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  • Vaibhav Kesarwani & Naman Kasliwal

RBI's Stance on Treatment of Wilful Defaulters: An Exclusion of Practicality

*The complete title of the article is 'RBI's Stance on Treatment of Wilful Defaulters: An Inclusion of Natural Justice but Exclusion of Practicality'.


On 21 September, 2023, the Reserve Bank of India (RBI) took a decisive step towards strengthening the framework for handling willful defaulters with the issuance of draft guidelines proposing changes to the treatment of Wilful Defaulters and Large Defaulters. These proposed changes encompass a broader scope for regulated entities empowered to classify borrowers as willful defaulters, and a more refined identification process that factors in the principles of Natural Justice.

One of the key highlights of the new guidelines is the introduction of a stringent timeline, mandating the review and finalization of willful default aspects within six months of an account being classified as a non-performing asset (NPA). These revisions are a response to a changing financial landscape and have taken into account the recent judgment from the Supreme Court in State Bank of India v. Rajesh Agarwal, where the court asked for the inclusion of Principles of “Audi alteram partem” by the RBI in cases of classification of bank accounts as fraud accounts.

The article delves into these draft guidelines and analyses the RBI's commitment to ensure a fair and just process for borrowers the practicality of the strict timelines proposed by it.

Inclusion of Natural Justice in the New Draft Guidelines

The significance of these draft guidelines extends beyond their regulatory framework. At their core, they exemplify the essential principles of natural justice. The concept of natural justice, often referred to as procedural fairness, is a fundamental tenet of law. It ensures that individuals affected by a decision have the right to be heard, present their case, and receive a fair and impartial hearing. In the context of willful default, the RBI's commitment to natural justice is evident in several key provisions.

First and foremost, the guidelines mandate a meticulous process for the identification and classification of willful defaulters. This process involves multiple stages, starting with an examination of evidence by an Identification Committee. If willful default is suspected, a show-cause notice is issued to the concerned parties, affording them an opportunity to present their side of the story. Submissions are carefully considered, and a proposal is made to a review committee, where the borrower or defaulter has another opportunity to make a written representation and even participate in a personal hearing.

Moreover, the guidelines clearly stipulate that non-whole-time directors, including independent or nominee directors, cannot be classified as willful defaulters unless it is conclusively established that they were complicit or aware of willful default. This provision aligns with the principles of natural justice by ensuring that directors are not unjustly implicated without due process.

These provisions reflect a commitment to upholding the principles of natural justice within the financial sector and correctly establishing a fair and transparent process that allows borrowers to present their case and be heard before any classification as a willful defaulter is finalized. This commitment to procedural fairness not only strengthens the integrity of the financial system but also underscores the RBI's dedication to fostering a balanced and equitable regulatory environment.

Balancing Timelines and Practicality

In the realm of banking and financial regulations, the requirement of practicality and efficiency is of paramount importance and any proposed guidelines or policies should keep this in account. Although this draft RBI Guidelines on Wilful Defaulters have brought a significant and positive shift towards inclusion of Natural Justice in the RBI process, this development has sparked a significant debate within the banking community, focusing on the practicality of the timelines set forth by the RBI in this context.

The guideline 4.2 that provides for review of accounts for identification of wilful defaulters underscores the need for lenders to actively identify and tag borrowers as willful defaulters within a relatively tight time frame. Specifically, these guidelines require the examination of the 'willful default' aspect in all accounts with an outstanding amount of ₹25 lakh or above as may be notified by RBI. This broadens the umbrella of wilful defaulters and thus moves towards an approach aiming to curb wilful defaulters and the associated negative impact on the financial stability of the lending institutions.

The critical component here is that this examination of wilful defaulters has to be completed within a strict timeline of six months of the account being classified as a Non-Performing Asset. The adherence to these timelines can result in an efficient and fast mechanism for examination of the wilful defaulters, resulting in strengthening and tightening of the financial system.

