful defaulters should be debarred from availing institutional finance from SCBs, FIs, NBFCs for a period of 5 years from the date of removal of their names from the list of wilful defaulters. All the master circulars issued on wilful defaulters, classification of frauds, resolution of stressed assets have not been withdrawn. So any bank board, which issues its policy on compromise settlement, should ensure that these instructions are part of its board policy.

iii.  The success of the spirit of the circular lies in its implementation:

The spirit of the circular, as explained by RBI in its FAQs, is to provide multiple validated avenues to lenders to recover money in default without much delay. While the aim of the RBI has always been good, the success lies in how the different banks implement the instructions of the regulator. A classic example that is quoted always is the way the different restructuring schemes formulated by RBI, post Global Financial Crisis (2008), was abused by the banks to hide their stressed assets. Taking a cue from that experience, post COVID, RBI appointed a committee headed by Shri Kamath to stipulate the eligibility criteria and the financial parameters for considering restructuring of loans, where the aggregate exposure of the borrower is Rs.1500 cr. and above. Due to this approach, we observe that the restructuring portfolio under corporate segment of the banking system was limited and the stress witnessed in the said restructured accounts is also minimal so far. A similar method can be thought of for handling compromise settlements in  wilful defaulters/ fraud accounts. 

Instead of leaving it to the banks' boards to formulate their own policy by just outlining factors such as minimum ageing, asset value, etc. RBI may handhold the banks, at least in respect of compromise settlement in wilful defaulters/ fraud accounts to begin with. This will ensure consistency among banks in handling restructuring/ compromise settlements in respect of wilful defaulters/ fraud accounts and the fraudulent lot are not permitted to exploit the loopholes prevalent in the system, due to different practices being adopted by the banks to settle such dues.

Regards

V. Viswanathan

CGM Retd. State Bank Group. 

21st June 2023

Note:I did not comment on technical write offs, as that is a balance sheet management tool adopted at the Bank level, without in any way reducing the balance to be recovered in such accounts at the branch and without any let off in recovery measures initiated. This practice is there for a very long time.