RBI's guidelines for rationalizing regulatory standards in compromise settlements

21 Jun 2023 , 11:43 AM

The RBI stated that recent guidance it provided to banks regarding ‘compromise settlements and technical write-offs’ had rationalized the regulatory guidance already in place and strengthened some associated requirements to ensure more transparency. 

The RBI published a detailed regulatory framework on June 8 for compromise settlements and technical write-offs that apply to all regulated firms as part of the bi-monthly monetary policy.

The central bank released FAQs (Frequently Asked Questions) about the June 8 circular on Monday as a follow-up.

The Reserve Bank’s decision to permit lenders to settle loans of wilful defaulters under compromise settlement has been contested by bank unions AIBOC and AIBEA.

The central bank’s FAQs stated ‘No’ in response to the question of whether the RBI had added a new provision allowing lenders to reach a compromise settlement with borrowers labeled as fraud or willful defaulters.

‘The said provision enabling banks to enter into compromise settlement in respect of borrowers categorized as fraud or wilful defaulter is not a new regulatory instruction and has been the settled regulatory stance for more than 15 years,’ the FAQs stated.

It also responded negatively when asked if the circular soften the penalties that apply to borrowers who are characterized as fraud or willful defaulters.

According to the FAQs, the circular introduces the idea of a ‘cooling off period’ for standard cases of compromise settlement, during which the lender undertaking settlement shall not assume any new exposure on the borrower entity. This is done to discourage both lenders and borrowers.

It claimed that by providing a clear legal framework, other regulated companies, in particular cooperative banks, are ‘enabled to undertake compromise settlements as part of the normal resolution efforts.’

According to the RBI, it clarifies the concept of technical write-offs and offers general guidelines on the procedure that must be followed by regulated firms for technical write-offs, which is standard banking practice.

Additionally, it was stated that allowing lenders to continue their credit relationship with a borrower entity in cases of fraud or willful default would present a moral hazard because restructuring generally entails the lenders having continuing exposure to the borrower entity even after restructuring.

A compromise settlement, on the other hand, involves a complete separation between the lender and the borrower, according to FAQs. Therefore, allowing lenders to reach settlements with borrowers in accordance with their commercial judgment would improve the likelihood of recovery.

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