Regulatory updates

The Reserve Bank of India (RBI) has from time to time, issued several instructions to the Regulated Entities (REs) regarding compromise settlements in respect of stressed accounts. This includes the Prudential Framework for Resolution of Stressed Assets dated 7 June 2019 (the prudential framework), which recognises compromise settlements as a valid resolution plan.

In order to provide further guidance regarding the resolution of stressed assets as well as to rationalise and harmonise the instructions across all REs, on 8 June 2023, RBI issued a framework for compromise settlements¹⁹ Compromise settlement refers to any negotiated arrangement with the borrower to fully settle the claims of the RE against the borrower in cash. It may entail some sacrifice of the amount due from the borrower on the part of REs with corresponding waiver of claims of the RE against the borrower to that extent. and technical write-offs²⁰ Technical write-off refers to cases where the non-performing assets remain outstanding at borrowers’ loan account level but are written-off (fully or partially) by the RE only for accounting purposes, without involving any waiver of claims against the borrower, and without prejudice to the recovery of the same. (the framework).

Subsequently, on 20 June 2023, RBI issued certain clarifications on the framework in the form of Frequently Asked Questions (FAQs). Following are some of the key aspects of the framework and FAQs:

• Applicability and Effective Date: The provisions of the framework would be applicable to the following REs:

• Commercial banks (including small finance banks, local area banks and regional rural banks)
• Primary (urban) co-operative banks/state co-operative banks/central co-operative banks
• All-India financial institutions
• Non-Banking Financial Companies (NBFCs) (including housing finance companies)

The framework has come into force with immediate effect (i.e., from 8 June 2023).

• Board-approved policy: The framework states that REs should put in place board-approved policies for undertaking compromise settlements with the borrowers as well as for technical write-offs. Such policies must comprehensively lay down the process to be followed for all compromise settlements and technical write-offs (including delegation of power for approval of such compromise settlements and technical write offs), with specific guidance on the necessary conditions precedent such as minimum ageing, deterioration in collateral value, etc. For compromise settlements, the policy should inter alia also contain the permissible sacrifice for various categories of investments while arriving at the settlement amount after determining the value of the security or collateral. The compromise settlements and technical write-offs included in the policy would be without prejudice to any mutually agreed contractual provisions between the RE and the borrower relating to future contingent realisations or recovery by the RE, subject to such claims not being recognised in any manner on the balance sheet of the REs till actual realisations of the receivables²¹It is to be noted, that any claims recognised on the balance sheet of the RE would render the arrangement to be a restructuring..
• Delegation of power for approval of compromise settlements and technical write offs: The REs should ensure that compromise settlements and technical write offs are approved as follows:

Compromise settlement with…	Approval required of…
Debtors classified as fraud or wilful defaulters	The board of directors of the REs in all cases
Other debtors	An individual or committee (authority) which is at least one level higher in hierarchy than the authority vested with the power to sanction the credit/investment exposure. An official who was a part of sanctioning the loan would not be a part of approving the compromise settlement of the same loan.

• Cooling period: As a disincentive to both the lenders and the borrowers from seeking a compromise settlement for resolution of stressed assets on a regular basis, the framework has introduced the concept of cooling period for normal cases of compromise settlement during which the lender undertaking settlement shall not take any fresh exposure on the borrower entity. This is given in the table below:

Exposure	Minimum cooling period22 REs are free to stipulate higher cooling periods in terms of their Board approved policies.
Compromise settlement for Farm credit exposure23 Farm credit for the above purpose shall refer to credit extended to agricultural activities as listed in Annex 2 to the Master Circular - Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances as amended from time to time.	As per RE’s board approved policies
Compromise settlement for debtors classified as fraud or wilful defaulters	Five years (as per penal measures applicable to borrowers classified as wilful defaulters or fraud)
Compromise settlement for other exposures	Floor of 12 months
Technical write offs	As per RE’s board approved policies

• Reporting mechanism: The framework specifies that there must be a reporting mechanism to the next higher authority, at least on a quarterly basis, with respect to compromise settlements and technical write offs approved by a particular authority. Accordingly, such settlements and technical write-offs which have been approved by the MD and CEO/board level committee would be reported to the board. Further, the board would mandate a suitable reporting format, covering the following aspects at the minimum:

• Trend in the number of accounts and amounts subjected to compromise settlement and/or technical write-off (quarter on quarter and year on year)
• A separate breakup of the accounts in (a) classified as fraud, red-flagged, wilful default and quick mortality accounts
• Amount-wise, sanctioning authority-wise, and business segment/asset-class-wise grouping of such accounts, and
• Extent of recovery in technically written-off accounts.

