Understanding Bank Loan Write-Offs and Waivers: A Closer Look at the Modi Government’s Actions

The recent news about the Modi government writing off outstanding loans amounting to Rs 68607 crore from the top 50 willful bank loan defaulters has sparked confusion among the public. It is important to clarify the nature of this action and its implications for bank operations and the overall economy.

Key Differences Between Write-Offs and Waivers

Firstly, it is common for there to be a misconception that these loans are being waived off entirely. However, the government is not waiving off these loans; it is merely technically writing off the amount. This means that the amount is not reflected in the bank's balance sheet, but the banks still have the legal right to proceed against the defaulters for recovery of the dues.

Consequences for Banks' Balance Sheets

This action is part of a broader strategy to cleanse the balance sheets of banks. If banks continue to hold these non-performing assets (NPAs), they are required to establish provisions based on their asset quality, with the requirement to hold as much as 100% provisioning for NPAs under the Basel III norms. This regulation ensures that banks maintain a high level of asset quality and manage risk effectively.

Provisions and Legal Recovery Rights

Indian banks generally set aside between 5% to 20% of loans as provisions. When loans turn into NPAs, banks are required to make 100% provisions, as mandated by the Basel III norms. Therefore, when a write-off occurs, the provision amount equivalent to the written-off amount can be used for other business activities. This could include lending again or other financial activities to generate revenue.

Impact on Bank Profitability

Any recovery made post-write-off is considered a profit, which improves the bank's balance sheet. In accounting, the assets size is reduced, and this is recorded as an expense or a loss, reducing the bank's liabilities and potentially lowering tax expenses for the year.

Malaya Bank Case Study

In some cases, loans written off under legal provisions can still be recovered through legal procedures. For example, the Malaya Bank case demonstrated that even loans written off can still be recovered legally. This shows that the write-off process is not a complete cessation of the bank's right to recover the debt.

Conclusion

While the government’s decision to write off these loans is a responsible move to improve the health of the banking system, it is crucial to understand that the debtors still have legal liabilities. Writing off the loan does not absolve the debtors but merely changes its status on the bank's balance sheet. As for the writer’s opinion, personally, I believe that write-off can be an acceptable practice if it helps in revitalizing the financial health of the banking sector and moving towards a sustainable recovery.

This article aims to provide clarity on the often misunderstood concepts of loan write-offs and waivers, and to highlight the importance of understanding the regulatory and financial implications of these actions.