The Ministry of Finance and the Insolvency and Bankruptcy Board of India (IBBI) are reportedly opposed to a recent circular issued by the Reserve Bank of India (RBI) that permits banks to engage in compromise settlements or technical write-offs for accounts categorized as wilful defaults or frauds. The government feels these settlements could potentially lead to delays in debt recovery through the Insolvency and Bankruptcy Code (IBC) process, resulting in a decrease in asset values, according to reports.
The RBI’s circular, dated June 8, 2023, reintroduced the option of compromise settlements for wilful defaulters, allowing lenders to exercise discretion in handling individual default cases based on commercial judgment. Under the RBI’s June 2023 circular, banks can engage in compromise settlements or technical write-offs for accounts labelled as frauds or wilful defaulters. After restructuring, they can also have fresh exposure to these borrowers after a minimum cooling-off period of 12 months.
This has marked a reversal of a policy from three years earlier that rendered borrowers found guilty of fraud, malfeasance, or wilful default ineligible for restructuring.
The rationale behind the RBI’s decision was to prevent the erosion of asset value due to delays in the resolution process, as extended delays often lead to a deterioration in asset value, hampering overall recoveries. The compromise settlement mechanism has traditionally been an efficient means of debt recovery for banks.
The concerns
The Department of Financial Services (DFS) within the finance ministry is said to be working closely with banks to encourage them to initiate the insolvency process promptly in cases of defaults. The DFS, along with the IBBI, aims to prevent situations where banks opt for settlements with debtors instead of following the IBC process, as this could lead to lower asset values and reduced recovery.
While some have criticized the compromise settlement for fraudsters and wilful defaulters, the IBBI is concerned about the declining rate of loan recovery under the IBC. A recent report indicated that the overall recovery rate under the IBC until Q1FY24 stood at 31.62%, implying a significant haircut of 68% for lenders. The reduced recovery rate is attributed to delays in the resolution process.
While efforts have been made to address the fall in recovery under the IBC, the unique nature of the code as a last resort for debt recovery means that it may not achieve the same recovery rate as other processes. It is essential to efficiently use the compromise settlement system under the RBI, relying on lenders’ commercial judgment.
As of the end of 2022, more than 16,000 borrowers with a combined debt of Rs 3.46 lakh crore were classified as wilful defaulters, marking a 40% increase from two years prior.
