F&O positions that were held until the expiry used to be settled in cash as per the price of the stock. But, from October 2019, through a SEBI circular, it was stated that F&O positions that are held till expiry will be settled through physical delivery of the underlying stocks.
Source:
https://www.sebi.gov.in/legal/circulars/apr-2018/review-of-framework-for-stocks-in-derivatives-segment_38629.html
Here, the quantity to be delivered/received is basically the Market lot multiplied by the Number of contracts that result in delivery settlement. Needless to mention, the amount is astronomical when compared to the overall margins spent by a retail player in the market for one such trade. Most people have small margins blocked for the trades at the initial level. So, failure to comply would mean a default.

Things were not so daunting as there was already in effect a system called the DNE (Do Not Excercise) facility for close-to-market option strikes.

However, a new risk was posed from October 2021 when a circular was published which meant that the Do Not Excercise Facility will be unavailable from 14th October 2021.
Source:
https://archives.nseindia.com/content/circulars/CMPT49775.pdf

The DNE facility would enable brokers to not exercise option strikes where the STT amount is more than the premium of the ITM option. With STT revisions, the DNE could be done away with. But, now, without DNE, there is a new risk altogether. A greater possibility of having to take or give the delivery of underlying stocks by the client him/herself. Failure to do would mean a default against a counterparty. It would incur a heavy penalty from the exchange owing to the auction penalty procedures, etc.

There can be situations where an out-of-money put option contract can suddenly be in the money on the expiry day. Even if a trader wants to exit, he might not be able to square off due to low liquidity (very low buyers or sellers) owing to the worthlessness of the expiring contract. In such cases, one must choose to get the entire stock in his/her Demat account with the full amount being paid, again failing to do so may result in short delivery. The auction penalty at the end of T+3 days would incur significantly higher losses eventually.

Many have been complaining all over the internet about such rules. Retail traders have been affected and the brokers are fearing undue systematic risks in the long run. Apparently, a trader had been crowdfunding to meet the penalty amount. Ideally, a client should have been given more power to instruct a broker on whether or not to use DNE at a discretionary level.

As a solution- I have also read that the brokers' associations have requested a trading session post the usual hours for the F&O stocks especially for the sole intention of settling the expired contracts without hurting the parties a lot.

How Counterparty risks plays a role in the Options Market?