Introduction
On 30.07.2024, the Reserve Bank of India (‘RBI’) issued the Reserve Bank of India (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024 (‘Master Direction)[i] following a consultation process initiated in September 2023. The Master Direction aims to establish a non-discriminatory and transparent framework for classifying borrowers as wilful defaulters (‘WDs’), ensuring adherence to principles of natural justice. These directives seek to maintain the integrity of the financial system and prevent further institutional finance to WDs by enhancing the existing regulatory framework, consolidating various guidelines, and introducing stricter procedures for identification and penalisation.
Chapter Wise Analysis of the Master Direction
Chapter I: Preliminary
This chapter sets the scope and applicability of the Master Direction. The provisions apply to all defined ‘lenders,’ including All India Financial Institutions (‘AIFIs’), banks, and Non-Banking Financial Companies (‘NBFCs’). Asset Reconstruction Companies (‘ARCs’) and Credit Information Companies (‘CICs’) are specifically bound by the reporting requirements outlined in Chapter III of the Master Direction.
Notably, the Master Direction ensures comprehensive coverage by applying restrictions on extending further financial accommodations to WDs to all entities regulated by the RBI, irrespective of whether they fall within the defined category of ‘lenders.’ Provisions concerning large defaulters extend to all RBI-regulated entities, ensuring a thorough and complete regulatory framework.
Key definitions in this chapter include:
Large defaulter: Refers to those with an outstanding amount of Rs. 1 crore and above.
Wilful default: Characterized by the borrower or guarantor’s intentional failure to meet obligations despite having the means, diversion or siphoning of funds, disposal of secured assets without approval, or failure to infuse committed equity.
WD: Includes borrowers or guarantors with outstanding amounts of Rs. 25 lakhs and above, and in the case of companies, extends to promoters and directors responsible for the entity’s management.
The Identification Committee (‘IC’) and the Review Committee (‘RC’) have also been touched upon, detailing their constitution and roles in identifying and reviewing WDs. Diversion of funds is defined as including unauthorised utilisation of funds and routing through unauthorised channels. The credit facility has been defined to include both fund-based and non-fund-based facilities, covering off-balance-sheet items such as derivatives, guarantees, and letters of credit. Additionally, terms not specifically defined in the Master Direction will adopt the meanings assigned in relevant RBI regulations, such as the Banking Regulation Act, 1949, the Credit Information Companies (Regulation) Act, 2005, and the Companies Act, 2013.
Chapter II: Treatment of WDs
This chapter outlines the procedures and measures for identifying and managing WDs. The process begins with lenders identifying and classifying borrowers as WDs following a specific procedure based on a deliberate and calculated default, not isolated incidents. The evidence of wilful default is examined by an IC, which, once satisfied, shall issue a show-cause notice (SCN) to the borrower, guarantor, promoter, or director within 21 days. The notice allows a written submission within 15 days, which would be considered by the RC. It may provide a personal hearing before making a final decision on the question of classification. Specific guidelines for the involvement of directors and the role of ARCs and CICs in reporting requirements have also been established. The chapter emphasises that the classification process is internal, and legal representation is not permitted during proceedings.
The chapter also details specific measures against WDs, including initiating criminal proceedings, publishing photographs, and implementing penal measures such as barring additional credit facilities and restructuring for a specified period. Lenders are required to incorporate covenants preventing the induction of individuals named in the List of WDs (‘LWD’) into borrower entities and take legal action to recover dues. Furthermore, a transparent mechanism for the identification process is mandated, along with the role of internal audit in ensuring adherence to instructions.
Chapter III: Reporting of WDs & Large Defaulters
This chapter focuses on reporting and disseminating credit information on large defaulters and WDs by entities regulated by the RBI. All regulated entities, including lenders, must submit monthly reports to CICs detailing suit-filed and non-suit filed accounts of large defaulters with thresholds that include unapplied interest. CICs must provide access to these lists to credit institutions and display suit-filed accounts on their websites. Suit-filed accounts encompass those under various recovery proceedings, including the Insolvency and Bankruptcy Code, 2016 (‘IBC’) and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). Additionally, lenders and ARCs are required to report WDs, with prompt removal from the list if the outstanding amount falls below Rs. 25 lakhs, subject to certain conditions. Further, reporting of WDs at overseas branches of Indian banks is required unless prohibited by local laws. NBFCs are reclassified to lower tiers and can no longer classify borrowers as WDs; they must continue reporting historical data.
