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  • Writer's pictureBhargesh Ojha

RBI's Approach to Wilful Defaulters and Large Defaulters: Directions 2023


Introduction

The Reserve Bank of India (RBI) plays a vital role in maintaining the stability and integrity of the Indian banking system. In response to concerns regarding wilful defaulters and large defaulters, the RBI has introduced comprehensive directions in 2023. These directions are specifically crafted to bolster the banking sector, enhance transparency, bringing credit discipline and promote responsible lending practices.


The primary aim of the Wilful Defaulter Directions 2023 is to ensure that wilful defaulters face appropriate consequences for their actions. These directions compel lending institutions to take strict measures against wilful defaulters. This may include preventing these individuals or entities from obtaining further credit facilities from the banking system. This approach serves a dual purpose: it discourages the potential misuse of the banking system and reinforces the fundamental principles of responsible borrowing and lending. In essence, it not only safeguards the interests of lenders but also upholds the integrity and trustworthiness in the banking system.


RBI (Treatment of wilful defaulters and large defaulters' directions, 2023) is intended to substitute earlier circulars and club the best practices of earlier circulars. The draft directions consolidate the existing provisions on the treatment of wilful defaulters and large defaulters and introduces some new measures to tighten the norms and streamline the process of identifying and classifying wilful defaulters. The draft directions also addresses some of the concerns raised by stakeholders regarding the earlier circulars. For example, the draft direction clarifies that non-whole-time directors of a company will not be classified as wilful defaulters unless they are actively involved in the management of the company and are responsible for the default.

Theses directions are still in the draft stage and may be subject to changes before they are finalized. However, from the matter that the direction is drawn, it appears that RBI is committed to strengthening the framework for the treatment of wilful defaulters and large defaulters.

Here are some of the key benefits of the draft direction:

  • It consolidates the existing provisions on the treatment of wilful defaulters and large defaulters into a single document, making it easier for lenders to comply with the regulations.

  • It introduces some new measures to tighten the norms and streamline the process of identifying and classifying wilful defaulters.

  • It addresses some of the concerns raised by stakeholders regarding the earlier circulars.It is expected to have a significant impact on the Indian banking system, reducing the incidence of wilful defaults and improving the quality of the loan portfolio of banks.

Overall, the draft direction is a positive step towards strengthening the framework for the treatment of wilful defaulters and large defaulters in India.

Directions on Wilful Defaulter

A wilful defaulter is a borrower who has deliberately defaulted on a loan or credit facility, despite having the ability to repay it. Wilful default can be caused by a variety of factors, such as siphoning off funds from the borrowing entity, disposing of assets without the lender's consent, or providing false or misleading information to the lender. In cases where a company is found to have wilfully defaulted on its financial obligations, accountability extends to the individuals involved, such as the company's promoters and its directors who were in charge at the time of the default. Similarly, for entities other than companies, those responsible for managing the entity's operations and affairs can also be held liable.

The RBI's directions for handling wilful defaulters establish a robust framework to address this behaviour. These directions will empower banks to take strict measures against such borrowers, ensuring they are held responsible for their actions. Consequences for wilful defaulters can include restrictions on accessing additional credit, removal from company boards if they are associated with any, and, in extreme situations, the initiation of legal actions or criminal proceedings.

These directions are designed to serve as a strong deterrent against deliberate loan defaults, safeguard the interests of lenders, and maintain the credibility of the banking system. They emphasize the importance of responsible borrowing and lending practices, ensuring that borrowers who have the financial means to repay their loans do so.

The direction provided in the draft impose various instructions on wilful defaulters to hold them accountable for their actions. These restrictions include:

  • Debarment from borrowing from banks and financial institutions for a period of five years after their name is removed from the list of wilful defaulters. This means that they will face consequences for their actions for an extended period.

  • Restrictions on starting new ventures for a period of five years after their name is removed from the list of wilful defaulters. This is deterrent for wilful defaulters from engaging in new business activities.

