The RBI’s recent circular giving new rules on how banks may arrive at a compromise settlement with defaulters have drawn a lot of criticism because it includes agreements with wilful defaulters and fraud accounts.

But, what we now understand from former RBI executives is that wilful defaulters may have been included because of some peculiarities with the definition in the Indian context.

Veteran commercial banker SS Mundra, who is also a former RBI deputy governor, explains that India has a complex history of dealing with defaulters and hence a common sense understanding of “wilful default” as the equivalent of “fraudsters” doesn’t work here.

DISTINCTION BETWEEN WILFUL DEFAULT AND FRAUD

Mundra says a 2014-15 RBI master circular defines wilful defaulter as:

1) One who has the resources but doesn’t pay.

2) One who has used bank funds for purposes other than for which it was availed.

3) One who has Used bank money for unauthorised purposes and those assets are not with the company.

4) When a borrower has defaulted in meeting repayment obligations and has also disposed of or removed the movable fixed assets, or immovable property given for the purpose of securing a term loan.

Mundra says while siphoning or diversion is a term understood universally, the first category – not paying despite having money- is an Indianism. He says how much money a person has, is sometimes a matter of judgment and whether he is willing to pay is even more a matter of opinion. Does a person not selling his luxury villa a wilful defaulter? What if he has only one personal home? What about money set aside for a child’s education or treatment of a sick family member?

Overtime bankers and Reserve bank realised the problem of defining a person’s ability and willingness and hence bankers began to make a distinction between wilful defaulter and fraud: Entries 2, 3 & 4 in the above list have been considered fraud, and not entertained for compromise, but the category one defaulters have been entertained for compromise. So, although the definition of wilful defaulters in the circular remained unchanged, in actual practice brankers made a distinction between wilful defaulters and fraud, Mundra said.

Former SBI Chairman Rajnish Kumar points out that this definition of a wilful defaulter as one who has the money but is unwilling to pay also stems from the fact that the layperson sees an industrialist whose company is an NPA, still living in style.

Bankers say this confusion comes from not knowing the nuances of the law. In law, a company is a person distinct from the promoter. If the promoter hasn’t given a personal guarantee for a loan, his personal assets cannot be seized. Also, he could be living in his mother’s, wife’s or son’s house, and these persons may be individuals with independent sources of income.

The short point, bankers and RBI have realised over time that the old understanding of a wilful defaulter as one who has the money but doesn’t pay is more an emotional construct. That was when RBI allowed compromises with so-called “wilful defaulters” who aren’t frauds ie haven’t misused money.

COMPROMISES WITH FRAUDS

While the 2015 circular didn’t speak of agreements with fraud borrowers, the June 8 circular certainly includes compromise agreements with frauds as well. Mundra says this sounds repugnant: how could one come to an agreement with someone who has defrauded the bank? However he added, there may be a couple of reasons for giving some so-called fraud accounts the benefit of the doubt.

About 2 decades ago a circular from the Central Vigilance Commission (CVC) required bankers to check all NPAs over Rs 25 lakh for fraud. Put under such onerous pressure of having to certify every account as above-board, bankers buckled under pressure and detected as fraud even minor transgressions – such as if working capital was used to buy capital equipment.

Such a cathartic order from the DFS came yet again in 2016 when all NPAs above 250 crore were to pass through a forensic audit and be tested for fraud. Again minor technical transgressions were also categorised as fraud.

It is possible therefore that the need has arisen to settle some of these cases with the borrowers so that the bank makes at least some money and the borrower who may be guilty of only technical accounting errors can be allowed to start again. In any case, the RBI has given two major caveats – legal cases against such borrowers must continue and each and every one of these compromises must be individually approved by the board.

Mundra points out that some circulars even spoke of a third category called “non-co-operative borrowers. Now, how does one conclusively measure or determine “non-cooperation”? Hence the need for an overarching circular that allows banks and borrowers to move on.

NO FREE PASS FOR FRAUDSTERS

The June 8 circular has been widely criticised on the ground that it is morally repugnant that banks will give a fresh loan to a fraudster. Both Kumar and Mundra pointed out that this is virtually impossible. Bankers don’t give loans to industrialists even if one company in their group is classified as NPA for reasons beyond the company’s control.

To expect that a banker, in fact, an entire committee of bankers plus their boards will back giving loans to a borrower with a blemish is fanciful, they said.

MERITS OF THE NEW CIRCULAR

The June 8 circular was more intended to render uniform the practice of arriving at compromise settlements with defaulting borrowers. The RBI probably just wanted to put in some hygiene rules such as the banker who gave the loan must not be involved in structuring the compromise and that all such compromises have to be approved by a higher authority.

These rules are already followed in all banks, but putting them down simply gives them more force, they said.

Ultimately, banks must try to recover as much money as possible, as quickly as possible, from a declining asset, said Kumar. A 100 rupees recovered today by the settlement is worth more than 200 rupees gained after ten years of litigation. Usually after ten years, the asset itself would have decayed to the point of fetching almost nothing. This circular must be seen in that spirit, the bankers said.

Also read: Compromise settlements with wilful defaulters is not a new concept, says SS Mundra

(Edited by : C H Unnikrishnan)

First Published:Jun 16, 2023 7:05 PM IST