The chapter also outlines specific procedures for handling defaulted loans, compromise settlements, and accounts undergoing resolution under the IBC or other frameworks. Before transferring defaulted loans, lenders must conduct thorough investigations for wilful default. Compromise settlements require full payment before removal from the LWD, and criminal proceedings may continue despite settlements. Post-resolution under IBC or similar frameworks, penal measures are lifted for entities but not for their erstwhile management. Lenders must ensure accurate reporting of borrower and director details, including the Director Identification Number (DIN), to avoid wrongful denial of credit. Guarantors who fail to honour commitments must also be reported as defaulters.
Chapter IV: Preventive Measures & Roles of Auditors
This chapter emphasises preventive measures and the roles of auditors and third parties in managing and mitigating risks associated with large defaulters and WDs.
It provides that RBI-regulated entities must verify the identities of directors, guarantors, and persons in charge during credit appraisal to check against large defaulters’ lists. They must also monitor the end use of funds through various measures, including scrutinising financial statements, inspecting assets, and conducting periodic audits. Project financing requires certification from Chartered Accountants, supplemented by lenders’ due diligence and internal controls to ensure funds are used appropriately.
The role of statutory auditors includes reporting any observed falsification of accounts and ensuring accountability through formal complaints to the National Financial Reporting Authority (‘NFRA’) or the Institute of Chartered Accountants of India (‘ICAI’). Lenders must engage their auditors for specific certifications to prevent fund diversion and may commission forensic audits for accounts exceeding a certain threshold.
Additionally, the responsibility of third parties in credit sanction/disbursement is highlighted, with lenders required to report negligent or deficient third parties to the Indian Banks’ Association (‘IBA’). This ensures a caution list is circulated among lenders to prevent assigning work to unreliable third parties.
Chapter V: Repeal Provisions
This Chapter outlines the repeal of previous instructions and guidelines issued by the RBI as listed in the Appendix of the Master Direction. It states that all approvals and acknowledgements given under the repealed circulars will remain valid as if issued under this new Master Direction. Furthermore, any actions taken under the repealed circulars until the effective date of this new Master Direction will also be considered valid. As per Chapter I of the Master Direction, it will come into effect 90 days after being placed on RBI’s website.
Our Analysis
This newly issued Master Direction by the RBI marks a significant advancement in addressing the issue of WDs and large defaulters. By incorporating principles of natural justice, the Master Direction aims to establish a fair and transparent mechanism for classifying WDs, addressing concerns raised in the Supreme Court decision in SBI v. Jah Developers[ii]. Including NBFCs and the expanded definition of wilful default enhances the regulatory framework, ensuring more comprehensive coverage of defaulters.
However, the Master Direction also present challenges, such as potential biases in the in-house mechanisms of banks and the broad scope of associated entities, which could hinder refinancing efforts for liquidity-strapped companies. While the Master Direction strengthens the norms and introduces a more stringent approach to tackling defaulters, balancing regulatory measures with fairness and judicial oversight remains crucial to avoid unintended consequences and ensure the protection of fundamental rights.
Impact on the 2016 RBI Master Circular on WDs
Notably, the 2016 Circular[iii], which laid down foundational procedures for banks and financial institutions to classify borrowers as WDs, is not listed among the repealed circulars in the Master Direction. This indicates that while the Master Direction introduces a more detailed, compiled, and transparent framework, it builds upon rather than entirely replaces the 2016 Circular by expanding and refining the framework for identifying and managing WDs. It enhances the provisions contained in the 2016 Circular by introducing stricter reporting requirements, broader definitions, and more detailed processes for dealing with both wilful and large defaulters. A key difference lies in the comprehensive inclusion of NBFCs and the clearer articulation of roles for ARCs and CICs, ensuring wider regulatory oversight. Additionally, the Master Direction integrates stronger safeguards, such as the involvement of internal audit mechanisms and specific guidelines for handling compromise settlements and resolution under the IBC, reflecting an evolved regulatory approach. The broader ambit and enhanced procedural safeguards introduced in the Master Direction mark a shift towards a more transparent and robust framework, potentially reducing ambiguities, streamlining processes, and ensuring more consistent application across various financial entities.
End Notes
[i] RBI/DoR/2024-25/122, DoR.FIN.REC.No. 31/20.16.003/2024-25, Dated 30.07.2024.
[ii] (2019) 6 SCC 787.
[iii] RBI/2014-15/73, DBR. No. CID.BC.57/20.16.003/2014-15, Dated 01.07.2015.
Authored by Shivam Mishra, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.