Be watchful as a guarantor

While we are heading towards last quarter of the current financial year, surge in bad loans owing to Covid-19 crisis is emerging as a major concern for the banks. The next three months (January – March) would equally be tough for the borrowers who failed to be committed to repayment of loans because of job losses and drop in incomes. However, the most troubled would be the individuals who have submitted themselves as guarantors to the loans, which have defaulted on account of EMIs. The banks would be simultaneously gearing up to chase them for recovery of dues pending against the defaulting principal borrowers.

We witnessed unprecedented disruption in business operations across sectors leaving millions of people jobless and suffering huge drop in incomes. This economic disruption has direct bearing on the performance of banks and experts have already dished out their estimation of bad loan ratio expected to climb to the highest level in more than 20 years at the end of this financial year.

According to the Reserve Bank of India’s semi-annual Financial Stability Report, non-performing assets (NPAs) may rise 4 percentage points to 12.5% of total advances by March 2021, the highest since the year ended 31 March 2000. The apex bank had even warned that if the economic conditions worsen further, the ratio may soar to 14.7% under the very severely stressed scenario.

Precisely, banks on asset side are currently facing huge stress and to arrest the deterioration of asset quality, they would not be hesitating to knock at the doors of their defaulting borrowers and their guarantors even in odd hours to stay afloat.

Though recovery drive against defaulting borrowers is not something unusual, laying hand on guarantors’ accounts is sort of a surgical strike during these times of financial stress. Otherwise also, here it’s a common practice among bankers to catch hold of guarantors to pressurize the principal borrower to repay the bank loan. Actually, the banks don’t hesitate to recover loan installments from the guarantor’s account if the principal borrower fails to deposit the loan installments.

This ‘surgical strike’ is not taken well by the guarantors. They call it ‘unjustified’ action. The other side of the story is that many guarantors have been struggling to live a routine life as the banks have forced them to repay someone else’s debt. The situation has led to unrest in family relations, neighbourhood and friend circles.

I have been regularly receiving emails from a vast section of readers expressing ‘displeasure’ over the behaviour of their respective banks. Mostly, the major cause of their ‘displeasure’ has been banks making them (as guarantors) to repay loan amount of a borrower who had defaulted in repayment of the loan within the stipulated repayment schedule.

I have also come across gullible people who had guaranteed repayment of a loan without knowing their responsibilities as a guarantor. They had mistaken their signing of loan documents as witnesses. But guaranteeing a loan is vastly different from signing a document as a witness.

Is banks’ action justified to recover loan installments from guarantors if the principal borrower fails to repay?

Let me share a small but significant situation with you. It’s tale of dead man who had raised a loan and expired without clearing it. The bank (lender) laid hand on the loan guarantor to recover the loan arrears from him after the death of the principal debtor. The guarantor got agitated over the bank’s approach for claiming loan arrears from him and contested it in the Supreme Court.

The apex court ruled that the guarantor of a loan is liable to pay it if the actual borrower fails to clear it. The apex court direction also stated that the guarantor cannot insist that the creditor (bank or financial institution) must first exhaust all remedies against the principal debtor (actual borrower) before recovering the debts from the surety holders (guarantors).

Here it’s worth mentioning that Reserve Bank of India (RBI) guidelines allow banks to take action against guarantors on a loan, even without exhausting the remedies against the principal borrower, in case of a wilful default. The RBI circular further states, “As such, where a banker has made a claim on the guarantor on account of the default made by the principal debtor, the liability of the guarantor is immediate. In case the said guarantor refuses to comply with the demand made by the creditor/banker, despite having sufficient means to make payment of the dues, such guarantor would also be treated as a wilful defaulter.

People mostly consider guaranteeing a loan repayment just a simple formality to help someone obtain a loan. Is it so? 

No, it’s not. It’s a responsibility, in fact a duty. If anyone signs a guarantee deed to go guarantor for someone else’s loan (debt), he is accepting that he would be taking on the financial and legal responsibility for paying off the loan if the actual borrower for whom he has stood guarantor defaults in its repayment.

So, as a guarantor you give a written promise to take on serious legal and financial responsibilities. If the borrower doesn’t pay back the loan according to the terms of the contract, the bank has the legal right to force you, as guarantor, to pay the money back instead. So, one has to be very clear on his obligations as a guarantor before signing on the guarantee deed.

Notably, guaranteeing the loan is usually done in a very casual manner. Often family members or friends stand guarantee without understanding the legal ramifications. The problem gets compounded when the guarantor cannot remedy the default owing to lack of sufficient financial resources to meet any of the financial obligations flowing from the borrower’s default. In this situation the bank can sell off guarantor’s assets and use the funds to pay for the principal, interest and other costs.

Does that mean you should never be a guarantor to anyone?

It’s not that you should never be a guarantor to anyone. But it is always advisable not to rush into anything that one is unsure about. You should always know full assessment of the borrower’s worth or financial position, whether he is able to repay the loan or not. I have never seen a person while acting as guarantor going through the guarantee deed. Mostly, the guarantors always sign these legal documents in a hurry. But this hurry has most of the time resulted in their casualty. Once the actual borrower defaults in loan repayment, the guarantor has to face the pressure of the bank to repay the outstanding loan amount.

So, before you guarantee a loan, first read and understand the nature of the guarantee. Don’t sign a document that you have not read or sign a document which is in fact a blank form or a partially completed form. After stepping in as a guarantor, ensure that you keep a track of the repayments of the loan.

What are your rights as a guarantor?

You have a right as a guarantor to ask certain important questions to bank – the lending institution. What is the total amount of money needed to pay off the loan at a specific date? How much the borrower does currently owes to the bank? How much has already been paid? What is the overdue amount? It is obligation on part of the bank to give you all such information as a guarantor.

Here it is important for the banks to make the person (guarantor) aware about his risks and responsibilities as a guarantor.

Can you withdraw guarantee?

The decision of withdrawing guarantee may be yours, but it is the prerogative of the Bank to allow it or not. Precisely, being a guarantor is as good as taking a loan yourself, in terms of credit exposure. Please note, this could impact the amount of loan that you as the guarantor can take in the future, as the banks can factor your potential obligation as a guarantor.

Meanwhile, you can sue the borrower if you as a guarantor had to pay out his debt under the guarantee.