The “compromise settlement norms” announced a few days ago by the RBI have, predictably, raised a storm among the Opposition and other critics. What is the rationale for permitting lenders to enter into compromise settlements with borrowers classified as fraud or wilful defaulter?
The apex bank has developed FAQs to douse the fire, but appears to defend itself against the indefensible. “The imperatives for lenders are no different when it comes to recovery from borrowers classified as fraud or wilful defaulters. Continuing such exposures on the balance sheets of the lenders without resolution due to legal proceedings would lock lenders’ funds in an unproductive asset, which would not be a desirable position,” the RBI said, replying to one of the FAQs.
“The primary regulatory objective is to enable multiple avenues to lenders to recover the money in default without much delay. Apart from the time value loss, inordinate delays result in asset value deterioration, which hampers ultimate recoveries. Compromise settlement is recognized as a valid resolution mechanism under the Prudential Framework on Resolution of Stressed Assets dated June 7, 2019,” it added.
The RBI seems to have been guided by opportunity cost theory. Opportunity cost is the potential gains forfeited when a person, company or investor selects one alternative over another. The underlying assumption in this instance is that the banking system is forfeiting potential gains delayed by the legal process. The RBI reiterated through the FAQs that “compromise deals” will not scuttle criminal proceedings against defaulters or fraudsters. But if long legal delays are the reason for compromising with fraudsters and wilful defaulters, it speaks very badly of the legal system. Rather than fixing legal delays, the RBI has chosen to embrace a compromise model! Is the RBI doing a service to the justice delivery system?
The regulator’s move is a slap on the face of the political masters, whose responsibility it is to beef up the legal system to ensure speedy resolution of cases. Are quick compromise deals a solution for legal delays relating to frauds and wanton defaults? Economic logic may justify such compromise deals, but they throw up a host of ethical and moral issues. The RBI did clarify that the one-year minimum cooling-off period for settled dues under compromise deals does not apply to fraud or wilful defaulters. “The cooling period has been introduced as a general prescription for normal cases of compromise settlements, without prejudice to the penal measures applicable in respect of borrowers classified as fraud or wilful defaulter as per the Master Directions on Frauds dated July 1, 2016 and the Master Circular on Wilful Defaulters dated July 1, 2015, respectively,” the RBI said in FAQs.
But doubts still persist. Does this cooling period apply only to the regulated entity (RE) involved in the compromise deal with the borrower? Can a fraud or wilful defaulter borrow from other REs after the compromise settlement? There is ambiguity on whether other banks can take fresh exposure to such a client during the cooling-off period.
No doubt, there are elaborate ring-fencing efforts to make the compromise settlement a quick alternative avenue for the banking industry to speed up the default resolution process. Yet, it is very difficult to wish away its negative fallouts. By encouraging compromise settlements with fraud and wilful defaulters, is the banking regulator not sending the wrong signal to the borrowing community? It is clearly a case of incentivising an avoidable practice among borrowers. The newly-announced compromise settlement formula is bound to open a Pandora box.
K.T. Jagannathan is a senior business journalist.