  • Restrictions on holding managerial positions in companies. This ensures that wilful defaulters cannot hold positions of authority or financial responsibility in organizations.

  • In accordance with Circular DBR.CID.BC. No.17/20.16.003/2016-17, issued on September 29, 2016, lenders are required to establish a non-discriminatory policy, duly approved by their board, which explicitly defines the criteria for the publication of photographs of individuals categorized and declared as wilful defaulters.

Wilful defaulters shall not be eligible for restructuring of credit facility. In case where the existing promoters are replaced by new promoters in terms of directions contained in circular 'Prudential Framework for Resolution of Stressed Assets" dated June 7, 2019, and the borrower company is totally delinked from such erstwhile promoters/management, lenders may take a view on restructuring such accounts based on their viability, without prejudice to the continuance of criminal action against the erstwhile promoters/ management.


Directions on Large Defaulter

In addition to addressing wilful defaulters, the RBI has introduced specific directions for handling large defaulters. These directions primarily target borrowers with substantial outstanding debt to multiple banks or financial institutions. As per Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated October 1, 2021, a defaulter is said to be a large defaulter when there is an outstanding amount of INR 1 crore or above and is further classified as doubtful or loss.

Under the large defaulter directions, banks are required to promptly identify and report borrowers whose aggregate exposure exceeds a specified threshold to a Central Repository of Information on Large Credits (CRILC). This centralized repository allows banks to monitor and evaluate risks associated with large borrowers more efficiently, enabling proactive decision-making and improved risk management.

Furthermore, these directions underscore the importance of early recognition and reporting of defaults, enabling banks to initiate prompt corrective actions. The RBI's focus on timely resolution aims to minimize the impact of default on the banking sector, ensuring that the recovery process is both transparent and effective.


Guarantor's liability

According to Section 128 of the Indian Contract Act, 1872, when someone acts as a guarantor for a loan, it means they promise to pay back the loan if the person who borrowed the money (the principal debtor) can't. This promise is usually as strong as the borrower's promise to repay the loan, unless the agreement says something different.

If the borrower can't make their loan payments, the lender can ask the guarantor to pay instead, even without trying to get the money from the borrower first. The guarantor's obligation to pay is immediate if the borrower can't. If the guarantor refuses to pay when asked by the lender, they might be labelled as a "wilful defaulter," which has serious consequences.

Additionally, if a group of companies provides guarantees for members of the group who don't repay their loans, and these guarantees are not honoured when the lender asks for repayment, the entire group of companies might be treated as wilful defaulters. Lenders should also look at each individual company's history of repaying loans within the group.

These directions and responsibilities for guarantors have been in place since September 9, 2014, and lenders need to inform potential guarantors about these directions when they agree to be a guarantor for a loan.


Reporting of Wilful Defaulters and Large defaulters

These directions are important for all organizations regulated by the Reserve Bank, not just banks. They make it mandatory for these organizations to regularly share information about big borrowers who are not paying their loans as agreed. This information includes accounts where legal action has been taken to get the money back, as well as accounts where legal action is still in progress. This data must be shared with credit information companies (CICs) monthly. The CICs, in turn, are required to display these lists of accounts with legal actions on their websites.

Additionally, these directions specify what qualifies as a "suit filed account," which covers accounts involved in legal proceedings, like court cases or actions under the Insolvency and Bankruptcy Code. The directions also ensure that once someone's outstanding loan amount falls below a certain threshold, lenders must promptly inform the CICs within 30 days to remove their name from the list of wilful defaulters. This system is in place to make sure everyone is aware of borrowers who deliberately avoid repaying their loans, including situations involving overseas branches of Indian banks if allowed by the host country's laws. The primary goal is to promote transparency regarding borrowers who intentionally don't repay their loans.


