Lender’s Liability In Stressed Asset Resolution - Can Banks And Financial Institutions Be Held Accountable

Author: LawSphereX

Category: Banking & Finance

Published: 2026-08-23T20:32:39.55893+00:00

Updated: 2026-08-26T17:10:37.162+00:00

LENDER’S LIABILITY IN STRESSED ASSET RESOLUTION:

CAN BANKS AND FINANCIAL INSTITUTIONS BE HELD

ACCOUNTABLE?

Mathew Jacob, LLM Candidate, LLM-IBL, NALSAR University of Law & Indian Institute of Corporate Affairs

ABSTRACT

When companies struggle with debt, most of the blame falls on borrowers, while the role of banks and financial institutions often goes unquestioned. But what happens when reckless lending, favouritism, or poor risk assessment by lenders fuels financial distress? This paper explores lender liability, the idea that banks should also be held accountable when their decisions contribute to financial crises. Looking at real cases like Yes Bank and IL&FS, we examine how risky lending and governance failures have deepened financial instability in India. While laws like the Insolvency and Bankruptcy Code, 2016 and the SARFAESI Act, 2002 focus on recovering bad loans, they don’t do enough to prevent careless lending in the first place.

To build a more responsible financial system, this paper calls for stricter due diligence, independent audits for large loans, and a dedicated Lender Accountability Unit within the RBI. By ensuring that both borrowers and lenders share responsibility, we can create a fairer, more stable banking environment, one that prioritizes financial discipline without discouraging growth. Keywords: Lender Liability, financial distress, risk assessment, reckless lending.

I.

Introduction The Insolvency & Bankruptcy Code, 2016 (“IBC”) was a watershed moment in the resolution of stressed assets. While all the headlines and attention has been devoted to the responsibilities of the corporate debtor and promoters, relatively little scrutiny has been directed at lenders, particularly the banks and financial institutions who play a decisive role in the credit cycle. This raises an important question: Can banks and financial institutions be held accountable for their role in financial distress, and if so, to what extent does Indian law recognize lender liability? The notion of lender liability stems from the principle that banks and financial institutions, as gatekeepers of credit have a duty to exercise prudence in lending, restructuring, and recovery.

Globally, the concept has been explored through doctrines such as lender misconduct, equitable subordination, and bad faith restructuring practices, which impose accountability on banks for exacerbating financial distress. In contrast, the Indian framework primarily focuses on the lender’s right to recover dues rather than their potential role in contributing to distress. Despite the absence of explicit provisions imposing liability on lenders, Indian law does acknowledge scenarios where lender actions may be challenged. The Reserve Bank of India (“RBI”) mandates prudential lending norms through RBI’s ‘Prudential Norms on Income Recognition, Asset Classification, and Provisioning pertaining to Advances’1 while the IBC provides mechanisms to scrutinize preferential or extortionate transactions involving financial creditors through sections 43 - 512.

The legal framework, however, remains largely silent on whether lenders can be held responsible for reckless lending, coercive recovery measures, or collusive practices in insolvency resolution. The absence of direct lender liability raises concerns regarding moral hazard, particularly when banks, shielded by government bailouts or regulatory forbearance, engage in risk-laden lending without adequate consequences. This paper aims to explore lender liability in the context of stressed asset resolutions in India. It will critically examine the legal and regulatory landscape, analyse judicial precedents and assess whether the current laws sufficiently address lender misconduct. 1 Reserve Bank of India (RBI), Master Circular – Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances, RBI/2011-12/66, DBOD. No. BP. BC. 12 /21. 04.

048/2011-12 (July 1, 2011), https://www. rbi. org. in/commonman/Upload/English/Notification/PDFs/66IRN300611F. pdf

2 The Insolvency and Bankruptcy Code, 2016, §§ 43–51

II.

Understanding Lender Liability in Financial Distress Lender Liability essentially refers to the legal and ethical responsibility of banks and financial institutions when their lending, restructuring or recovery practices contribute to financial distress. It is often seen through the lens of fiduciary duty, which begs the question as to what extent should banks be held responsible when a borrower becomes insolvent. Reckless Lending occurs when banks approve loans without proper risk assessment driven by aggressive market expansion strategies. For instance, Yes Bank’s financial crisis in 2020 is a textbook example of reckless lending.

