Supreme Court Order Balances Borrowers’ Rights but Lenders’ Liability and Accountability Remains a Dream
When the finance ministry admits in Parliament that banks have written off a stunning Rs10.09 lakh crore in just five financial years (FY17-18 to FY21-22), there cannot be any public sympathy for corporate defaulters. Especially when the government also admits that it infused Rs2.76 lakh crore to recapitalise banks—money that could have been utilised for social upliftment, health or education goes into filling the hole caused by big corporate defaults.
On 27th March, a Supreme Court (SC) bench, headed by chief justice Dr Dhananjay Chandrachud (Read: SC Refuses Stay on Telangana HC Judgement on Classification of Fraud as per RBI Circular), issued an order which said that banks must give the borrower a hearing before classifying the loan account as a fraud.
The order has evoked mixed reactions. The Reserve Bank of India (RBI) and State Bank of India (SBI), which had filed appeals before the apex court, are upset. In off-the-record reactions, bankers claim that this is a setback to their effort to recover bad loans. Is it really? Or is this a fair order, which is perhaps the first step to making banks more accountable for their actions? Let’s take a look.
The Master Directions on Fraud
First, the background. In 2016, RBI issued a set of ‘Master Directions on Fraud’, which led to hundreds of corporate borrowers who had defaulted on their loans being classified as fraud accounts. In most cases, bankruptcy proceedings were filed under the Insolvency and Bankruptcy Code (IBC) and complaints were filed with the central bureau of investigation (CBI).
Some borrowers went to court alleging that they were not given any notice or hearing before banks initiated precipitate action. Such unilateral action, they said, violated the principles of natural justice and has serious civil and reputational consequences for them as borrowers. The litigation led to some orders upholding the action by banks and others supporting the borrowers’ contention that principles of natural justice must be followed and read into RBI’s master directions.
The cases before the SC included a power transmission and distribution company in whose case the Telangana High Court had ruled that principles of natural justice should be followed. Another was a rice and edible oil company where the lower court did not go into the natural justice aspect but ruled that the account was correctly classified as a fraud, based on adverse findings of a forensic audit. A third was a Hyderabad hotel where the borrower knew about the special audit and participated in the findings but knew that the account was classified as a fraud only when it received a copy of the FIR (first information report). Here, too, the forensic audit came up with adverse findings. There was a similar finding in another appeal by an oil and foods company.
The SC noted that RBI’s master directions do not require any notice to be given to the borrowing company, its promoters or directors, or to inform them about the final decision of the bank. It agreed with borrowers that there are serious consequences to this action. First, there is the reputational damage and stigma when a CBI complaint is filed; second, the company as well as its promoters and directors are immediately debarred from accessing institutional finance and credit markets for five years. This impacts the fundamental rights of the individuals concerned, without allowing them to be heard.
The SC order mentions that RBI sided with banks and argued that their actions were not arbitrary and that its master directions were issued to ensure early detection and timely reporting of fraud. It also argued that all the consequences faced by those accused of fraud are ‘preventive measures’ without which the master directions will be ‘rendered toothless’. The SC wasn’t impressed. Justice Chandrachud’s order said that a final decision by a review committee declaring the borrower a ‘wilful defaulter’ must be a ‘reasoned order’. The reasons need not be on the same ‘pedestal as a judgement of a court’; but the reasons “must comport with fairness by indicating a due application of mind…” It must allow that the borrower be served a notice and given  a hearing.
Impact of the Order
Will there be a delay in loan recovery and fraud detection, if banks took the time to issue a reasoned order? Or will banks be forced to turn more accountable for fear it would expose their shoddy lending practices? As I said earlier, views differ. The head of a lending institution believes that this seemingly fair order may give “fraudulent promoters and companies one more way to cheat the system.” He argues that banks are very hesitant and slow to declare fraud because they would immediately need to make a 100% provision for the loan; and, secondly, because they worry about being sued by the borrower. This is in line with what the late Dr KC Chakrabarty, former deputy governor of RBI, had often told us: there is usually nothing much to recover by the time banks are ready to classify a borrowing as a non-performing asset (NPA) or bad loans.
But Dr Chakrabarty also deplored the fact that lenders’ liability enshrined in the Fair Practice Code on Lenders’ Liability (FPCLL) of 2003 is just a motherhood statement posted on bank websites, much like the empty ‘Consumer Charter’ issued by former RBI governor, Raghuram Rajan. Ironically, mischief by banks and the likelihood of them colluding with defaulters and asset reconstruction companies has been acknowledged and a committee was set up in 2002 to consider a ‘lenders liability law’. Banks lobbied successfully to scuttle it.