Natural Justice, fair and Transparent Directions

Natural justice is a fundamental principle that embodies fairness and impartiality in decision-making. In the context of the RBI's directions for defaulters, it means that borrowers are given a fair chance to present their side of the story before any severe actions are taken against them. This ensures that individuals or companies facing loan defaults are not treated arbitrarily and can provide their perspective, reasons, or mitigating circumstances. Natural justice is like a safety net to ensure that classifications are made with a balanced and unbiased approach.

Being fair and transparent means that the entire process of dealing with defaulters is conducted without favouritism or hidden agendas. "Fair" implies that the process is equitable, with consistent treatment for all borrowers. There is no discrimination, and everyone is held to the same standards. "Transparent" means that the process is open and clear, with no hidden secrets or concealed information. It allows for public scrutiny, ensuring that actions and decisions are readily visible, and no one can manipulate or distort the process.

In essence, the new directions emphasize that the treatment of defaulters must be just, unbiased, and carried out with clear and visible steps. This helps build trust in the system, as borrowers can be assured that they will be treated fairly and that all actions and decisions will be made openly and without any hidden motives. It's about ensuring that the entire process is based on principles of fairness and transparency.


Process

The process for identifying and classifying a borrower as a wilful defaulter under the draft direction is as follows:

  1. The lender will first issue a notice to the borrower, informing them that their account is being considered for classification as a wilful default. The notice must specify the reasons why the lender is considering such a classification.

  2. The borrower will be given a reasonable opportunity to make representations to the lender. The borrower may submit written representations or request a personal hearing.

  3. The lender will then set up an identification committee to examine the case and make a recommendation. The identification committee must consist of a Whole-time director other than CEO as chairperson and two senior officials not below two ranks of chairperson. In respect to 'Credit facilities', lenders can formulate identification committee comprising of an officer as chairperson who would be just below the rank of a whole-time director, and two senior officials not below two ranks of chairperson.

  4. The identification committee will consider all relevant factors, including: The borrower's financial condition

    • The reasons for the default

    • Any representations made by the borrower

    • Whether the borrower has a history of defaults

    • Whether the borrower has diverted funds or disposed of assets without the lender's consent

    • Whether the borrower has made false representations to the lender

5. The identification committee will submit its recommendation to the lender and the lender will constitute a review committee to review the proposal of identification committee. The review committee must consist of Whole-time director who is CEO of lender as chairperson and two independent directors as members. The chairperson shall be an independent director if credit facility has been sanctioned by CEO.

6. The lender will then make a final decision on whether to classify the borrower as a wilful defaulter.


If the lender decides to classify the borrower as a wilful defaulter, it must inform the borrower in writing and provide the borrower with an opportunity to appeal the decision. The lender shall examine the "wilful default" aspect in all accounts with outstanding amount of INR 25 lakh and above or as per the latest notification by RBI. Further, lender completes the process by declaring the borrower as a wilful defaulter if its account was declared NPA for a period of six months.

In regard to credit facility threshold, lenders may constitute a review committee formulated by the lender with a designation of whole-time director as chairperson and two senior officials not below two ranks of chairperson.

The bar on additional credit facility shall be effective upto one year after name of wilful defaulter has been removed from the List of Wilful Defaulters (LWD) by lender. Moreover, a lender cannot provide a loan to a wilful defaulter, or any business connected to a wilful defaulter for five years after the wilful defaulter's name has been removed from the list of wilful defaulters by the lender.


Ineligible for restructuring

Wilful defaulters cannot have their credit facilities restructured. However, if new promoters take over a company according to the circular "Prudential Framework for Resolution of Stressed Assets," and the company is entirely separated from the previous promoters, lenders may consider restructuring based on the company's financial viability. This decision does not affect ongoing process against the former promoters or management.


Quick Actions

RBI (Treatment of wilful defaulters and large defaulters' directions, 2023) proposes the following quick actions:

- Timely identification of wilful defaulters: The draft direction mandates that banks and lenders identify wilful defaulters within six months of an account being classified as a non-performing asset (NPA). This is a significant improvement over the current requirement, which does not specify a deadline for identifying wilful defaulters.

