Banks weigh in a lot of factors before sanctioning a loan to a borrower. In spite of such thorough scrutiny, some loans turn bad; The borrower is unable to repay the loan. Such loans are termed as bad debts and the banks write them off.
But the big question is, ‘Why do banks just write off bad debts?’. Shouldn’t they make attempts to recover the money from the borrower? What is the benefit to the banker by writing off bad debts?
The reason is very simple; they don’t want their balance sheet to look bad.
Debt write-off is a method used by lenders to tidy up their balance sheets. It is primarily used in cases of bad debts or non-performing assets(NPA). If on account of repayment defaults, a loan goes bad for at least three successive years, the exposure (loan) will be deducted.
A debt write-off sets the funds reserved by the banks free for the provision of some other loan. Loan provision applies to a certain proportion of the value of the loan set aside by the banks. The regular lending rate for Indian banks ranges from 5 to 20% depending on the business sector and the borrower’s repayment ability. In the case of NPA, 100% of provisioning is needed in compliance with the Basel III requirements.
How do banks write off bad debt?
They balance the sheet by debiting the bad debt under the ‘Accounts for Doubtful Accounts’ and crediting the same amount under the ‘Accounts Receivable’ ledger.
When a debt is written off, that amount shall no longer be a part of the bank’s gross and net non-performing assets. However, the creditor will not be exempted or pardoned from the redemption of the loan and the banks will continue with the recovery process. As a result, banks may not lose interest in the write-off asset and can recover their loan in part if the bad loan is resolved. The provisions shall be written back when a benefit is realized.
Bad debts are usually deemed unrecoverable. We should remember that the loans portfolio is the primary asset-creating portfolio of any bank. Yet, banks have to write-off debts that prove to be very difficult to recover. Such debts are better to be written-off than pursuing them at high costs.
How do ‘Bad Debt Write-offs’ help the bank?
Loans are the primary revenue-generating portfolio for banks. When a huge amount of their funds is stuck for provisioning of loans, the banks are unable to use those funds for other purposes. Debt write-offs release such funds for the banks’ use.
Also, the banks can still pursue the borrower for loan recovery. Any money they recover from the borrower will be additional profit for them.
Banks also get tax concessions for the amount that has been written off.
Who bears the cost of Debt Write-offs?
These write-offs are usually borne by the government in the form of losing tax revenues as any such losses are set-off against tax.
Debt write-off is not a new concept in India. Loans worth around Rs.8.8 crores have been written off by Indian banks over the last 10 years. In fact, Indian banks saw a steep rise in the number of debt write-offs during 2019-20 which was at around Rs.2.37 lakh crores. Of these, around Rs. 1.7 lakh crores were from PSBs alone and another Rs.53.9 crores were by private sector banks. The numbers don’t even include the smaller loans that have been written off by small finance banks.
A significant portion of debt write-offs is borne by government-owned banks, as per the latest data by RBI. RBI has been registering a growing concern regarding such write-offs hurting the economy in the long run.
What is the difference between a Debt Write-Off and Debt Waive-Off?
| Debt Write-Off | Debt Waive-Off |
| The non-performing asset is included in Debt Write off after all ways of recovery are expended and the odds of recovering the loan amount are remote. | The loan is totally cancelled and shall not be pursued for recovery. |
| Writing off a loan is not a total severance of recovery. | The borrower is no longer required to make payments towards the loan. |
| This is an accounting provision enabling banks to free up money set aside for loan provisioning. | A scheme mostly offered by the government to farmers and other borrowers during natural calamities or economic breakdowns. |
Key Points to Know about Debt Write-offs
- Debt write-off means that the bank foresees a lesser chance of recovering the loan
- Banks do this often, to remove some bad loans from their balance sheet
- Banks anyways allocate a portion of their budget for bad loans
- Bad debt doesn’t necessarily mean that the banks cannot attempt to recover the loans
Wrapping Up
Bad Debts are written off using accounting principles to release locked-up capital for the banks. Write-offs shouldn’t be confused with “waiver” of loans. Writing off doesn’t mean that the banks have given up on recovering the debt. They can very well pursue the loan recovery options to recover as much loan amount as possible. Loans are highly regulated by the RBI and it requires banks to set aside 100% of the loan amount for bad debt provisioning.
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