On defaulters, RBI prioritises public interest

Hence, it is wrong to think that the RBI has permitted something unusual. One-time settlements are part and parcel of the business of banking. The RBI has simply given a formal regulatory structure to a standard banking practice.

Some of these settlements can indeed be with wilful and fraudulent defaulters. When trying to recover a loan, a bank should not make any distinction between whether the default is wilful, fraudulent or otherwise. Irrespective of the nature of the default, it is up to the bank to decide whether a settlement is a better and quicker option instead of triggering the IBC or pursuing some other strategy. The sole motivation behind such a decision should be to maximise recovery, as speedily as possible. This will help unlock banking capital that is stuck in the wilful default or fraud categories.

What about the crimes that these defaulters may have committed?

The RBI circular makes it clear that banks should feel free to file cases against fraudulent or wilful defaulters. It states that banks will undertake settlements “without prejudice to the criminal proceeding underway against such debtors”. This separates the criminality of a particular default case from the commercial aspect of it. In other words, the circular does not condone any crime. But the pursuit of criminal action against a defaulter should not necessitate suspending commercial judgement. This distinction is vital.

That said, there are some valid concerns. One apprehension stems from government control over the boards of public sector banks. This creates a risk that the settlement process might be misused to favour politically connected defaulters at the cost of the banks’ commercial interests. This concern may not be without merits, and it is, therefore, incumbent upon the RBI to allow commercially prudent decisions and prevent politically motivated ones. Only time will tell whether the requirements and safeguards laid down by the circular will be sufficient for this purpose.

In addition, some broader issues need to be highlighted. There is ample anecdotal evidence that private sector banks have been settling with wilful defaulters for a while now. If banks have already been reaching such settlements and various instructions to this effect have already been issued by the RBI to them over the years, one might ask: What was the need for this circular?

The answer possibly lies in the fact that two-thirds of the Indian banking system is owned by the government and public sector banks are more likely to come under the scrutiny of investigative agencies for any action they take. The RBI circular gives these banks regulatory cover for settlement-related decisions. In a narrow sense, therefore, the circular merely levels the playing field. But from a wider perspective, the fact that a circular needed to be issued underscores the distortions that the Indian banking system suffers from owing to the government ownership of banks. In a fully privately-owned banking system there would be no need for such a circular and the ensuing controversy could have been avoided.

The second broad issue concerns regulatory governance. A year ago, the RBI’s Regulations Review Authority 2.0 recommended that the RBI place all draft instructions on its website for stakeholder comments and finalise them after considering the feedback. Exceptions should be made only in special circumstances.

There do not appear to have been any special circumstances surrounding the June 8 circular. There were no issues related to financial stability, or fiduciary duty, or confidentiality. There does not even appear to have been any pressing urgency. At the same time, the circular is of great public interest since it applies to entities against whom criminal proceedings are underway.

Hence, the draft circular could and should have been placed on the RBI’s website for public consultation along with a discussion paper clearly explaining its rationale. Concerned stakeholders could have expressed their concerns and the RBI would have had the opportunity to assuage their misgivings by making suitable clarifications to the draft circular before notifying it. That would have saved the central bank and the government much trouble.

Banks are commercial enterprises and should be allowed to operate accordingly. In principle, separating a commercial decision such as loan recovery from criminal proceedings against wilful defaulters is a step in the right direction. However, the situation in India is unduly complicated because of government ownership of commercial enterprises and gaps in regulatory governance. Future public discourse should focus on these fundamental problems, and not on how banks or the RBI could play the role of moral police.

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Datta is Senior Research Fellow, Shardul Amarchand Mangaldas & Co. and Sengupta is Associate Professor of Economics, IGIDR. Views are personal