The Reserve Bank of India (RBI) defined wilful defaulters a decade ago in its circular RBI/2013-14/63, DBOD No. CID.BC. 3 /20.16.003/2013-14 dated 1 July 2013. Wilful default broadly covered the following:
a) Deliberate non-payment of the dues, despite adequate cash-flow and good net worth.
b) Siphoning off funds to the detriment of the defaulting unit.
c) Assets financed have either not been purchased or been sold and proceeds have been mis-utilised.
d) Misrepresentation or falsification of records.
e) Disposal or removal of securities without the bank's knowledge.
f) Fraudulent transactions by the borrower.
On top of this, RBI also specified that all such accounts above Rs25 lakh should be scrutinised by a high-level committee of the bank consisting of the executive director, two general managers and a deputy general manager. Banks and financial institutions (FIs) were advised to examine all cases of wilful defaults of Rs1 crore and above for filing of suits and consider criminal action wherever instances of cheating or fraud by the defaulting borrowers were detected. Banks were expected to proceed legally against such borrowers for recovery of dues.
It has also issued instructions on a prudential framework for tackling the distressed assets after classifying them as special mention accounts (0,1,2) and non-performing assets (NPA) management. Each bank reviews the NPA accounts regularly. With all these mandates, banks ended up with a huge list of wilful defaulters!
Here appears a compromise by RBI with its own directives.
Strangely, contrary to the best practices in banking and financial institutions, RBI directed at resolving such wilful defaults through a compromise settlement for which board approval should be in place. These instructions were issued just a couple of days after governor Shaktikanta Das exhorted banks to implement good governance practices.
The questions that beg response are: Is it difficult to identify such wilful defaulters in the first place for a well-supervised asset? Why did the banks not act against wilful defaulters for long periods?
Banks financing working capital monitor the cash-flows regularly. It is easier to find the diversion within a quarter. Similarly, the diversion of funds for unintended purposes could be found at the first level visit to the enterprise after the enterprise has been financed for such an asset. Siphoning of funds detrimental to the interests of the enterprise functioning is also easily detectable.
Likewise, if the funds have been spent for assets other than what they were sanctioned for—for instance, buying a top brand car instead of a machine within days of releasing the money (usually, such funding has to be done by the banks directly to the machinery supplier after the margin money or that portion of the value of the asset that the borrower has to meet), it is detectable within days of release.
Disposal or removal of assets without the bank's knowledge could also be identified during the bank's routine monthly and quarterly inspections of the units (each account will have a debit towards inspection charges). The only easily non-detectable wilful default rests with fraud and misrepresentation of facts. This would require criminal proceedings, once detected.
The 17-page exhaustive circular also gave an illustration of the identification of such wilful defaulters to ensure the end-use of funds:
"Meaningful scrutiny of quarterly progress reports, operating statements and balance sheets of the borrowers, regular inspection of borrowers' assets charged to the lenders as security, periodical scrutiny of borrowers' books of accounts, periodical visits to the assisted units, periodical stock audits in case of working capital finance, periodical comprehensive audit of the 'credit' function of the lenders so as to identify systemic weaknesses in the credit administration."
RBI directed the banks to initiate the following actions against the wilful defaulters:
The following measures should be initiated by the banks and FIs against the wilful defaulters identified as defined in the circular:
a) "No additional facilities should be granted by any bank and FI to the listed wilful defaulters. In addition, the entrepreneurs/ promoters of companies where banks and FIs have identified siphoning or diversion of funds, misrepresentation, falsification of accounts and fraudulent transactions should be debarred from institutional finance from the scheduled commercial banks, development financial institutions (DFIs), government-owned non-banking finance companies (NBFCs) and investment institutions for floating new ventures for five years from the date the name of the wilful defaulter is published in the list of wilful defaulters by the RBI.
b) The legal process, wherever warranted, against the borrowers and guarantors and foreclosure of recovery of dues should be initiated expeditiously. The lenders may initiate criminal proceedings against wilful defaulters wherever necessary.
c) Wherever possible, the banks and FIs should adopt a proactive approach for a change of management of the willfully defaulting borrower unit.
d) A covenant in the loan agreements with the companies in which the banks and notified FIs have a significant stake, should be incorporated by the banks and FIs to the effect that the borrowing company should not induct a person who is a promoter or director on the Board of a company which has been identified as a wilful defaulter, and if such a person is found to be on the Board of the borrower company, it would take expeditious and effective steps for removal of the person from its Board."
If these instructions were followed, the wilful defaulters' list would not have reached the proportions now obtaining billions of rupees.
The circular on wilful defaulters in 2013 also required that the borrower, who is declared as a wilful defaulter, is given a chance to prove his credentials before a high-level committee at the head office of the banks.
There is no evidence of such a thing happening during the last decade, save very few exceptions. Why did RBI not follow those instructions in their regular annual inspections and initiate action?
No wonder, the Supreme Court, in a hearing recently, advised RBI to provide a window of opportunity to hear the willful defaulters and record them before branding them as such. RBI did not even argue that such instructions were issued but would check on their implementation.
Annexure I of the circular required that the banks submit quarterly data in the prescribed format in the list of wilful defaulters with borrowing above Rs25 lakh and the names of directors of such wilful defaulting companies at quarterly intervals. It looks as though RBI did not follow its own instructions for affirmative action.
When it came to the question of micro and small enterprises, banks hurried to act by branding even circumstantial default as wilful default and proceeded to sell the assets under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) provisions.
According to a number of studies, wherever collateral securities were available, in 60% of the defaulted cases, banks proceeded to sell them off, treating them as wilful defaults.
Six years ago, RBI allowed banks to classify accounts of wilful defaulters as fraudulent and empowered banks with the Insolvency and Bankruptcy Code (IBC). Unfortunately, the courts as well as IBC did not help speedy resolution of distressed assets. There would appear to be deliberately planned delays in legal settlements. The Act providing 250 days is ludicrous as the assets would lose value by that time for sale, save land that might have accelerated in value. There is no accountability for settlement delays. This exhaustive master circular on wilful defaults also has a grievance redress mechanism.
The elation of the government and banks over the banks' balance sheets on 31 March 2023, representing the position as of that particular day, hides many ills plaguing the banks. While digitisation has helped banks, bank branches complain of long working hours, poor response over the system, and a volley of customer complaints. There is a need for a thorough overhaul of the banks when the going appears good and not when the house is burnt.
RBI would do well to withdraw its latest instructions on compromise settlement of wilful defaulters and hold the banks accountable for not implementing its earlier directives, if warranted by imposing appropriate penalties for violating those instructions that are very material for financial stability. This will set an example of good governance by RBI.
It would be imperative on the part of the banks and FIs to put in place a transparent mechanism for the entire process so that the penal provisions are not misused, and the scope of such discretionary powers is kept to the barest minimum. It should also be ensured that a solitary or isolated instance is not made the basis for imposing penal action.
Now, why this sudden love for wilful defaulters and settlement through compromise, which would actually hurt the honest borrowers? Why do the regular bank statutory audits/ bank inspections/ RBI inspections in certain select cases tolerate them in the books of the banks for so long? Instead of dealing with inefficient loan origination and monitoring as internal to the bank, why is RBI trying to compromise the process and allow settlements out of the courts? It is obvious such wilful defaulters are in big-ticket loans.
(The author is a retired senior banker, economist and risk management specialist)
To my knowledge I do not think npas are man made in any well administered economic system . NPAs do occur because of natural calamities and business failures due to some inevitable circumstances which the economy can bear naturally and the stakeholders can understand and bear with it .