Retrospective Effect and Re-Examination

One notable feature of the guideline related to the review of accounts is the retrospective effect it introduces. According to guideline 2.2, In cases where willful default was not initially observed during the account examination, the guidelines obligate lenders to re-examine these accounts. This re-examination is to be carried out according to the board-approved policy of the lender, ensuring that no potential willful default goes unaddressed.

Such retrospective measures are a clear manifestation of the RBI's unwavering commitment to upholding the integrity of India's financial sector and ensure that any lapses oversight in the initial examination can be rectified. However, at the same time such re-examination increases the time taken for the completion of the process.

Practical Concerns Surrounding Timelines

While the Reserve Bank of India's (RBI) draft guidelines on the classification of willful defaulters aim to instill financial discipline and accountability, concerns surrounding their practical implementation loom large. One key issue is the stringent timeline set for the identification of willful defaulters. Financial institutions are grappling with the complex challenge of adhering to these timelines while conducting thorough forensic audits and personal hearings.

According to one of the reports, a senior private sector banker has highlighted the considerable challenges banks can face in implementing these guidelines, particularly in relation to meeting the six-month deadline for willful defaulter identification. A critical component of identifying willful defaulters involves conducting forensic audits, a meticulous process that scrutinizes financial records, transactions, and operations. These audits aim to unearth any evidence of fraudulent activities, mismanagement, or diversion of funds. Similarly, personal hearings are essential to provide individuals associated with the borrowing entity an opportunity to present their case. However, both these procedures are inherently time-consuming.

Forensic audits, in particular, necessitate a deep dive into financial records, often spanning several years, to uncover irregularities and fraudulent activities. This meticulous process can take months, if not years, to complete effectively. Adding to the complexity, personal hearings require time to schedule and conduct, and further delays can occur due to adjournments in these hearings.

Furthermore, the draft guidelines stipulate that individuals associated with the borrowing entity must be provided an opportunity to make a written representation against the proposal to classify them as willful defaulters. This step not only adds another layer of complexity but also extends the timeline. The subsequent review committee, which is tasked with considering the identification committee's proposal and the written representations, must also allocate time for personal hearings. The cumulative effect of these steps can lead to considerable delays in the overall process.

Conclusion and Way forward

The RBI's guidelines not only promote natural justice by providing due process for the identification of willful defaulters but also seek to instill financial discipline and accountability. However, striking the right balance between these commendable objectives and the practical challenges faced by banks is essential. It is crucial to acknowledge that the process of identifying willful defaulters is a complex one, often involving multiple stakeholders and extensive investigative procedures. Therefore, there is a need for a nuanced approach that ensures natural justice without imposing unrealistic burdens on the banking sector.

In conclusion, even though the RBI's drafted guidelines place a strong emphasis on fairness and due process when identifying willful defaulters, they also need to take into account the real-world difficulties that lending institutions encounter. One of the possible solutions for the same can be that regulators and banks can collaborate to identify workable solutions as the financial environment changes and gets more complicated. For instance, instead of a rigid six-month deadline for the entire process of identifying wilful defaulters, the banks and regulators can adopt a phased milestone approach which could include initial assessments and evidence gathering in the first phase, followed by forensic audits and borrower representations, and concluding with review and finalization phase by review committee. Implementing such phased approach will allow for a more structured and manageable process, providing adequate time for the necessary investigative procedures while ensuring that borrowers are given the opportunity to present their side of the story. This approach could strike a balance between adherence to timelines and the practical challenges faced during forensic audits and personal hearings.

In addition to this, the guideline can also include a provision for extension of timeline in case of delay in the procedure. This would not only solve the problems of the banking sector surrounding the practical financial environment but also reconcile the principles of justice into the treatment of wilful defaulters in the financial sector.


This article is authored by Vaibhav Kesarwani & Naman Kasliwal, students at Gujarat National Law University, Gandhinagar. This blog is a part of the RSRR's Rolling Blog Series.


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