“When one door closes, another opens…,” AG Bell, the great inventor, scientist and engineer once said. This adage is probably relevant for India’s banks when it comes to making recoveries from Bad Loans amid the Covid-19 pandemic. One-time Settlement (OTS) is that another door which acts as a recovery scheme for lenders in case borrowers fails to fulfil the commitments undertaken by them. Prompt recovery of loans and advances not only increases liquidity and profitability but also keeps fund cycle moving by continuous lending for the development of the economy. Compromise Policy is a step in this direction. The important aspect in connection with settlement proposals is the concept of opportunity cost of funds. The opportunity cost of funds in hand vis-à-vis that of funds, which could come in hand at a later period should be calculated to establish a comparative advantage of ‘now or later’.
OTS involves compromise settlement of non-performing loans (NPLs) between a bank and its borrowers as per the board-approved policy maintained by each bank. This settlement entails the lender/ creditor taking a hair-cut on the outstanding loan amount. The banks agree to accept an amount lesser than what was originally due. They settle the loan and waiver/write it off against a one-time instalment, thereby compromising on a portion of their profits.
The Reserve Bank of India (RBI) mandate states that banks must have a loan recovery/settlement policy that may be responsible for negotiations and settlement of non-performing assets (NPA). OTS schemes are available in all banks as an effort to deal with NPA levels. However, not every borrower is given this provision as to settle a bad loan account through OTS. It is on a sole discretion of the concerned bank based on some criteria. It is for the banks to decide if they have to extend this facility to the borrowers or not. In case the bank holds the borrower’s security and is sure to recover both the principal and interest in full, they may reject the borrower’s plea for OTS. Conversely, when the assets or prime security is inadequate, banks may choose to grant a OTS to the borrower.
Some of the guiding factors that the banks may consider while opting for a compromise settlement may be the balance outstanding in the account as on date of NPA; provision held in the account; market value of the securities and time taken for realizing it; reasons for failure i.e. factors beyond borrower’s control like natural calamities; present status of the account and the amount that can be recoverable and several others.
The guidelines of such loan recovery policy are applicable to NPAs and Technically Written-off accounts including Credit Card dues. Bank also entertain compromise proposal from the borrowers (in justifiable cases) on whom SARFAESI notices are served for taking possession of securities, provided the borrower comes forward for a compromise proposal. Moreover, where there is a loss of security charged to the Bank on account of natural calamities such as floods, earthquakes, riots, civil commotion, strikes, fire accidents etc., acquisition of securities by the Government agencies and similar other circumstances, which are beyond the control of the borrower, banks can entertain compromise proposals with a reasonable sacrifice.
While entering into compromise settlement against a NPA account, the Bank shall ensure that the Net Present Value (NPV) of the settlement amount should generally not be less than the NPV of the realizable value of securities in case of secured loans.
However, there are few cases that may not be eligible to be covered under this scheme:
· Cases reported as fraud to RBI will not be eligible.
· Central Govt. / State Govt. guaranteed accounts will not be considered under this Scheme.
· “Compromise cases” where repayment has already commenced as per the agreed terms, are not eligible. However, cases of failed compromise settlement where the amount is not received within the stipulated time can be considered afresh. Cancellation of failed compromise letter to be issued to the borrower before considering application under OTS.
· Any case admitted into insolvency will not be eligible.
· Units under liquidation will not be eligible.
· Units under rehabilitation/ restructuring will not be eligible. However, units where rehabilitation/ restructuring have failed are eligible.
Arrangement and Combinations Under OTS
The OTS package may have various combinations of incentives including, inter-alia, interest waiver, conversion of unpaid interest into loan, partial waiver of principal portion of the loan. To incentivize faster payments of OTS amount, several banks even have incentives for those borrowers who make full payment in a comparatively shorter span. As far as possible, before entertaining the proposal, the banks ensured that the borrower makes upfront payment of at least 10%- 20% of compromise amount. At the same time the banks also assure that the repayment period of compromise amount is not exceeding 18 months.
