What loan write-offs are, and what they are not

It is generally assumed that a loan written off does not have to be repaid. This isn’t accurate. Technically loan write-off means taking this borrowing, an asset on the bank’s books, off it after having failed to collect or recover the interest or principal or both for long. Banks have to classify a loan as a non-performing loan or asset after 90 days if the borrower does not repay by that date. Progressively, the bank sets aside funds to cover this potential loss in line with the rules set by the Reserve Bank of India. Often after four years, the bank writes off this loan, without in any way losing the right to recover money through a resolution process. Finance ministers themselves have said that this is done to help banks free up capital, benefit from tax laws and to help show a better picture of the state of a bank’s book of accounts.

You might also like 

Zee will be back on the pitch with International League T20

Should India worry about China’s covid surge?

A PLI-type scheme for ‘atmanirbhar’ vaccine industry

Cement investors see Q3 with mixed feelings

All this can best be understood if you take into account the fact that Indian policy makers have mastered the art of softening the negative impact of a measure or a move through recourse to jargons. A non-performing asset or NPA, as it is been called for long in India, perhaps to intimidate the aam admi is plain and simple a loan on which either the interest or principal or both are not repaid on the due date. That is how it is in many parts of the world. The practice then is for lenders to set aside a good part of the potential loss to cover the full loss quickly, freeing up capital and also recovering money if possible through sale of assets or by selling the loan itself. The shocks to the system are thus relatively low. In the West, recovery of assets or liquidation is swift, easing hassles of lenders.

Not so in India, a late entrant to the world of correctly classifying assets as good or bad and in recognising incomes of banks. Rules relating to all these kicked in only after economic liberalisation in 1991 after a committee headed by former RBI Governor M. Narasimham recommended new norms and after being nudged by multilateral institutions which had funded India during a fiscal crisis then. And the word NPAs then came into vogue in the mid-1990s with banks getting the leeway of time to classify loans as bad.

Progressively, the RBI did tighten these norms. But in India, applying those global norms of recognising a default from day one may not be acceptable or feasible from a political-economy point of view. One, it would mean capital to be set aside, which in turn would mean the owner of most banks in India, the government, stumping up an enormous amount of cash. Besides, of course, lower profits. More importantly, it is also a recognition of ground realities, which is the tortuous process of recovery in India, through mechanism such as negotiations or the insolvency law which appears to have been gamed by promoters and grounded due to judicial delays. But unlike the West, there is no vibrant bond market even now to tap for corporates and other borrowers, making it a predominantly bank loan market in India, thus adding to pressure on local lenders.

Given this backdrop, it would perhaps be difficult to pin the entire blame on both banks and the government. Earlier RBI governors may have been much more mindful of all these.

Contemporary chiefs of the RBI such as Raghuram Rajan and, especially, Urjit Patel see the downside of this practice of kicking the can down the road. Patel’s stepping on the gas in terms of putting in place rules in early 2018 to recognise a loan default a day after the repayment due date finally led to a pushback by the government and industry and ending up with him quitting the central bank later that year.

In his memoir, former RBI Governor YV Reddy wrote almost despairingly on bad loans, saying that credit culture is a question of fairness in India; “And that if we do not ensure a sense of fairness, this moral compulsion may be eroded“. The failure to address the basic debt contract will mean, as Urjit Patel said in his book, ‘Overdraft’, that the “living dead borrower” stays afloat. What it does not mean, however, is that depositors lose their savings. Not a rupee of deposits is lost. What is lost is potential return on the deposits. The cost of borrowing for the honest borrowers that repay loans on time increases, this includes government borrowings, and the interest paid on savings accounts reduces because of the inefficiencies created by loan defaults and consequent write-offs.

Elsewhere in Mint

In Opinion, Anurag Beher says covid memories tell us we can be better versions of usual selves. Aashi Gupta, Vani S. Kulkarni & Raghav Gaiha write on the link between religiosity and well-being. Rajiv Sabharwal says India will be best served by a multi-engine credit delivery system. Long Story narrates the hope and despair in covid-ridden China.