The bank extended substantial loans to financially unstable companies such as Anil Ambani-led Reliance Group, Dewan Housing Finance Corporation Limited (“DHFL”) and Infrastructure Leasing & Financial Services (“IL&FS”)3, all of whom defaulted leading to a surge in Non-Performing Assets (“NPA”). Despite their deteriorating creditworthiness, the bank had continued to extend large credit facilities leading to a significant accumulation of NPAs. The Gross NPA (“GNPA”) ratio which stood at 2. 10% at December 20184 rose to 7. 39% by the end of the fiscal year 2018-20195. As the crisis deepened, the RBI intervened by imposing a 30-day moratorium where withdrawals were capped at Rs. 50,000 per depositor while simultaneously superseding Yes Bank’s board and appointing an administrator to oversee its operations6.

Further, in order to restore confidence, the RBI and the government orchestrated a rescue package that involved a capital infusion from a consortium of financial institutions led by the State Bank of India (“SBI”) wherein SBI acquired a 49% stake in Yes Bank with a commitment to further capital support if necessary7. Another example would be Infrastructure Leasing & Financial Service (“IL&FS”) crisis of

2018. IL&FS having over 250 subsidiaries, engaging in various infrastructure projects across

India accumulated a debt of Rs. 91,000 crores by 2018. A major chunk of this debt was financed through short-term borrowings while the company's assets were tied up in long-term 3 Young Scholars Initiative – Program on Financial Stability, What is the YES Bank Crisis?, Yale Program on Financial Stability (2020), https://ypfsresourcelibrary.blob.core.windows.net/fcic/YPFS/WhatisteYesBankCrisis.pdf

4 YES Bank Ltd., Earnings Release for Quarter Ended December 31, 2018, (Jan. 24, 2019),

https://stockdiscovery.s3.amazonaws.com/insight/india/4547/Earnings%20Release/ER-Dec18.pdf

5 Vishwanath Nair, Yes Bank Discloses Bad Loan Divergence for FY19, NDTV Profit (Nov. 19, 2019),

https://www.ndtvprofit.com/business/yes-bank-discloses-bad-loan-divergence-for-fy19

6 Yes Bank Withdrawal Limit Capped at Rs 50,000; RBI Supersedes Board," Econ. Times (Mar. 6, 2020),

https://economictimes.indiatimes.com/industry/banking/finance/banking/yes-bank-withdrawal-limit-capped-atrs-50000/articleshow/74498382.cms

7 C.P. Chandrasekhar, The Cost of a Yes to a Bank Rescue Act, The Hindu (Mar. 10, 2020),

https://www.macroscan.org/cur/mar20/pdf/Yes_Bank.pdf

infrastructure projects creating a mismatch between its assets and liabilities. In spite of these challenges, IL&FS continued to secure loans with banks and financial institutions extending credit without adequate due diligence, largely due to the company's high credit ratings and perceived government backing8. The first default took place in June 20189 followed by a series of further defaults. These defaults led to a series of credit rating downgrades, triggering panic among investors and lenders. The crisis led to a liquidity crunch as confidence in the financial system eroded10. Similar to Yes Bank, the government intervened by superseding the IL&FS board and appointed a new board to manage the resolution process. The new management focused on asset monetization and restructuring to repay creditors. As of September 2024, approximately Rs.

55,000 crores of the debt had been addressed through various resolution strategies such as asset sales and debt restructuring11. However, a significant portion of the debt remains unresolved. Both these cases serve as a cautionary tale about the dangers of reckless lending and the systemic vulnerabilities it can create within the financial system. III.

Current Legal and Regulatory Framework Governing Lender Conduct The current legal framework does not impose direct liability on banks for financial distress, instead it provides for mechanisms to scrutinize and current misconduct. (A) The Insolvency and Bankruptcy Code, 2016 The IBC provides some checks and balances on lender actions through provisions addressing fraudulent and preferential transactions. Preferential transactions as per section 43 of the IBC is essentially when one creditor is favoured over the others. For instance, in the case of IDBI Bank Ltd. v. Jaypee Infratech Ltd. 12, the National Company Law Tribunal (“NCLT”), Allahabad Bench found that the properties of 8 Shishir Asthana, Flashback 2018: When IL&FS Nearly Sank the Financial System, Moneycontrol (Dec. 27, 2018), https://www. moneycontrol.

com/news/business/economy/flashback-2018-when-ilfs-nearly-sank-thefinancial-system-3300731. html

9 Id.

10 Nupur Anand & Abhirup Roy, IL&FS May Not Have Disclosed Bad Loans for Years: RBI Report, Reuters

(Aug. 14, 2019), https://www.reuters.com/article/world/ilfs-may-not-have-disclosed-bad-loans-for-years-rbireport-idUSKCN1V41OE/ 11 Infrastructure Leasing & Financial Services Ltd. (IL&FS), IL&FS Appoints Nand Kishore as CMD After CS Rajan’s Term Ends, Media Release (Sept. 30, 2024), https://www.ilfsindia.com/Transition%20-%20CSR%20- %20Sept%2030%202024.pdf

