Baba’s Explainer – Loan Write-offs

  • IASbaba
  • December 7, 2022
  • 0
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  • GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development
  • GS-2: Government policies and interventions for development in various sectors and issues arising out of their design and implementation.
  • GS-2: Statutory, regulatory and various quasi-judicial bodies. 

Context: During the last five years — from 2017-18 to 2021-22 — scheduled commercial banks (137) wrote off non-performing assets (NPAs) worth ₹9,91,640 lakh crore out of which 12 public sector banks accounted for ₹7,27,330 crore.

  • Minister of State for Finance Bhagwat Karad, said this in a written reply to a Rajya Sabha unstarred question raised by Mallikarjun Kharge, in August.
  • However, according to RBI data, banks have written off ₹10,09,510 crore over the last five years. Public Sector Banks (PSBs) accounted for ₹7,34,738 crore of these write-offs.
What Is a Non-Performing Asset (NPA)?
  • A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or in arrears.
  • A loan is in arrears when principal or interest payments are late or missed.
  • A loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet his obligations.
  • In India, a non performing asset (NPA) is defined as a loan or advance for which the principal or interest payment remained overdue for a period of 90 days
  • NPA resolution is crucial for the economy because banks’ ability to lend is critical for businesses and the economy to grow. A deluge of bad loans (i.e. NPAs) impairs banks’ ability and willingness to lend that furthers impairs the growth prospects of economy.
What is the genesis of the NPA Problem that we are witnessing now?
  • Boom years of late 2000s: A large part of the problem started in the latter half of 2010s, as assumptions of persistently high economic growth made several large corporates overzealous in their investment ambitions, thus over-leveraging themselves in the process.
  • Role of Easy Credit by Banks: On the prospects of high economic growth financial sector, led by public sector banks, fuelled these expansion plans through easy money on credit.
  • 2008 Financial Crisis: Growth (and demand) fizzled out following the global financial crisis of 2008. Despite the fire-fighting measures taken by government, the impact of the global crisis was felt in coming years. The crisis got further precipitated by Policy Paralysis of UPA-2 government (Corruption Scandals, Coalition Politics, standstill bureaucracy)
  • Vicious cycle: The stress from stretched corporate balance sheets (revenue impacted due to slowdown) infected banks’ own books and underwhelmed banks own capacity for fresh lending. Former Chief Economic Adviser Arvind Subramanian had called it India’s ‘twin balance sheet problem’ in the Economic Survey for 2016-17.
  • Peak reached in 2018: Over the course of 2014-19, India’s banks were put on high alert by RBI for tighter recognition norms for bad loans. As a result, in March 2018, when bad loans on their books peaked to over ₹10 lakh crore — around 11.5% of all loans.
Why do banks resort to write-offs?
  • Writing off a loan essentially means it will no longer be counted as an asset.
  • The bank writes off a loan after the borrower has defaulted on the loan repayment and there is a very low chance of recovery.
  • Bank then moves the defaulted loan, or NPA, out of the assets side and reports the amount as a loss.
  • Therefore, write-off is an internal accounting procedure to clean up the balance sheet of a bank. It is resorted to even in cases where the bank has not exhausted all avenues for recovery of dues.
  • By writing off loans, a bank can reduce the level of non-performing assets (NPAs) on its books.
  • The tax liability will also come down as the written-off amount is reduced from the profit.
  • Such write-offs do not affect the right of the bank to proceed against the borrowers to collect the dues. Any recovery made against the borrower is considered as a profit for the bank in that financial year.
  • However, the chances of recovery from written-off loans are very low — as the RTI reply shows — which raises questions about the assets or collateral against which the banks lent funds to these defaulters.
  • Banks were able to recover only 13 per cent of this amount subsequently.
    • Analysts have questioned why banks are able to recover only a fraction of the written-off amount when banks normally lend funds against assets or collaterals.
Is write-off necessary for banks?
  • Losses in any business can occur for a variety of reasons. Losses in banking / financial sector (BFSI) broadly reflect the downturn in real economy and businesses that these institutions lend to.
  • Some businesses are impacted by
    • technological disruption
    • change in government policies
    • regulatory hurdles
    • even increased competition.
    • Fraud or malfeasance is only one among the many reasons.
  • It is also possible that a lender/banker may commit an error of judgement in advancing funds to a particular borrower or industry.
  • Factors that are beyond the control of both the banks and the borrowers could also lead to defaults. Under such circumstances, one cannot attribute malafide intentions on banks.
  • It may also be important to realise that all loan write-offs are not lost money. Significantly, many write-off cases continue to be on “birth register’ of banks/financial institutions.
  • Loan write-offs are generally undertaken when a particular business is failing. In fact, it may be worse than a ‘fire-sale’ or a ‘retrieval-sale’.
  • Prudential norms on Income Recognition, Asset Classification and Provisioning (IRACP) pertaining to advances have been in force for more than two decades. Despite this, Indian banks hid losses for decades.
  • The ‘write-offs’ we are investigating today would not have been possible but for a policy change by the RBI in 2015 that mandated all banks to come clean on the extent of bad loans they had been hiding in their financial reports.

Main Practice Question: Why do banks write-off loans? What are its implications on the economy?

Note: Write answer his question in the comment section.

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