The issue of bad loans in India has remained a persistent concern. Over the past decade, banks have written off a total of Rs 16. 35 lakh crore in bad loans, highlighting the severity of Non-Performing Assets (NPA) in the Indian financial system.
This staggering figure raises serious concerns for the economy. What does it really mean, though? Does it help borrowers? What does it mean for banks and investors? Let’s find out.
Following the rules set by the Reserve Bank of India (RBI), if a loan is not paid back for a long time and it becomes hard to get the money back, banks take it off their balance sheets. This is called “write-off.” ’.
According to the Ministry of Finance, banks wrote off Rs 16. 35 lakh crore in loans between 2014-15 and 2023-24. The biggest write-off was Rs 2,36,265 crore in the financial year 2018–19. The smallest was Rs 58,786 crore in the financial year 2014–15.
Banks and other financial institutions sometimes find themselves dealing with bad loans – loans that have little to no chance of being repaid While no lender wants to be faced with uncollectable debt, it is an unfortunate reality of the lending business When a loan is truly unrecoverable, banks have the option to write it off. But what does this entail and what are the implications?
What Constitutes a Bad Loan?
A bank has to decide that a loan is bad before it can write it off as a loss. Some of the things that can happen to a loan make it “bad” are:
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Borrower default means that the borrower doesn’t make loan payments for a long time, usually at least 120 days. This makes it unlikely they will suddenly resume payment.
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In bankruptcy, the borrower files for bankruptcy, which usually frees them from having to pay back the loan.
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Death or Disability: The borrower dies or becomes seriously disabled and has no cosigner or estate to pay back the loan.
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Fraud – The loan application contained false information and the borrower had no intention or ability to repay.
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Collateral Deficiency – The current value of the loan’s collateral is insufficient to cover the outstanding balance.
Once a loan is bad, the bank has to decide whether to work with the borrower on repayment options or accept that the debt is a loss.
The Write-Off Process
Writing off a loan removes it from the bank’s balance sheet. This is an accounting function that allows the bank to acknowledge the loss for tax purposes and no longer carry nonperforming assets.
To write off a loan, the bank credits the “allowance for loan losses” contra account and debits “bad debt expense.” The allowance account is meant to cover expected losses, while the expense account hits the bank’s profit/loss statement.
The write-off does not technically eliminate the legal obligation to repay the loan. The bank still has the right to pursue collection. However, additional recovered funds would be credited to “bad debt recoveries.”
Banks aim to write off loans before the end of their tax year to maximize bad debt expense deductions on their tax return. Loans are reported as charged-off to credit bureaus around 120 days past due.
Impact on Borrowers
For borrowers, having a loan written off can negatively impact their credit. The overdue status will show for up to 7 years. Most lenders are hesitant to approve borrowers with recent charge-offs.
However, borrowers may actually benefit from no longer accruing interest and fees if they were unable to keep payments current. The write-off stops the swelling of the loan balance.
In some cases, lenders are willing to negotiate a discounted settlement amount once the loan is charged-off, which allows the borrower to resolve their obligation for less than the full balance.
Borrowers should be aware that they may owe taxes on discharged debt if the lender reports it to the IRS.
Considerations for Banks
Banks aim to minimize loan losses, but write-offs are unavoidable in many cases. Here are some key considerations regarding loan write-offs:
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Writing off long-delinquent loans improves bank financial ratios related to asset quality and risk.
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Too many write-offs signal problems with underwriting and collections processes. Banks could face regulatory action if losses are excessive.
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Write-offs reduce tax liability but hurt profitability. Banks want to balance both.
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Bad debts not written off quickly enough inflate the balance sheet with nonperforming assets.
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Banks typically sell severely delinquent accounts to debt buyers rather than writing them off immediately.
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Securitizing and selling bad loans shifts the risk so banks can remove them from their books.
Alternatives to Write-Offs
In some instances, banks may opt for alternatives to writing off bad loans:
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Loan Modification – The loan terms are adjusted to make repayment possible. This may involve reduced payments or interest rates, extended maturity, principal reduction, or payment deferrals.
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Payment Plan – The borrower agrees to a scheduled repayment plan, often in gradually increasing installments.
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Forbearance – The bank temporarily pauses or reduces payments, usually for up to 12 months. Interest still accrues.
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Partial Charge-Off – Only a portion of the loan balance is written off if some recovery is expected. The rest remains on the books.
