RBI permits banks to undertake compromise settlement of wilful defaults

In order to ensure maximum recovery from distressed assets, the Reserve Bank of India (RBI) has allowed banks to go for compromise settlement of ‘fraud accounts’ and ‘wilful defaults’.

• All regulated entities (REs) are required to put in place a ‘board-approved policy’ for undertaking compromise settlements, with the borrowers as well as for technical write-offs laying down the process to be followed for all compromise settlements with specific guidance on the necessary conditions precedent.
• The policies would also put in place a graded framework for the ‘examination of staff accountability’ in such cases with reasonable thresholds and timelines as may be decided by the board.
• Conditions would include minimum ageing, deterioration in collateral value
• The methodology for arriving at the realisable value of the security shall also form part of the policy.
• Objective:
  • The objective would be to maximise the possible recovery from a distressed borrower at minimum expense, in the best interest of the Regulated Entity (RE).

What are the provision for borrowers?

• The compromise settlements and technical write-offs would be without prejudice to any mutually agreed contractual provisions between the RE and the borrower relating to future contingent realisations or recovery by the RE.
• The above conditions are subject “to such claims not being recognised in any manner on the balance sheet of REs at the time of the settlement or subsequently till actual realisation of such receivables.”
• In respect of borrowers subject to compromise settlements, the notification said, there would be a cooling period as determined by the respective board-approved policies before the REs can assume fresh exposures to such borrowers.
• The cooling period in respect of exposures other than farm credit exposures would be subject to a floor of 12 months.
• REs are free to stipulate higher cooling periods in terms of their Board approved policies.

What are Non-performing assets (NPA)?

• They are loans or advances that are in default or in arrears.
• In other words, these are those kinds of loans wherein principal or interest amounts are late or have not been paid.

When a loan is classified as NPA?

• Non-Performing Assets are basically Non-Performing Loans.
• In India, the timeline given for classifying the asset as NPA is 180 days. As against 45 to 90 days of international norms.

Why is there a need to recognise NPAs?

• In the banking system, the government and regulatory authorities need to have a good view of how healthy the financial system is.
• India became more aggressive in recognising loans as ‘bad’ in the 2014 to 2015 period.
• The periodic asset quality review was introduced. Further, the regulator stepped in to prevent ever-greening of loans (i.e., lending more to an already stressed asset in the hope that it could be brought back to its feet).

What process does a bank undertake to recover NPA?

• The banks employ the Lok Adalats for settling the NPA loans. The Lok Adalats help in settling the NPA between the banks and defaulters.

Impact of NPAs on Financial Operations:

• This reduces the profits of the banks.
• This reduces a bank or financial institution’s capital adequacy.
• The banks have become averse to giving loans and taking risks of zero per cent. Thus, the creation of fresh credit is debarred.
• The banks start concentrating on the management of credit risk instead of the bank becoming profitable.
• The funds happen to cost due to NPA.