Issues in Credit Risk Mitigation : A Case on Indian Banking

The regulatory norms for provisioning of capital against Bank’s credit exposure include the application of risk mitigants to protect the overall losses for the Bank. Credit risk mitigation (CRM) includes approaches to mitigate the credit risk to which banks are exposed. However, the use of CRM may also involve residual risks including legal or operational risks and the capital relief which is granted to the Bank against such mitigation may be insufficient to counteract the overall risks arising out of potential legal impact. The purpose of this study is to provide an overview of the legal issues involved in identification and application of mitigants to unburden the credit risk exposure of Banks in India. RBI guidelines intend to ensure minimum standards for legal documentation to obtain capital relief for mitigation. Banks need to have specific lien on the collateral with legal certainty and must possess the right to liquidate the pledged asset with enforceable security interest, by registering it with the Registrar. The management of such mitigants may not be easy for the Banks. For example, in case of property mortgages as collateral, the application of mitigation may pose unique problems for the bank. In case of joint family holdings, it is difficult to obtain comprehensive possession of the property without the protection of civil suits. Further, even with the support of various recovery laws, there could exist technicalities with respect to Limitation or other Acts to countermand the efforts of the Bank. We review the efficacy and failures of the Debt Recovery Tribunals (DRT) by describing the trends in recovered amounts and also elaborate example cases where borrowers have won against DRTs. We conclude that Banks must have clear and robust procedures for the collateral fulfilling legal conditions not only to declare the default of the counterparty but also to be able to liquidate the collateral