RBI Eases Flow of Credit in Economy - June 23

[Vivek Jalan]

‘Compromise Settlements’ and ‘Technical Write-offs’ policy for wilful defaults: The RBI has pushed the peddle on growth of credit and liquidity in the market. With a focus on expediting closure of settlement proposals under a certain regulatory framework, cleansing of bank and corporate books and to boost credit and business growth, it has allowed banks to go for compromise settlement of fraud accounts and wilful defaults. Vide Circular No. RBI/2023-24/40 DOR.STR.REC.20/21.04.048/2023-24, Dated 08.06.2023, RBI has introduced a framework for compromise settlements. Regulated entities must establish board-approved policies for such settlements. Compromise settlements involve fully settling borrower claims in cash, potentially requiring Regulated Entities (REs) to sacrifice some amount due with a corresponding waiver of claims against the borrower. In non-farm credit cases, REs will maintain a cooling period of at least 12 months before they take fresh exposures to such borrowers. They can prescribe higher cooling, based on board-approved policies. The Circular also allowed technical write-off wherein NPA will be written off for accounting purposes without waiving claims against the borrower or hindering future recovery. This would ease out the liquidity in the economy by allowing the defaulters to start on a clean state and ensure cleaning of Balance Sheets for Banks and businesses.

Further it would also bring in some liquidity for REs. Bills discounting on TReDS gets a push by insurance facility: In a move which may improve cash flow of MSMEs, the RBI expanded the trade receivables discounting system (TReDS) by permitting insurance companies to function as participants. This may also result in an increase in NBFC registrations on TREDs platforms. This step would also further push up TReDS volumes which have already doubled in the last couple of years. Financers are generally not inclined to bid for payables of low-rated buyers. To overcome this, an insurance facility is being permitted for TReDS transactions, which would aid financiers to hedge default risks. Premium for insurance shall not be levied on the MSME seller.

Further, all entities that can undertake factoring business under the Factoring Regulation Act would be allowed to participate as financiers in TReDS RBI allows Fintechs to enter into Default Loss Guarantee (DLG) arrangements with a cap: In August 2022, RBI issued digital lending guidelines, which placed restrictions on the practice of DLGs and noted that the same was under examination. Now, The RBI vide RBI/2023-24/41, DOR.CRE.REC.21/21.07.001/2023-24 dated 8th June implemented the Default Loss Guarantee (DLG) arrangements as a result of which Fintech lending firms can now offer loans to borrowers with lower credit scores and limited credit histories thus broadening the customer pool and serving the underserved segments of the market. The guidelines are applicable to regulated entities (REs) such as commercial banks (including small finance banks), primary (urban) co-operative banks, state co-operative banks, central co-operative banks, and non-banking financial companies (including housing finance companies). Fintech lending firms may enter into DLG arrangements with regulated entities with which they have entered into outsourcing arrangements. However, the total amount of DLG cover on any outstanding portfolio specified upfront is capped at 5% of the amount of such loan portfolio. This also includes arrangements involving implicit guarantee linked to performance of the RE’s loan portfolio specified upfront. This small cap may be a dampner in bolstering the digital lending space.