The Reserve Bank of India (RBI), in a series of FAQs (frequently asked questions) on June 20 said it has not introduced a "new clause" when it comes to permitting lenders to enter into "compromise settlement" with borrowers classified as "fraud or wilful defaulter", and that this regulatory stance has been there for over 15 years.

The central bank said this enabler was available to banks via its letter, circular, and directions issued in 2007, 2015, and 2016, respectively. The RBI’s circular on June 12, 2023, had issued a circular framework for all banking and other financial institutions for compromise settlements and technical write-offs to provide "further impetus to the resolution of stressed assets in the system as well as to rationalise and harmonise the instructions across regulated entities”.

Will the RBI's latest circular "dilute" the penal measures applicable to borrowers classified as "wilful defaulter or fraud"? The RBI said the penal measures currently applicable to such borrowers remain "unchanged", and will continue to be applicable in cases where the banks enter into compromise settlement with such borrowers.

"Such penal measures entail inter alia that no additional facilities should be granted by any bank/FI to borrowers listed as wilful defaulters and that such companies (including their entrepreneurs/ promoters) get debarred from institutional finance for floating new ventures for a period of five years from the date of removal of their name from the list of wilful defaulters," the central bank said.

On the minimum cooling period of 12 months prescribed in the RBI circular, the apex bank said such borrowers will not be able to borrow fresh funds from the lenders after the cooling period.

To ensure the provisions of a compromise settlement with fraud or wilful defaulter are not mis-utilised, the RBI said: "Compromise settlement is not available to borrowers as a matter of right; rather it is a discretion to be exercised by the lenders based on their commercial judgment".

The prudential guidelines provide sufficient safeguards with regard to such settlements considered by banks, says the RBI, adding that all such decisions are required to be taken by lenders as per their board-approved policies, instead of adopting an ad-hoc approach in each case.

The circular further strengthens the regulatory guidance by mandating that all such cases of compromise settlement involving the said borrowers must be approved by the board, the RBI said.

Wherever recovery proceedings are pending before a judicial forum, any settlement arrived at with the borrower will be subject to obtaining a consent decree from the concerned judicial authorities, it says. Also, the boards of lenders have oversight of the overall trends in approvals of all compromise settlements.

On the rationale behind permitting lenders to enter into compromise settlement in such cases, the RBI says it aims 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."

With this circular, the RBI said it wants to rationalises the existing regulatory guidance to banks on compromise settlements; enable other regulated entities, particularly cooperative banks, to undertake compromise settlements; and provide clarity on the definition of a technical write-off.

As a disincentive to both the lenders and the borrowers, it introduces the concept of a cooling period for normal cases of compromise settlement during which the lender undertaking settlement will not take any fresh exposure on the borrower entity, said the RBI.

Follow us on Facebook, Twitter, YouTube & Instagram to never miss an update from Fortune India. To buy a copy, visit Amazon.