Regulation for stressed assets needs work

The Reserve Bank of India (RBI) in its June 2023 development statement noted that while the Prudential Framework for Resolution of Stressed Assets of June 2019 provides a “broad principle-based framework”, to further encourage the resolution of stressed assets, there was a need for a “comprehensive regulatory framework” on compromise settlements and technical write-offs. This has been addressed by the RBI’s Framework for Compromise Settlements and Technical Write-offs issued on the same day as the statement. The change took effect immediately, with no reason given for the urgent implementation.

The framework applies to all RBI-regulated entities (RE). It permits the REs to enter into compromise settlements or technical write-offs (together, settlements) with borrowers classified as wilful defaulters or fraudulent borrowers. The framework defines a compromise settlement as a negotiated arrangement with the borrower to fully settle the claims of the RE against the borrower. This must be in cash. The settlement may require the sacrifice of some amounts due, with corresponding waivers of claims against the borrower. A technical write-off is defined as a non-performing asset being fully or partially written off only for accounting purposes without any waiver of claims against the borrower.

Such settlements will not affect any existing criminal proceedings against the borrowers. Settlements must also comply with any other applicable law. Where recovery proceedings are pending, the court or tribunal must consent to the settlement.

REs must have in place board-approved mechanisms for settlements. Their objective is to maximise recovery from distressed borrowers at minimum expense. These policies must fully prescribe the process to be followed. They should contain specific guidance on matters such as minimum ageing, devaluation of collateral, staff accountability and delegation of powers for approval of settlements. Policies should provide for permissible write-downs for various categories of exposure when arriving at the settlement amount. These should take into account the realisable value of any collateral.

A committee considering a proposal for a settlement must not include any officer who had originally approved the loan. Proposals for a settlement with a fraudulent borrower or a wilful defaulter will require approval from the board of directors.

Settlements will not affect any contractual arrangements between an RE and a borrower on future realisations or recovery, as long as such claims are recognised on the balance sheet of the RE until actual realisation. If any such claims are so recognised, they will be treated as a restructuring.

A cooling-off period applies to any fresh credit exposure to a borrower the subject of a settlement. A minimum cooling-off period of 12 months applies to exposures other than those involving farm credit. An RE’s board may prescribe a longer period. The period for a technical write-off will be in accordance with the RE’s board-approved policy.

An RE’s board must prescribe the manner of reporting, including trends in the number of accounts and amounts subject to settlements, on quarter-to-quarter and year-to-year bases. Reporting should include breakdown accounts by fraud; red-flagged accounts; wilful default and “quick mortality” accounts; the grouping of settlement accounts based on amount and approving authority; business segment and asset class, and the extent of recovery in technically written-off accounts. An RE must also have a reporting system where settlements are reported on at least a quarterly basis to the next level of authority. Any settlements approved by the managing director and chief executive officer of an RE or a board-level committee must be reported to the board.

The framework is comprehensive and provides much-needed clarity on how the REs may undertake settlements and technical write-offs. For public sector banks, this is much needed and provides a mechanism for settlements of distressed loans without the threat of constant regulatory enquiry and investigation.

While the framework provides for a reporting mechanism, it is silent on the moral hazard of excessive technical write-offs, in which the recovery of loans that have been properly written off from an accounting perspective becomes a source of out-of-turn profit. The framework is a good start but must be improved over time.

Sawant Singh and Aditya Bhargava are partners at Phoenix Legal