Understanding a loan write-off

Even after a loan is written-off, the borrower still remains legally liable for its repayment.
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It was a jaw dropping revelation for common bank customers, when the government on December 19, 2022, disclosed that banks wrote off loans worth Rs 10,09,511 crore during the last five financial years.

An acquaintance made an interesting  observation on loan write-offs. “The banks are meticulously chasing small borrowers for repayment and make their life hell when they owing to plausible reasons delay repayment of their loans.

Contrary to this, big sharks and influential borrowers who mostly willfully default in loan repayments see their loans written off. This is gross discrimination and an act of crime done by banks,” said my acquaintance. 

How come banks are writing off loans so conveniently and relieving the defaulting borrowers of their liabilities?  This is the immediate question haunting the general public, particularly the bank customers.

Bankers are usually taunted for writing-off loans of influential borrowers and most of the times, the bankers fail to defend their act or maybe they are not inclined to explain the strategy and regulatory backing governing such loan write offs. Precisely, in common man’s understanding loan write off means relieving the defaulting borrowers of the debt without actually recovering it. 

Actually, bad loans have remained a permanent companion of banks. In fact, these bad loans are immortal. The banks create assets by providing loans and advances, as they earn interest from them. However, the loans are always loaded with the risk of default in repayments. Such loans where repayment remains overdue for a specific period turn into non-performing assets (NPAs) or what we call in common parlance as bad loans.

Incidents of a borrower defaulting in loan repayment are not new in the banking industry. But willfully refusing to repay the loan is simply a crime.

Banks get deposits from the public and the same deposits are granted as loans and advances to the borrowers belonging to various sectors of the economy.

When these funds change hands, the money gets multiplied. The appreciation in the value of money in the process results in the growth of the individuals, firms, companies and overall in the economy. Any blockade happening in this flow of money cycle hampers growth. Here the willful defaulter turns out to be a parasite on the economy.

The mounting NPAs have been a major concern when it comes to the health of the banks. Today, a higher volume of these bad loans  remains one of the major challenges in the Indian Banking system.

On many occasions, these bad loans behaved as a termite and wiped  out a good number of banks from the scene in the past. Irrational lending, deficiencies in monitoring, economic slow-down etc. are among a few of the various factors leading to the loan defaults.

The write-offs have significantly contributed to the decline in bank NPAs over years. According to the Reserve Bank of India (RBI) financial stability report for June 2022, the gross non-performing asset (NPA) ratio of banks fell to six-year low of 5.9 percent in March 2022. The net non-performing assets (NNPA) ratio fell to 1.7 percent in March 2022.

What exactly does writing-off a loan mean?

First, we have to understand a bad loan. A bad loan is a non-performing asset of a bank as it fails to generate income for the bank due to default in repayment. So, when a bad loan fails to generate income, it is no longer considered as a performing asset.

Every bad loan  adds to the NPA level of a bank. Higher NPAs means trouble for the bank. When the chances of recovery of a loan which has turned non performing asset are very low, the bank writes-off the loan. By writing-off loans, a bank reduces the level of non-performing assets (NPAs) and cleans its balance sheet of bad loans. 

It is also worth mentioning that banks are required to do 100 per cent provisioning in case of bad loan (NPAs) in accordance with the Basel-III norms.

As per the regulatory norms, provisioning  means banks are required to set aside a certain percentage of loan amount. By writing-off a loan, the banks set free the money parked for the provisioning and utilise the amount for business.

Does writing-off the loan means the bank won’t chase the defaulting borrower for recovery of dues any more?

A loan written-off does not mean the bank will stop effort to recover the loan from the defaulter.  Even as recovery chances of the written-off loans are very low, the banks are supposed to continue to explore recovery options, including legal action against the loan defaulter.

A bank will also lay hand on the security against which the loan was given. For example, any collateral in the shape of immovable property given against the loan by the borrower can be auctioned by the bank despite writing-off the loan.

So, writing-off a loan should not be construed that the defaulting borrower is absolved from the loan liability. It’s just an option available with the banks to clean their balance sheets and reduce their tax liabilities. Even after a bad loan is written-off, the borrower still remains legally liable for the loan repayment. Notably, any recovery made against a bad loan after writing-off is a profit for the bank in the year of recovery.

What kind of recovery mechanism can be adopted by the bank?

Banks have been taking actions in written-off loans against the defaulting borrowers through various recovery mechanisms. As per the RBI data, banks have made a total recovery of over Rs.1.32 lakh crore from written-off loan accounts during the last five financial years. This comes to around 13 per cent of the write-off.

Recovery mechanism options available with the banks include filing suit in civil courts or in debt recovery tribunals; action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; filing of cases in the National Company Law Tribunal under the Insolvency and Bankruptcy Code, 2016; through negotiated settlement/compromise; and through sale of NPAs.

What is loan waive-off?

A loan waive-off is not the same as writing-off a loan.When a bank waives-off a loan, it means the borrower is free from the burden of repaying the outstanding loan amount.

The bank won’t pursue any loan recovery and won’t even resort to legal action against the borrower. If the borrower has given any collateral or security against the borrowed amount, it will be given back to the borrower after his/her loan is waived off.

We have usually seen loan waive-offs extended to farmers who have gone through stressful situations like the poor monsoon, abnormal conditions, floods, earthquakes, natural calamities due to which farming may have affected them and they are unable to repay the debt. Here, the provision of loan waive-off is generally called by the government.

(The views are of the author & not the institution he works for)

DISCLAIMER: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.

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