Don’t be confused- Loan Write off is not a Waiver

loan write off

“Written off does not mean maafi…. It doesn’t mean that the loan ceases to be a loan. We will still chase the loan, the entry in the book changes from being a performing asset to a non-performing asset.”

-Finance Miniter, Shri Arun Jaitley

Write-offs are a very common tool to clean up bank balance sheets around the world. It does not mean Vijay Mallya or anyone else for that matter is off the hook. Earlier this year, China’s top four banks wrote off 130.3 billion yuan (equivalent to 19.5 billion dollars) of bad loans for the first half of the year. It was an increment of 44 percent from the previous year. Moreover, from fiscal 2011 to fiscal 2015, India’s banking industry also wrote off a cumulative Rs 1.76 trillion worth of loans.

A write-off isn’t a waiver and shouldn’t be confused as such. According to the RBI, ‘Writing off’ of non-performing assets (NPAs) is a regular exercise conducted by banks to clean up their balance sheets. The substantial portion of this write-off is, however, purely technical in nature. It is primarily intended at cleansing the balance sheet and achieving taxation efficiency.

So what is exactly a debt or loan write off?

The loans will be taken off from the balance sheet and transferred to ‘Advance under collection account’. It will not affect the recovery process.

Arundhati Bhattacharya, the chairman of SBI, has issued a clarification as well. She reiterated that it is just an accounting entry to clean off the balance sheet.

Further, write-offs are generally carried out against accumulated provisions made for such loans. Once recovered, the provisions made for those loans flow back into the profit and loss account of banks.

For a clearer explanation, let us assume you have taken a loan of Rs 100,000 from a bank but are unable to repay. From the bank’s point of view, the loan is an ‘asset’ and the interest that would have accrued from you would have been ‘income’. In the bank’s balance sheet, the loan amount will be shown as an asset.

In case if you stop repaying the monthly instalments, the bank will generate lower revenue due to lack of interest payments. But, the loan amount remains as an ‘asset’ in its books since the bank still hopes that you will pay back the money. So, beyond a point, as per RBI norms, if there is no income – in this case, interest – coming from an asset, the bank will have to first provide for the loss of the ‘asset’ and then eliminate it from its balance sheet.

This process of declassifying the loan as an ‘asset’ in the books is what is termed as a write-off.

Whether it means no need for repayment?

When a bank writes off a bad debt, that write-off does not constitute a waiver of the bank’s right to collect on it. Banks can continue to pursue the collection of the bad debts in courts and through other civil proceedings, or choose to sell the debt to third party distressed debt buyers.

The debt has been written off from a creditor’s book but not from its memory. You continue to owe them money.

So what advantages does a bank have in writing off your loan?.

Chiefly, it helps the banks in the following ways.

1. It gives a true and fair picture of the ‘assets’ that are making money. After all, there is no point in having a huge asset base that doesn’t give any returns.

2. The write-off reduces the bank’s earnings for the current period and thereby reduces its taxable income. This accounting procedure may reduce the bank’s overall tax liability.

3. It reduces the capital burden for the banks. As per the BASEL norms (international banking norms applicable to all banks in the world), every bank has to maintain 8 % of its assets as capital. The reduction in assets reduces the capital requirement for the banks as well.

Why does the central bank encourage the write-offs?

Most of the public sector banks were inflating their asset base by continuing to show the defaulting accounts as normal, and not lending money to others who needed it. The practice of lending a defaulting borrower more money, so that the loan does not have to be classified as non-performing, known as ‘ever-greening’ continued as a practice.

Before writing off the toxic assets, recapitalization of banks would not have been of much use as banks would have used this money to hide their losses. So, in order to encourage lending and kick-starting the economy, banks are now being encouraged, rather forced, to clean up their balance sheets and start afresh.

Do write-offs impact other depositors.?

Yes, it does. Banks that have a high level of nonperforming asset tend to have low deposit rates and keep lending rates high in order to recover the losses on these assets.

Conclusion-

In banking and finance, the term “write-off” is really just an accounting term. It  just means the bank or lender doesn’t count the money borrower owes to it. There is no way that the borrower is pardoned or got exempted from payment. His debt will remain and recovery measures against him will continue.

Further reading:

CRR, SLR, Repo, Bank Rate- Explained

Twin Balance Sheet Challenge and NPAs explained

Monetary Policy Committee Explained

References-

1. http://www.wsj.com/articles/chinese-banks-throwing-out-soured-lending-to-clean-up-balance-sheets-1472559952

2. http://www.livemint.com/Industry/RV7ySo4hst0MYnDRYVazjL/SBI-says-writeoffs-arent-loan-waivers.html

 

2 thoughts on “Don’t be confused- Loan Write off is not a Waiver”

  1. Non performing asset anyways is not generating any income for the bank, so how does writing off an NPA will reduce the taxable income? (point 2 of the advantages). Please help!!

    1. The non-performing assets are not generating any income for the banks, but they are classified as assets in the balance sheet. In simple accounting language, writing off an asset means reducing the value of the asset by ‘x’ amount and showing the ‘x’ amount as an expense in the profit and loss account (which reduces profits). For eg- you have an asset worth Rs. 50000 in the balance sheet. Its value has reduced to 0. So, you will deduct the 50000 from the asset side of the balance sheet and show this 50000 as an expense in the profit and loss account. Hope this helps 🙂

      Edit: If profit reduces, taxable income also declines

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