RBI Circular

Guidelines on Settlement of Dues of Borrowers by ARCs

The Reserve Bank of India (RBI) has issued revised directions regarding the settlement of dues payable by borrowers, applicable on January 20, 2025, replacing paragraph 15 of the Master Directive for ARCs issued on April 2024. The revisions are in the nature of greater transparency of the working of ARCs in the settlement of dues payable by borrowers and corresponding accountability. Below in this article, we will break down the guidelines and their impact in simple terms.  

Shedding Light on Asset Reconstruction Companies (ARCs)

Asset reconstruction companies occupy a key position in the financial ecosystem by taking over nonperforming assets (NPA) from banks and FI. They thus clear lenders’ balance sheets for renewed operations in their core banking functions. However, in most situations, they encounter hurdles in the effective recoverability of dues from borrowers. Oftentimes settlement is the only option available. The review effectively provides the ARCs with detailed scaffolding for dealing with such settlements appropriately.

Key Highlights of the Revised Guidelines for ARCs

1. Board-Approved Policy for Settlements

Each ARC must have a policy approved by its board of directors that guides the settlement of dues with the borrower. The policy would cover:

• The criteria to determine the eligibility for one-time settlements.
• Guidelines concerning the extent of sacrifice permitted for different categories of exposure.
• Method to be adopted for assessing the realizable value of the securities.

This will ensure that the settlements are made as per established criteria and are fair, aligning with the aim of ARC and regulations. 

2. Settlement as a Last Resort

Only when all prudent avenues for recovering dues have been attempted, consideration should be given to settlements. The financial circumstances should enable ARCs to consider whether settlement is indeed their best option at the time.

3. Net Present Value (NPV) Considerations

Normally, the amount of settlement should not fall below the values realizable from the securities in the hands of the insured parties. Whenever the valuation of securities at the time of acquisition is highly divergent from their realizable value at the time of settlement, ARCs are obliged to record and provide justification as to the differences in such valuations.

4. Preference for Lump Sum Payments

Preferably, in any given settlement, there should be payment of the agreed sum in a lump sum. In the case of settlements with installment payments, the case must be financially substantiated with a well-developed business plan, projected earnings, and cash flows of the borrower.  

Special Provisions for High-Value Settlements

The provision deals with the steps to be followed for borrowers whose principal amounts outstanding exceed ₹1 crore:

a) Independent Advisory Committee (IAC)

The settlement proposal has to be reviewed and evaluated by an independent advisory committee of selected executives having expertise in finance, law, or technical areas. The I AC responsibilities would be:

• Analysing the financial position of the borrower and their future cash flows.
• Advise whether a settlement is feasible.

b) Board Approval

The recommendations of the Independent Advisory Committee regarding the settlement would have to be considered by the Board of the ARC with at least two independent directors. The Board must contemplate every avenue of recovery before it allows and orders settlement.

Provisions for Low-Value Settlements

For borrowers with outstanding principal amounts of ₹1 crore or below:

a) Conflict of Interest Avoidance

No official engaged in the acquisition of the financial asset may process or approve any settlement proposal concerning that financial asset.

b) Quarterly Reporting

ARCs should table a quarterly report for their Board of Directors or a committee named:

• Trends in the number and value of settled accounts.
• Details of accounts classified as fraud or wilful default.
• To be segmented by acquisition authority, asset class, and business segment.
• Recovery timelines and amounts.

Special Cases: Fraud and Wilful Default

Borrowers described in any publication must be under far more scrutiny; the said guidelines listed in 15.5 shall apply to such agencies irrespective of their settlement amount. An ARC may settle without prejudice to any criminal action that might be pending against such borrowers.

Legal and Judicial Provisions

a) Compliance with Other Laws

All settlements must conform to the subsisting laws and regulations. It’s not to have the effect of cancelling any provision of any statute currently in force.

b) Consent Decrees

If recovery proceedings are pending before a judicial forum, any settlement must receive a consent decree from the relevant judicial authority. This ensures that settlements are legally binding and enforceable.  

Consequences of the Revised Guidelines

The revised guidelines bring significant improvements to the settlement process in the following ways:

1. Enhanced Transparency

By approving striking Board-approved policies with independent reviews, the guidelines get transparency regarding settlement processes. It enables borrowers and other stakeholders to believe that decisions are made objectively and based on the principles of prudence.

2. Improved Accountability

The requirement of comprehensive documentation and reporting shall hold them accountable for their decisions. This shall eliminate the fear of any arbitrary or biased settlements.

3. Focus on Realistic Recoveries

NPV and realizable value being focused on will make sure that settlements are economically sensible. The guidelines encourage asset reconstruction companies to favour lump sum payments over installment-based settlements based on strong business plans.

4. Fair Treatment of Borrowers

The guidelines provide a systematic framework that seeks to balance the interests of the ARCs and the borrowers. Borrowers in genuine financial trouble can benefit from settlements while ensuring that the ARCs recover their fair value.

5. Stronger Governance for High-Value Cases

High-value settlements undergo an extra layer of scrutiny through the IAC and Board approval process, which restricts the risk of mismanagement or diversion of funds in high-value accounts.

6. Stringent Measures for Fraud and Wilful Default

Stricter provisions against fraud and wilful default would discourage malpractices and preserve the sanctity of the financial system.

Challenges and Considerations for ARCs

While the revised guidelines aim to enhance the settlement framework, their implementation poses some challenges:

1. Operational Complexity

Implementation of the guidelines will require ARCs to cultivate strong internal processes which may include IACs and extensive reporting mechanisms. This may create a rise in operations cost and complexity.

2. Subjectivity in Valuation

Determining realizable value for securities and assessing business plans involve subjective judgments. ARCs need to ensure accuracy in these assessments with no bias.

3. Judicial Delays

Getting the consent decree from judicial forums can be time-consuming. ARCs have to factor in these delays while planning settlements.

4. Monitoring and Compliance

Regulatory authorities have to keep a close watch on ARCs for compliance with the revised guidelines. Non-compliance could destroy the efficacy of the framework. 

To Wrap Up

The revised guidelines for the settlement of dues by ARCs can be viewed as a landmark start toward enhancing the resolution of non-performing assets. By furthering arc operating principles based on transparency, accountability, and fairness, the RBI hopes to build the role of ARCs within the Indian financial system.

While providing ARCs with more responsibilities, these guidelines also offer a definite and structured way to resolve borrower dues. In the long term, these initiatives are expected to engender greater efficiency and credibility in the asset reconstruction process, thus facilitating lenders, borrowers, and the wider economy.

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