Indeed, I have repeatedly highlighted how banks accept dodgy documents and meaningless guarantees from promoters or turn a blind eye to the systematic siphoning of funds until it is too late. In most cases, the chairman and officers who sanctioned such loans, usually by colluding with borrowers to accept shoddy, or incomplete documents, would have retired long before a loan is declared bad after rounds of ever-greening and restructuring. By the time a forensic audit is ordered and personal guarantees invoked, there is little to recover, leading to a liquidation of companies or banks accepting 90%+ haircuts, if a buyer is available.
Fair Judgement
While the RBI’s official stand defended its master directions on fraud, senior central bankers, who I spoke to, supported the judgement but refused to be quoted. One central banker told me that banks treat large borrowers (who ended up as big defaulters) very differently from smaller borrowers. “Many banks routinely classify loan accounts as a fraud when there is a default and they realise that the bank does not have tangible collateral because it had not ensured proper documentation at the time of disbursal,” he says.
Since there is no ‘lender’s liability’, banks are never held accountable for the damage caused to businesses by their actions such as delaying or withholding working capital for frivolous reasons or the timely release of duly sanctioned credit. Often, the borrower is forced to default because government undertakings delay payments, those  in the power, construction and highway businesses are notorious for this. Defaults can also be triggered by government decisions which impact prices of raw materials, sometimes rendering entire projects unviable. Central and state governments have also reneged on payment obligations and further tied up contracting companies in legal disputes; but holding them accountable involves prolonged and expensive litigation. In many such cases, when the borrowers are not at fault, banks are known to have unfairly declared them wilful defaulters.
Allowing a borrower to be heard allows the defaulter company to present facts and have them taken on record. The central banker quoted above says he has come across bank documentation so shoddy that a Rs100 crore loan was disbursed to a manufacturer of inner-wear without verifying the company’s address and personal guarantees are a piece of paper with a list of assets that are not verified nor a proper lien created on the assets.
Another banker, who has worked with a repeatedly bailed-out bank and has been active in exposing bad lending practices, says that, bankers sleep for years and allow loot and then wake up to initiate ‘non-compliant’ actions. In his own case, he says, his former employer, a bank, filed a report with CBI mentioning him as the official responsible for a loan, although he had left the bank five months before it was sanctioned. The action was initiated 10 years after the loan was sanctioned. Moreover, the bank ignored all his letters asking it to set the record straight. Fortunately for him, CBI accepted his statements and discharged him.
Banks and bankers are no saints. So RBI’s stand before the apex court—that its master directions on fraud had deliberately allowed banks to ignore the need for notice, hearing and reasoned order—is a matter of concern. There is a pattern here of RBI ignoring complaints against banks and refusing to hold them accountable or to impose stiff penalties when customers or borrowers are treated unfairly. The same callousness is in the freezing of bank accounts without notice for the delay in updating know-your-customer (KYC) documents. RBI and its banking ombudsmen invariably allow banks to fudge facts and falsely claim that customers were notified before initiating precipitate action. No customer has been compensated for hardship suffered and no banker has been punished for negligence. Unfortunately, disaggregated customers find it impossible to reach the Supreme Court and get an order that would compel banks to become accountable.
6 months ago
The ultimate sufferers on account of loan defaults and insensitivity of bankers to come to the rescue of genuine borrowers are the stakeholders of the economy and banks who include tax payers depositors and investors in banks and borrowing corporates. Instead of fixing regulatory and supervisory lapses and accountability on borrowers, lenders and weaknesses in the legal and administrative systems in particular , this sort of elusiveness seen in general in running the very sensitive institutions like banks is not good for the economy and its stakeholders. Banks , Borrowers , Regulators and administrators including the legal support systems have their own roles and responsibilities to deal with the public money and derive benefits the society deserves ethically, morally and socially . Any failure in any link in the system cannot be tolerated and allowed to persist in public interest.
6 months ago
Without an iota of doubt, SC Judgment is fair to all stake holders and the article presented facts in a lucid manner. This article is a master piece and deserves to be an index for the text book of frauds. The accountability of Bankers is always doubtful and in some cases, some lower cadre employees become scape goats. Infact after computerization, Banks can initiate some artificial intelligence system to plug the frauds at the initial stage. The system should not end with write off , one must go to roots to eradicate the pests that destroyed the noble objective of Nationalization
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