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Foreclosure – Repossession and sale of the mortgaged property. For mortgages, this is preferable to a straight write-off.
Writing off bad loans is an accounting procedure that allows banks to reduce the gross amount of troubled assets being carried on their books. For the borrower, it usually damages their credit standing but may actually ease their repayment burden. Banks will make efforts to recover funds after a write-off, but they cannot maintain delinquent loans on their balance sheet indefinitely as this distorts their financial health. Overall, write-offs are an unfortunate but necessary part of managing lending risks.
Does This Benefit Borrowers?
A write-off does not mean the loan amount is completely erased. Banks continue efforts to recover these loans, but the recovery rate remains low.
The Ministry of Finance has clarified that loan write-offs do not equate to loan waivers. Even after a write-off, banks pursue legal channels to recover dues. Finance Minister Nirmala Sitharaman stated that public sector banks have recovered Rs 2. 27 lakh crore from written-off loans. However, recovery rates have been lower in large corporate defaults, while collections from personal and small business loans have been relatively better.
What Does It Means for Investors?
As per RBI data, as of December 31, 2024, 29 companies had loans classified as NPAs, each with outstanding dues of Rs 1,000 crore or more. The total outstanding loans of these companies amounted to Rs 61,027 crore.
Bad loan write-offs can influence banking stocks in the market. However, they can also signal a fresh start for banks. A cleaner balance sheet strengthens lending capacity, benefiting investors in the long run. Investors should assess a bank’s NPA levels alongside other fundamentals before investing. If a bank’s NPAs are consistently rising, it may be wise to stay cautious.
What does Charge Off mean on my Credit Report? Does Charged Off mean I don’t have to pay?
FAQ
Do banks have to write off bad debt?
Under GAAP, banks are usually required to keep reserves for bad loans. Writing down a bad debt means getting some of the money back and writing off some of it. This is usually done as part of a settlement. Banks prefer to never have to write off bad debt since their loan portfolios are their primary assets and source of future revenue.
How do banks write off bad loans?
To make the balance sheet equal, banks and other financial institutions take the same amount out of the “Allowance for Doubtful Accounts” column. This is known as writing off bad loans. Bad loans are expensed using the direct write-off method.
What happens if a loan is written off?
Bad loans and illiquid holdings might be sold to another financial institution called a bad bank. Most of the time, selling these assets to bad banks will cost shareholders and bondholders money, but it will protect depositors from a possible bank failure. When a nonperforming loan is written off, the lender receives a tax deduction from the loan value.
Can a bank recover a bad loan after a write-off?
The loan write-off does not remove the bank’s legal right to recover the loan from the borrower. Any recovery made against bad loans after they have been written off is considered profit for the bank in the year of recovery. This is another advantage to writing off bad loans.
What happens if a loan goes bad?
If a loan goes bad due to repayment defaults for at least three quarters in a row, the exposure (loan) can be written off. A loan write-off frees up funds held by banks for the provisioning of any loan. A loan provision is a percentage of the loan amount set aside by the bank.
What is a loan write-off?
A loan write-off is used by banks as a tool to balance their books. It is used when there are bad loans/debts or non-performing assets (NPA). If a loan goes bad due to repayment defaults for at least three quarters in a row, the exposure (loan) can be written off. A loan write-off frees up funds held by banks for the provisioning of any loan.
Can the bank write-off my loan?
A bank writes off loans when recovering the loan has become untenable, and they have to begin utilising the assets related to the defaulter to recover the dues. Also, the bank writes off loans when the borrower’s assets do not have any more value.
Can you write-off a bad loan?
Generally, to deduct a bad debt, you must have previously included the amount in your income or loaned out your cash. If you’re a cash method taxpayer (most individuals are), you generally can’t take a bad debt deduction for unpaid salaries, wages, rents, fees, interests, dividends, and similar items of taxable income.Nov 22, 2024
How do I get my bank to write-off debt?
As with any write-off, you will have to convince the creditor that your situation means a partial write-off is in their best interest as well as in yours. Offer at least the monthly payment that the creditor is likely to get if they applied for a court order and start making payments.
What qualifies as a bad debt write-off?
The unpaid debt must be 100% worthless before you can deduct it. There must be no chance that the borrower can or will ever pay you back the amount of the loan.May 12, 2025