Compromise Settlement

Compromise Settlement is a mechanism used by banks and financial institutions to resolve stressed loans and recover dues by accepting a mutually agreed amount that is lower than the total outstanding liability. In banking and finance, compromise settlements are an important tool for managing non-performing assets and improving balance sheet health. In the Indian context, compromise settlement has gained particular significance due to the persistent challenge of stressed assets and its implications for financial stability, credit flow, and the overall economy.

Concept and Meaning of Compromise Settlement

A compromise settlement refers to an agreement between a lender and a borrower in which the bank agrees to settle a loan account for an amount less than the total outstanding dues. The settlement amount is typically paid in a lump sum or within a short, predefined period. In return, the bank agrees to close the loan account and waive the remaining balance.
This mechanism is generally applied to loan accounts that have become non-performing and where full recovery through normal repayment, legal action, or insolvency proceedings is uncertain or time-consuming. Compromise settlement is based on the principle of maximising recovery while minimising delays and costs.

Rationale for Compromise Settlement in Banking

Banks resort to compromise settlements primarily to expedite recovery from stressed assets. Prolonged litigation, enforcement actions, and insolvency proceedings often involve high legal costs and uncertain outcomes. In such cases, a negotiated settlement may yield faster and more predictable recovery.
Compromise settlement also helps banks clean up their balance sheets by reducing the stock of non-performing assets. This, in turn, improves asset quality indicators, releases capital locked against bad loans, and allows banks to focus on fresh lending and core banking activities.

Regulatory Framework in India

In India, compromise settlements are governed by internal policies of banks, which are framed in line with regulatory guidelines issued by the Reserve Bank of India. The RBI does not prescribe a uniform settlement amount but requires banks to ensure transparency, fairness, and proper governance in settlement decisions.
Banks are expected to follow board-approved policies, conduct due diligence, and assess the borrower’s repayment capacity and asset position before approving a compromise settlement. Regulatory oversight aims to prevent misuse, moral hazard, and preferential treatment while safeguarding public interest, especially in the case of public sector banks.

Process of Compromise Settlement

The compromise settlement process typically begins with an application or proposal from the borrower or an initiative by the bank. The bank evaluates the proposal based on factors such as the outstanding amount, value of available securities, borrower’s financial position, and recovery prospects through alternative mechanisms.
After internal assessment and approvals, the settlement amount and payment terms are negotiated. Once the agreed amount is paid, the bank closes the loan account and records the recovery, while the unrecovered portion is written off in accordance with accounting norms. Proper documentation and audit trails are maintained throughout the process.

Compromise Settlement and Non-Performing Assets

Compromise settlement plays an important role in the management of non-performing assets in India. Given the high levels of NPAs observed during certain periods, particularly in sectors such as infrastructure, steel, and power, compromise settlements have been used as a supplementary recovery tool.
While insolvency mechanisms aim at resolution or liquidation, compromise settlement focuses on negotiated recovery. It is often preferred in cases involving small and medium borrowers, where insolvency proceedings may be disproportionate to the size of exposure.

Impact on Banking Performance

From a banking perspective, compromise settlements can improve liquidity and reduce the burden of stressed assets. Faster recovery enhances cash flows and supports capital adequacy by lowering provisioning requirements over time. It also reduces management time spent on prolonged recovery efforts.
However, excessive reliance on compromise settlements may impact profitability in the short term, as banks accept recoveries lower than the outstanding dues. Therefore, banks must balance recovery efficiency with prudent credit discipline.

Implications for the Indian Economy

Compromise settlements have broader implications for the Indian economy. By enabling banks to resolve stressed assets and restore lending capacity, they support the flow of credit to productive sectors. Improved bank balance sheets strengthen financial intermediation and contribute to economic growth.
At the same time, frequent or poorly governed settlements can create concerns about credit culture. If borrowers expect easy settlements after default, it may weaken repayment discipline and increase future credit risk. Ensuring that compromise settlements are used judiciously is therefore critical for maintaining systemic stability.

Challenges and Criticisms

Compromise settlements face several challenges and criticisms. There are concerns about transparency, valuation of recovery amounts, and potential favouritism, particularly in large-value accounts. Public perception issues arise when significant loan amounts are waived, especially in public sector banks.
There is also the risk of moral hazard, where borrowers deliberately default with the expectation of negotiating a settlement later. Addressing these concerns requires strong internal controls, clear eligibility criteria, and strict accountability mechanisms.