12 CA No. 26/2018 in CP (IB) 77/ALD/2017, National Company Law Tribunal, Allahabad Bench (2018)

Jaypee Infratech Ltd. were mortgaged to pay the creditors of Jaiprakash Associates Ltd. (the holding company) especially when Jaypee Infratech Ltd. themselves had defaulted on their loan payments. The NCLT held that these mortgages amounted to preferential, undervalued and fraudulent transactions under the IBC and reversed the said transactions. (B) The SARFAESI Act, 2002 The SARFAESI Act provides for a mechanism for secured creditors to enforce security interests without court intervention. Despite its efficiency in debt recovery, SARFAESI has been challenged for potential misuse, especially in bad-faith recoveries where lenders act arbitrarily. To address these concerns, the law provides borrowers with limited safeguards. Under Section 17, a borrower who believes that lender action is unlawful, excessive, or arbitrary can file an appeal before the Debt Recovery Tribunal (“DRT”).

The landmark Supreme Court case, Mardia Chemicals Ltd. v. Union of India13, reinforced borrower rights by striking down a provision that required borrowers to deposit 75% of dues before challenging lender actions. While the SARFAESI empowers lenders, it also provides limited safeguards for borrowers against aggressive recovery tactics. Courts have intervened in cases where lenders have misused SARFAESI to harass borrowers rather than enforce genuine loan defaults. Also, Section 19 allows borrowers to claim compensation in cases of wrongful enforcement. However, borrower protections remain comparatively weak compared to lender rights, making judicial oversight through DRT appeals essential in preventing abuse of power.

(C) RBI’s Prudential Framework for Stressed Asset Resolution, 2019 By way of this framework, the RBI mandates banks to recognize and resolves NPAs in a timely manner prior to accessing the IBC or the SARFAESI. It was also introduced to prevent financial institutions from arbitrarily restructuring loans to hide bad debts, a problem that was particularly highlighted during the Yes Bank crisis. In the event that this fails, creditors are expected to pursue the IBC or the SARFAESI.

13 Mardia Chemicals Ltd. v. Union of India, (2004) 4 S.C.C. 311

IV.

The Way Forward The recent banking crises in India, including the Yes Bank collapse and the ICICI Bank- Videocon case, underscore the urgent need to reassess the role of lenders in asset deterioration and introduce measures that ensure financial discipline without discouraging credit availability. To lend responsibly, banks need to get better at assessing risks and doing our homework before approving loans. The RBI has set guidelines14 for managing stressed assets, but their implementation often varies. A more structured approach, especially for large corporate loans can help prevent bad lending decisions. For instance, making risk-based criteria mandatory for high-value loans could add an extra layer of scrutiny. If a company is seeking a loan above Rs.

500 crores, a third-party audit before approval could ensure banks aren’t lending to businesses

with a track record of financial mismanagement. This way, we protect both banks and the broader economy from unnecessary financial risks. Additionally, establishing a Lender Accountability Unit (“LAU”) within the RBI could help keep a closer watch on reckless lending and favouritism in loan approvals. Currently, India has systems like the Central Repository of Information on Large Credits (“CRILC”) to track big loans, but they need to be stronger to catch repeated lending to financially unstable borrowers. If banks are required to submit detailed risk assessments before approving loans for high-risk entities, it would bring much-needed transparency and responsibility to the lending process. This way, we can prevent bad loans before they happen and build a healthier financial system. V.

Conclusion The issue of lender liability in stressed asset resolutions poses a fundamental challenge to the integrity of India’s financial system. While borrowers are rigorously scrutinized and held accountable for defaults, banks and financial institutions continue to operate with relative impunity, even when their lending decisions contribute to financial distress. The Yes Bank crisis, the IL&FS collapse, and the ICICI Bank-Videocon case serve as stark reminders that reckless lending, preferential creditor treatment, and governance failures are not just borrower-

14 Reserve Bank of India (RBI), Master Circular – Prudential Norms on Income Recognition, Asset

Classification and Provisioning Pertaining to Advances, RBI/2011-12/66, DBOD.No.BP.BC.12/21.04.048/2011-12 (July 1, 2011), https://www.rbi.org.in/commonman/Upload/English/Notification/PDFs/66IRN300611F.pdf

induced problems but systemic vulnerabilities within the financial sector itself. If borrowers are expected to act responsibly, why should lenders be exempt? A financial system that does not demand accountability from all stakeholders is not just flawed, it is incomplete. The time has come for India to redefine lender liability, ensuring that those who hold the power to shape financial destinies are also bound by the duty to wield that power responsibly.