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What is the difference between a loan waiver and a write-off?

Bad credit written in a memo stick.

Bad credit written in a memo stick.

What is it?

The Centre earlier this month told Parliament that non-performing assets (NPAs) worth ₹2.41 lakh crore have been written off from the books of public sector banks between April 2014 and September 2017. Since the banks were able to recover only 11% of the distressed loans worth ₹2.7 lakh crore within the stipulated time, the rest had to be written off as per regulations. The government, however, clarified that the defaulters will have to pay back the loans, though they were written off. So, a write-off is technically different from a loan waiver in which the borrower is exempted from repayment. This, of course, does not mean banks will manage to collect the dues from defaulting borrowers.

How did it come about?

For long, India has lacked a proper legal framework to help creditors recover their money from borrowers. According to the World Bank, the country ranks 103rd in the world in bankruptcy resolution, with the average time taken to resolve a case of bankruptcy extending well over four years. Banks in India, in fact, are able to recover on an average only about 25% of their money from defaulters as against 80% in the U.S. Public sector banks have also been lenient in collecting their dues from defaulting borrowers because of pressure from powerful interest groups. Instead of classifying sour loans as troubled assets and taking action to recover them, banks have often chosen to hide such assets using unethical accounting techniques. Since 2014, however, the Reserve Bank of India has been stepping up efforts to force both private and public sector banks to truthfully recognise the size of bad loans on their books. This caused the reported size of stressed assets to increase manifold in the last few years.

Why does it matter?

The news about the huge loan write-off comes amid the Union government’s efforts over the last few years to expedite the process of bankruptcy and improve recoveries. The Insolvency and Bankruptcy Code (IBC), which came into force last year, was the most notable among them. Many large corporations, as well as smaller enterprises, have been admitted to undergo liquidation under the IBC so that the proceeds can be used to pay back banks. The poor loan recovery reported by the government reflects poorly on the ability of the new bankruptcy law to help banks recover loans and mounts more pressure on bank balance sheets. It is notable that the Centre recently vowed to inject ₹2.11 lakh crore into public sector banks to cushion their balance sheets from the impact of bad loans. The poor recovery may increase the size of funds the Centre will have to allocate for the purpose.

What lies ahead?

It seems unlikely that banks will be able to drastically improve their rate of recoveries since the new bankruptcy code is far from perfect. Its critics say the IBC is focussed more on the time-bound resolution of proceedings than on maximising the amount of money banks can recover from stressed loans. In particular, since there are strict time-limits imposed on the resolution process, there is the imminent danger that it may lead to the fire-sale of valuable assets at cheap prices. This can affect investment incentives. But, for now, the quick resolution of bad loans will free resources from struggling firms and hand them to the more efficient ones.

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Printable version | Sep 9, 2022 6:58:06 pm |