Aam aadmi vs khaas aadmi: How rules differ when you default on loans
While banks write off loans for large borrowers, it is often individual borrowers who find themselves on the short end of the stick, even for very small loans related to credit card, house or car repayment.india Updated: Feb 17, 2016 14:48 IST
The Supreme Court on Tuesday ordered the Reserve Bank of India (RBI) to furnish details of loans written off by public sector banks in the last five years along with the particulars of alleged defaulters who owe Rs 500 crore or more, terming such practices a fraud on the public.
But, while banks write off loans for large borrowers, it is often individual borrowers who find themselves on the short end of the stick, even for very small loans related to credit card, house or car repayment.
A look at how lenders approach individual and corporate borrowers differently.
Endless phone calls
Most banks engage outsourced agencies to assess any loan applicant with due diligence. Among other things, the borrower is rated against a host of parameters including repayment capacity based on current and expected future earnings, existing financial and physical assets, family dependents and others.
In the case of a late payment, banks engage the same agencies to contact the customer.
Most customers dread such phone calls complaining that the calls swiftly transition from persuasion to threats and intimidation.
Rules do allow a borrower to opt for converting the unsecured loan — such as personal loans not backed by physical collateral – to a secured one by offering alternate assets. These could include shares and debentures that the borrower owns or physical assets such as a car or a house.
Ideally, such a move should help bring down interest rates. But customers complain that since banks approach borrowers through third-party agents, there is limited scope for such a dialogue.
For the same reasons, the incidence of restructuring individual loans is often lower than corporate loans.
Banks generally give borrowers a notice of 7-15 days to clear outstanding dues before it seizes a moveable asset such as a car.
The asset is usually auctioned away within 90 days from the date of possession if the borrower does not clear the outstanding dues.
Customers often complain that seizing – “repossession” in banking parlance – is carried out by third party agents who often use strong-arm tactics and intimidation.
A similar approach is adopted for default of house loans although the sale and auction of a house can take much longer than assets like a vehicle.
Loan default can have serious consequences. Apart from resulting in seizure and auction of assets, it can dramatically reduce one’s `Credit Score’, making it difficult to obtain a loan in the future.
During the last few years, banks have been looking for greater benchmark scores to extend loans to consumers. Banks are now charging lower interest rates from those who have a better credit history depending on a set of parameters.
Credit information companies such as CIBIL give a numeric summary of your credit history, scoring from 300 to 900 points. The closer a score is to 900, the more favourably a loan application will be viewed by a bank. The ‘probability of default’ of an individual is estimated based on the credit history and tells a lender the likelihood of a loan being paid back. The assumption is also based on the past pattern of credit usage and loan repayment behaviour.
Four factors determine the score: Late payments or defaults in the recent past, high utilisation of credit limits, high unsecured loans such as credit cards and personal loans, and “credit hungry” behaviour where you apply for loans often. According to bank data, 80% of all loans sanctioned in the last three years are to those with a credit score above 750.
Banks are beginning to take a tough stance on defaulters who can pay, but won’t. Such wilful non-payment will attract strong punitive action, including a ban on floating new ventures.
The recovery process, however, is slower and not as intimidating and threatening as it is for individual borrowers. In some extreme cases, criminal charges are pressed.
Wilful defaulters are borrowers who have not repaid bank loans of more than Rs 25 lakh despite having the capacity to do so. They divert funds to projects other than those for which the loan was availed and sell off assets that were pledged to get loans without the bank’s knowledge.
One-time settlement (OTS)
Banks enter OTS with chronic defaulters to recover bad loans. In such settlements, they forgo interest and even part of the principal amount, depending on the loan profile.
This is a transaction where a person borrows money from a lender against a security of a movable asset (vehicles, jewellery, etc). The security belongs to the borrower and remains in their possession during the repayment period. If the loan is defaulted, the financier can claim the hypothecated asset only after obtaining a court order.
Such cases, however, can drag on for several years in various courts, delaying the recovery process.
Strategic Debt Restructuring (SDR)
Under SDR, RBI allows banks to convert a part of their debt to majority equity in a defaulting firm. This is aimed helping banks take control of the defaulting firm and effecting a change in management.
However, the restructuring cannot happen by the dozen as workable solutions have to be reached. The process is devised to help banks reduce non-performing assets by taking over loss-making assets of borrowers. SDR can happen only when a conversation is ongoing with a strategic investor where there is a foreseeable way out.
Banks often find it difficult to find buyers of defaulting firms even after taking over management control. While the defaulter loses control over the company, the onus of recovering the loan actually shifts to the bank itself.