Why independent directors are jittery over RBI directive

Independent directors on the boards of some public sector banks are developing cold feet after the Reserve Bank of India’s (RBI) decision to shift the onus of approvals onto the boards of banks for one-time settlement (OTS) or write-offs in the case of wilful defaults and frauds.

As of March 2023, scheduled commercial banks have reported frauds worth ₹28,792 crore in the advances category. While private banks have a higher share of card and internet frauds, public sector banks had maximum frauds in their loan portfolios.

Under new guidelines on compromise settlements and technical write-offs issued as part of the monetary policy statement recently, the central bank has placed the responsibility of settling cases of wilful defaulters or frauds with the supervising office (board) against the earlier practice where the responsibility lay with the operating office (managing committee).

Though the RBI has given the discretionary power for OTS to the banks, it has stated the lenders must have board-approved policies outlining the process for compromise settlements and technical write-offs. While all the banks follow their own internal guidelines, with the new diktat the ambit of those responsible has only widened.

Fortune India learns that at a recent board meeting of a large public sector bank, some directors objected to the quantum of sacrifice that the bank had to make in one such case. The director is learnt to have told the MD and other executive directors at the meeting that the amount being written off was not justifiable and that the director was not “comfortable” about the “sacrifice” that the bank had to make.

One of the EDs of the bank in question, on condition of anonymity, says, “As long the managing committee was involved in the process [of taking a call on the write-offs] the independent director had no qualms but now with the new directive putting the onus on the board taking such a tough decision has become uncomfortable for some independent directors. So long as the board is following the guidelines laid down by the bank, what is the reason to worry?”

What will queer the pitch for banks is that since some independent directors come from a non-finance background, they have an inadequate understanding of how the banking sector works, and now when faced with the prospect of being party to such write-offs, they are worried about any post-write-off fallouts, especially about the prospect of law agencies probing any allegations of favouritism.

Of the several mechanisms to recover bad loans in FY23, the country’s largest public sector bank, the State Bank of India (SBI), recovered a substantial amount of (35%) through the compromise route. SBI, which has four independent directors, reported recoveries of ₹7,097 crore under the Advance Under Collection Account, an account that holds a portion of non-performing assets (NPAs). In FY23, Punjab National Bank, which has four independent directors, reported recoveries worth ₹29,000 crore.

Bank managements, however, have got a shot in the arm, as a recent law provision states that a bank needs to report fraud only if its employee has made wrongful gain and not just because the lender has incurred a loss. Further, Section 17A of the Prevention of Corruption Act, which came into effect in July 2018, states that an inquiry or investigation needs the prior approval of an 'appropriate authority'. Only if staff connivance is established should banks intimate fraud cases above ₹3 crore and within ₹25 crore to the CBI's anti-corruption bureau and cases above ₹25 crore to ₹50 crore to the CBI's banking security and fraud cell.

The RBI’s new guidelines, among other measures, state that a bank’s policy should include specific conditions including the minimum age of the debt and collateral value deterioration, a framework to assess staff accountability in such cases, besides policies that ensure that individuals or committees responsible for approving such settlements hold higher authority than those sanctioning the credit or investment exposure. The RBI has also stated that compromise settlements or technical write-offs can be entered into without prejudice to the criminal proceeding underway against such [wilful and fraudulent] debtors.

Though the Supreme Court through several cases has been supportive of the discretionary power of banks to decide the quantum of settlement, it has also criticised banks for double standards. Last year, presiding over a case involving an OTS between Bank of Maharashtra and a farmer, the SC bench comprising Justices DY Chandrachud and Surya Kant stated that "You [banks] don't file cases against the big borrowers...you don't go after big fish but only harass poor farmers…"

According to the banking regulator, gross NPAs of banks have fallen from a high of 11.5% in FY18 to 3.9% in FY23, while and net NPA ratio has shrunk from 6.1% to 1% over the same period. The current net NPA ratio of scheduled commercial banks is at the level last seen in 2011 and that comes after deep provisioning undertaken by banks even as the cumulative profit of public sector banks crossed ₹1 lakh crore in FY23.

The RBI has stated that the primary objective for letting banks enter a compromise settlement with fraudulent or wilful defaulters is to enable multiple avenues for lenders to recover their money as inordinate delays result in asset value deterioration, thus hampering ultimate recoveries. Compromise settlement is recognised as a valid resolution mechanism under the Prudential Framework on Resolution of Stressed Assets dated June 7, 2019. The central bank has stated that holding on to such exposures on the balance sheets of lenders without any resolution owing to legal proceedings would lock up funds in an unproductive asset.

“As long as larger policy concerns are suitably addressed and the costs of malafide actions are made to be borne by the perpetrators, early recoveries by lenders should be a preferred option, subject to safeguards. Further, continuation of criminal proceedings underway or to be initiated against the borrowers classified as fraud or wilful defaulter, would ensure that perpetrators of any malafide action do not go scot-free,” states the RBI.

Though the boards have been empowered to take a tough decision on wilful defaults and frauds, if independent directors refuse to give their approval, its quite likely that the banks will have to push for recovery through the IBC process which itself has proved to be an inefficient mechanism to resolve legacy bad loans.