- Central registry of wilful defaulters: The draft direction proposes to create a central registry of wilful defaulters to which all banks and lenders will have access. This will help to prevent wilful defaulters from obtaining credit from multiple lenders.

- Stricter penalties for wilful defaulters: Once a borrower is identified as a wilful defaulter, they will be barred from receiving any additional credit facilities from any lender for a period of five years. They will also be barred from floating new ventures for a period of five years after their removal from the list of wilful defaulters. These penalties are much stricter than the existing penalties for wilful defaulters.


Differences between the old circulars and the new circular

The draft direction introduces several new features, including:

- Expanded definition of wilful default: The expanded definition of "wilful default" in the draft direction encompasses intentional actions by borrowers that go beyond financial incapacity, including the deliberate diversion of loan funds for unauthorized purposes, disposal of collateral assets without lender consent, and the provision of false information to deceive the lender, signalling an intent to evade loan obligations and undermining the terms of the loan agreement.

- Timely identification of wilful defaulters: The draft direction mandates that banks and lenders identify wilful defaulters within six months of an account being classified as a non-performing asset (NPA).

- Stricter penalties for wilful defaulters: Once a borrower is identified as a wilful defaulter, they will be barred from receiving any additional credit facilities from any lender for a period of five years. They will also be barred from floating new ventures for a period of five years after their removal from the list of wilful defaulters.

- Central registry of wilful defaulters: The draft direction proposes to create a central registry of wilful defaulters to which all banks and lenders will have access. This will help to prevent wilful defaulters from obtaining credit from multiple lenders.


Preventive Measures

These are some directions to make sure that banks and other lenders are careful when giving out loans. First, they need to check if the people in charge of a company or the ones guaranteeing the loan have a history of not paying their debts. If there is any confusion about their names, the lender should find other sources to confirm who they are, instead of just asking the company borrowing the money.

Second, when the money is given for a specific project, the lender should check if it's being used for that purpose. They can ask accountants to confirm this, but they shouldn't rely only on their word. Lenders should also keep a close watch on the borrowers and their financial reports, visit their businesses, and even do audits to make sure everything is okay.


Role of Statutory Auditors

These directions talk about what to do if a bank or lender thinks that a company, they lent money to has lied about their financial records, and if the auditors didn't do their job properly. If the bank finds such problems, they can make a formal complaint against the auditors to a government organization called the National Financial Reporting Authority (NFRA) or the Institute of Chartered Accountants of India (ICAI) to investigate and hold the auditors responsible.

Before reporting to NFRA or ICAI, the bank needs to be sure that the auditors were involved and give them a chance to explain themselves. The Indian Banks' Association (IBA) will also make a list of such auditors to warn other banks. If the bank wants to make sure the money lent is used properly, they can ask the borrower's auditors for a special certification. They can even hire their own auditors to check things if they don't trust the borrower's auditors. Depending on how serious the problem is and the evidence they have, the lender might also do a deep investigation of the borrower's financial records.


Conclusion

The RBI's approach to wilful defaulters and large defaulters through the 2023 directions is expected to have a positive impact on banking system and the Indian economy. By enforcing stringent actions against wilful defaulters, these directions discourage wrongful practices, promote responsible borrowing, and reduce the burden on the banking system.

Furthermore, the improved monitoring and reporting for large defaulters empower banks to detect potential risks promptly, enhancing the overall health of the banking sector and boosting investor confidence. The draft directions are set to impact both wilful and large defaulters significantly. The transparent process for identifying wilful defaulters makes it harder for them to evade the consequences and access credit from other lenders. These directions are expected to benefit the banking sector by reducing wilful defaults, bolstering asset quality, and enhancing resilience in the face of financial challenges. In summary, the aim is to create a transparent and responsible financial environment, strengthening the banking system and contributing to overall economic stability, which reflects RBI's commitment to a robust banking system in India.


The article was published in Taxmann. Click here to read the article.


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