Rules of recovery: Settlement framework provides another option

Source: The post is based on the article “Culture shift: UNESCO must act on nations exiting, re-entering on frivolous grounds” published in the Business Standard on 16th June 2023

Syllabus: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Relevance: About the Framework for Compromise Settlements and Technical Write-offs.

News: Recently, the Reserve Bank of India (RBI) has announced the “Framework for Compromise Settlements and Technical Write-offs”.

Banks now have the option of recovering loans through the Insolvency and Bankruptcy Code. The compromise settlement framework may be useful in settling relatively small loans. The framework gives a bit of flexibility. But some bank unions have termed it a detrimental step that can compromise the integrity of the banking system.

What are the key aspects of RBI’s Framework for Compromise Settlements and Technical Write-offs?

According to the framework, regulated entities are expected to put in place board-approved policies for making compromise settlements with debtors as well as for technical write-offs.

Compromise settlement would mean a negotiated arrangement with the borrower to settle the claims of the lender in full, which may lead to a sacrifice of some amount due from the borrower. For the borrowers benefiting from the compromise settlement, there would be a cooling period as determined by the boards of the lenders before fresh lending can be made to such entities.

The technical write-offs would mean non-performing outstanding loans at the borrower’s account level and those have been written off by the lender for accounting purposes.

Respective boards are expected to give specific guidance. They are also expected to put in place an accountability framework for the staff dealing with such cases. An official who was involved in sanctioning the loan as an individual or as a member of a committee will not be part of this process.

Settlement for wilful defaulters will require board approval in all cases.

What are the bank’s concerns with RBI’s Framework for Compromise Settlements and Technical Write-offs?

Seeks clarification: Banks seek clarification on lending to accounts that are classified as wilful defaulters or fraud.

Options of restructuring: Banks make a large number of lending decisions on an ongoing basis and some may go wrong even in the best of circumstances. In the case of businesses, things could be negative because of a variety of factors, including unexpected changes in the macroeconomic environment, affecting the repaying capacity of borrowers. Banks often restructure the terms of loans in such cases.

What should be done?

Focus on lending standards: Lending standards are critical for preserving banking-sector stability. So, the banks must constantly monitor loan accounts and report the true picture to all stakeholders.

Avoid ever-greening of loans: The RBI has found innovative ways used by banks to conceal stress. Banks are also said to be using new methods of ever-greening. Such practices tend to undermine the integrity and stability of the banking system and should be avoided.

The banks should proceed with wilful defaulters or fraud with care and transparency. Lenders must use all avenues made available to them for recovering as much as possible from non-performing accounts.