Failure In To Comply With The Scheme, Beyond Borrower’s Control
There might be a situation where the borrower has entered into an OTS scheme with a bank and has successfully deposited a substantial amount within the originally stipulated period of settlement but could not make remaining payment within the schedule prescribed under an OTS scheme for reasons beyond his control. In such a scenario, the borrowers in deserving cases such as during this time of pandemic, must be considered with some flexibility to achieve the ultimate goal of such settlement and must be entitled to extension in time for payment of balance settlement amount. The High Court, in Anu Bhalla &Anr. Vs. District Magistrate Pathankot &Anr., clearly stated that the banks have the discretion to extend OTS period keeping in view attending and demanding circumstances to ensure achievement of the ultimate purpose of settlement.
Effects Of OTS:
1. Impact on Credit ScoreThe banks, when decide to write off a loan, immediately informs the case to CIBIL and other rating agencies. Though the loan transaction comes to an end in the form of settlement, it is not that positive closure. Therefore, credit rating agencies term the transaction as ‘settled’ making other lenders view it as a negative credit behaviour. In turn, the borrower’s credit score drops. These agencies hold on to this information for about seven years. Some borrowers understand the loan write-off as an opportunity to pay less for the closure of the loan account. However, most borrowers are not aware of the inner calculations and consequences of such a settlement. One wrong step may bother borrowers for about seven years i.e. as long as credit rating agencies hold the information in their repository. If the borrower wishes to take another loan during this
Civil Writ Petition No. 5518 of 2020
period, lenders may get wary of the repayment capability of the borrower. There are possibilities for lenders to reject the loan application as well.
1. Impact on the lenders and the borrower’s relationship
Once the loan is settled with a particular bank for any reason as may be specified by the borrower, the relationship with the particular bank will be sabotaged.
2. Hinderance in availing future loans
Credit score, as discussed above, drops after settlement which in return cause direct hinderance for the borrowers to avail another loan in future. The banks might reject the application filed by the borrower for loan based on their credit score. Loans and credit score share a positive correlation: the higher the credit score, the higher the chances of the borrower to avail a loan and negotiate the interest rate on the loan.
Another Way Out
OTS is one option that may come in handy as a last resort, but there are plenty of things a borrower can do to repay the loan in full.
1. Defer your payments
One could inform the bank of their inability to temporarily make payments and seek an EMI holiday for a few months. A situation of this nature can occur due to many reasons provide they must seem genuine to the banks. Banks can accept these as genuine reasons but may impose penalties for the deferment.
2. Reducing your EMI
If one is struggling with the EMI amount, it must consider having the monthly outgo reduced. The borrower can approach the lending institution and request them to increase the loan tenure. This would reduce the monthly EMI amount though the borrower may end up paying a higher amount in interest. Once the financial situation is sturdier, the EMI amount can again be rolled back to normal.
3. Restructuring the loan
If a borrower is unable to maintain the terms and conditions of his loan, he can request the bank to relax the same. This may lead to a reduction of charges, lowering of interest rate, lengthening of the loan tenure, a moratorium on interest, etc. The RBI on 05.05.2021, announced several relief measures to help citizens and small businesses to restructuring their loans which they are unable to repay due to the devastating effects of the pandemic on their businesses.
4. Liquidate your assets
A borrower can also plan to liquidate a part of their portfolio or some of the asset in order to be in a position to clear off the loan for good.
In a situation where the borrower has no other option but to close the loan that he is unable to repay, OTS scheme comes as an only best option which can help him to gain a settlement to repay a possibly low amount than what he was under obligation to pay against his loan in total. However, OTS may seem the easiest and feasible option at the time but it does have the long-term implications. The borrower must ensure, before opting for OTS scheme, that all the other existing remedies/option have been exhausted.