Recently, the Reserve Bank of India published a draft master direction on treatment of wilful defaulters and large defaulters. This direction is open for feedback till October 31 and has set a cat among the pigeons. On one hand, the regulator has widened the scope and applicability of ‘wilful default’ to enable not just banks but all financial institutions including asset reconstruction companies to declare specific defaulters on loans as ‘wilful’.

It has strengthened the framework and process involved in identifying such defaulters and set a cooling off period during which such defaulters cannot avail of formal finance. But the directions also reiterate a proposal to allow wilful defaulters to enter into a settlement or compromise with their lenders, where the latter would have to take a haircut. This could be counter-productive.

Banks name a borrower as a wilful defaulter after a rigorous process of ascertaining his/her credit-worthiness. In most cases, a wilful defaulter is not simply a borrower who has been caught unawares by the consequences of a change in business terrain or the economic unviability of a business. A wilful defaulter is a borrower who is financially fully capable of meeting his/her loan obligations but fails to honour repayment commitments.

Siphoning of funds

In some cases, the borrower may have kept up his obligations to a certain bank but failed to honour it with another bank on purpose. There could be instances of siphoning of bank funds into personal coffers or routing of funds out of the business.

Whatever be the case, banks are required to find evidence of intent to default and give an opportunity to be heard to the borrower, before labelling him a wilful defaulter. This is not a unilateral call by the bank.

The rules around wilful defaulters go back to 1999, but it was in 2015, when the domestic bank bad loan crisis was unfolding at a swift pace, that the RBI came out with a consolidated master circular on the issue.

After this circular, there is genuine fear especially among mid- to large-sized corporates about failing to use bank borrowings judiciously. Allowing room for compromise or settlement now, after these changes, would dilute the intent and spirit of all the measures that the regulator and the government have taken since the advent of the Insolvency and Bankruptcy Code to bring wilful defaulters to book.

Then there is the question of practicality. Given the vigilance and enforcement authorities looking over their shoulder, especially in state-owned banks, who would willingly compromise with a wilful defaulter? After knowing that a borrower has the financial capability to repay the loan in full, would a bank be comfortable settling for, say, ₹150 crore against dues of ₹200 crore? Such negotiations could be re-opened for scrutiny by government agencies many years after these settlements are reached.

There is a moral hazard angle too. The money involved is that of the common man. Nearly 80 per cent of bank lending in India happens due to depositors’ faith in the banking system. Compromising with wilful defaulters is tantamount to taking this faith for granted.

Supreme Court ruling

The RBI appears to be reviewing its regulations on wilful defaulters due to the recent Supreme Court ruling that went in favour of a borrower, where a large bank classified him as a wilful defaulter without giving him a fair opportunity to defend himself. This is possibly a case of a relatively small individual borrower being wronged. But should this set a precedent for large borrowers?

If the intent is to protect or give space to retail borrowers who are treated unfairly by lenders, they may need to be given more time than the two weeks currently specified in the proposal, for a hearing, before being classified as wilful defaulters. There could be merit in increasing the threshold for this classification from the present ₹25 lakh to ₹1 crore. This would ensure that even high net worth retail borrowers availing bank loans are covered.

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