• Prudential treatment: The prudential treatment for exposures subject to compromise settlement and technical write offs is as under:

Particulars	Prudential treatment
Compromise settlement	Where the time for payment of the agreed settlement amount exceeds three months, the settlement shall be treated as restructuring24 Defined in terms of the Prudential framework on Resolution of Stressed Assets dated June 7, 2019..
Partial technical write off	The prudential requirements in respect of residual exposure, including provisioning and asset classification, shall be with reference to the original exposure.

• Treatment of debtors classified as fraud and wilful defaulter: REs may undertake compromise settlements or technical write-offs w.r.t. the debtors categorised as wilful defaulters or fraud, without prejudice to the criminal proceedings underway against such debtors. RBI vide the FAQs has clarified that penal measures²⁵ Penal measures include:
  ⁃ No additional facilities should be granted by any bank/financial institution to borrowers listed as wilful defaulters, and that such companies (including their entrepreneurs/promoters) get debarred from institutional finance for floating new ventures for a period of five years from the date of removal of their name from the list of wilful defaulters.
  ⁃ Borrowers classified as fraud are debarred from availing bank finance for a period of five years from the date of full payment of the defrauded amount. currently applicable to borrowers classified as fraud or wilful defaulter remain unchanged and shall continue to be applicable in cases where the banks enter into compromise settlement with such borrowers.

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To access the text of the notification, please click here

To access the text of the FAQs, please click here

On 2 September 2022, the Reserve Bank of India (RBI) issued guidelines on digital lending, which are applicable to all Regulated Entities (REs). The REs must ensure that the Lending Service Providers (LSPs) engaged by them, and the digital lending apps of the REs and of the LSPs comply with these guidelines. However, these guidelines did not stipulate the regulation for First Loss Default Guarantee (FLDG).

In this regard, on 8 June 2023, RBI issued guidelines on DLG (DLG guidelines), commonly known as FLDG, in digital lending. Some of the key aspects of the DLG guidelines are discussed below:

• DLG arrangement: There must be a contractual arrangement between the RE and a DLG Provider under which the DLG Provider should guarantee to compensate the RE for the loss due to default up to a certain percentage of the loan portfolio of the RE, specified upfront (as per the DLG guidelines, the amount of DLG cover on any outstanding portfolio should not exceed five per cent of the amount of that loan portfolio). Any other implicit guarantee of similar nature linked to the performance of the loan portfolio of the RE and specified upfront, should also be covered under the definition of DLG. The DLG arrangement would remain in force for a minimum period of the longest tenor of the loan in the underlying loan portfolio.
• Eligibility for a DLG Provider: DLG arrangements are to be entered into with LSPs which are corporates/other REs. An outsourcing arrangement should have been entered into with these parties.
• Declaration from DLG provider: Prior to initiating or renewing a DLG arrangement, the RE should at the minimum obtain a declaration from the DLG provider, certified by the LSP’s statutory auditor on (a) aggregate DLG amount outstanding, (b) the number of REs (c) The respective number of portfolios against which DLG has been provided and (d) past default rates on similar portfolios.
• Approval by board of directors: REs should put in place policies approved by the board of directors before entering into any DLG arrangement. At the minimum, the policy should include:

• The eligibility criteria for DLG provider
• Nature and extent of DLG cover
• Process of monitoring and reviewing the DLG arrangement, and
• The details of the fees, if any, payable to the DLG provider.

• Forms of DLG: RE should accept DLG only in one or more of the following forms:

• Cash deposited with the RE
• Fixed Deposits maintained with a scheduled commercial bank with a lien marked in favour of the RE
• Bank Guarantee in favour of the RE

• Recognition of Non-Performing Asset (NPA): The RE would be responsible for recognition of individual loan assets in the portfolio as NPA and consequent provisioning as per the extant asset classification and provisioning norms irrespective of any DLG cover available at the portfolio level. Additionally, the amount of DLG invoked should not be set off against the underlying individual loans. The DLG guidelines have also clarified that DLG should be invoked within 120 days, unless the amount is made good by the borrower before that.
• Disclosure Requirements: The REs should have a mechanism to ensure that LSPs with whom they have a DLG arrangement should publish on their website – the total number of portfolios and the respective amount of each portfolio on which DLG has been offered.

Effective date: The aforementioned DLG guidelines have come into force w.e.f. 8 June 2023.

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To access the text of the DLG guidelines, please click here