What is loan write-offs and black money
After State Bank of India (SBI) announced write-off of loans worth about Rs7,000 crore including that it lent to Kingfisher Airlines owned by Vijay Mallya, there has been uproar from public and also from many intellectual and political quarters as well that this write-off is denotation of waiver of loan. During this season of economic crisis, post-announcement of Prime Minister Narendra Modi’s historical decision to curtail on cash circulation (demonetization of Rs1,000 and Rs500 notes) to contain black money at the cost of common man’s perils, the write off has been attributed with a kind of ‘cheating ‘ of public by state owned banks and Government itself.
 
When a loan is disbursed, it is meant to create an asset. The loan disbursal is directly proportion to the value of asset to be created out of it. That is the moment the money goes into circulation out of bank’s cash balances raised in the form of deposits and capital. The value of asset is actually notional or in fact, based on certain market valued benchmarks and it can be plus or minus. That is the moment many entrepreneurs take advantage of valuation of asset or project and get the loan disbursal out of the actual asset and utilise the ‘surplus’ for other business or personal purposes. This becomes unaccounted money and, in other words, can be called as black money.  For now, we will confine to this piece of creation of asset out of debt funds giving rise to black money creation, which is one of the most common method.
 
The write-off of loan by a bank is actually an activity done at Bank’s end, not at the borrower or corporate’s end. Once the loan is out of their hands, the banks would be considering that the money has gone to an asset creation and that is how the loan lies in their records. The income recognition out of a loan and marking any loss against this would be a commercial decision of the bank within regulatory framework suggested by the Reserve Bank of India (RBI). Generally, the procedure followed is a gradual provisioning for loans when default (it is defined as payment beyond a certain period). Provisioning is nothing but disallowing bank to declare any remunerative returns to their investors out of the profits. However, banks would still budget for their income and keep their restructuring efforts on to make the defaulted loan, called as non-performing asset (NPA), a productive one in their books possibly with the least reliefs and concessions possible within regulatory framework. When write off happens, it goes like this –
 
(i) The profit marked during that period will be reduced to the extent of 100% of the amount written off, which means lesser profits for investors. This is more towards transparency and one-stroke sacrifice of profits. This allows the banks to claim income tax benefit too (but not for provisioning done in regular fashion). 
 
(ii) The loan book size or assets will come down in the balance sheet of the banks. This allows investors and interested parties to evaluate actual productive loan size and possible income generating ability of the bank. This also lets the respective Bank to provide less capital (capital adequacy ratio-CAR, as per Basel II accord, is at 9% that is for every Rs100 the bank lends, to put it in a layman language, bank would need Rs9 of its own funds or equity capital from investors), which is mandatory,  (money raised from profits and investors) to the loans, as the recorded size of loans would come down to the extent of write-off.
 
 
The RBI generally prescribes to write-off a loan after 100% provisioning is done or in case any unsecured portion of the loan is lying in the books of accounts. However, RBI would not step in any acceleration of provisioning or write-off of loans and it is left to individual Boards of the banks.
 
This means, in simple language, if you had given some loan to your friend and he ditched you, you will continue to make your future plans not depending on the repayment expected form him but as per your own realistic estimates of other income sources. However, this calculation in your mind does not entail your friend to claim default as his right nor you will give up any effort to recover money out of him.
 
The write-off also lets individual bank, having completely ignored the asset for any business target purposes, may incentivise to take a lenient view on the assets as ‘whatever realized out of it is a straight profit‘. By the time of write off, bank has already prepared itself to provide its expenditure against the possible income from other loans but not out of a loan, which has gone out of its balance sheet. Banks, at times, with this perspective, may likely to have an approach to look for least recovery and close down the headache forever. There have been no guidelines from RBI on what should be the approach by banks for recovery on written off loans. Individual Banks’ Boards may have certain overall broad guidelines, which, however, would not be as stringent as they are supposed to be as the returns on the overall portfolio were already compromised with once, in the past. Possibly, one time settlement is encouraged in such cases. 
 
The write off can happen against a particular borrower or against bulk of (small categorised) loans. The recovery action would also include bundling up these and selling it to other asset reconstruction companies -ARCs (meant for recovery out of a portfolio of loans but not driven by an individual loan, per se). To explain better, a model balance sheet of a bank is given as under:
 
 
If you see the first item in assets (right hand side), loan book of Rs75 is funded by various sources as given at left hand side items. Suppose, in a given year, the Bank decides to write off Rs5 out of it, while the operating profits were at Rs25. This decision will leave bank’s profits at Rs20 while the existing loan book size would be down to Rs70. Has this Rs5 really gone out of system? No, as this is still in profits, which are not accounted for. Though the declared profit is Rs20, Bank would still use Rs25 to deploy it in given assets. Loan book comes down to Rs70 signalling interested parties to that extent.
 
The notion that write-off is similar to going easy on loans is not completely correct. Many foreign banks do follow this approach and our Indian banking system has been writing off several loans worth of lakhs of crores over last 70 years and SBI’s decision is not unique or out of place.
 
Many a places, referring to former Deputy Governor of RBI, the write-off issue is being sensationalised in the context of present cash withdrawal measure, which actually would stand weak in front of any common mind. At the same time, it is a concerned point of view to demand, an appropriate monitoring and disclosures of these loans to the public from RBI. It is also important, India being capital starving economy, to set up a separate umbrella unit of all banks with appropriate frame of recovery options, inter alia, involving ‘near nationalization’ of such assets with the help of public sector enterprises, to work together on such loans under the guidance of RBI. It also needs an unchallengeable legal framework for such recovery enhancing the negotiating position of banks against such borrowers.
 
What everyone has to realise is that black money is created when loan is disbursed, but not by an accounting treatment of the bank, per se. When the money goes into circulation, there is always a beta factor of dripping of money into black money form at each stage. Our thinking should be to curtail black money at the source of generation. Any measure thereafter would be really to take a chance of recovery of it. Developed economies like Singapore, Dubai, US, and Russia are known for its sophisticated methods of creating black money through trade finance route and other methods. 
 
Compared to many economies, including developed countries, our black money economy is below average line. There have been several, especially, foreign banks, market their products which can help how to ‘save liquidity ‘. The recent news of HSBC Bank involving in laundering and notoriety of Swiss banks on preserving money are classic examples of Banks’ involvement in the entire process. 
 
The international deliberations by banks at various fora to curtail money laundering has been not-so-great effect on the same till date as the capitalist economy would continue to be driven by greed and deeply driven by the urge to garner returns to their investors. The resilience of economy can practically be made so perfect, unless an uncompromising people’s well-wishing political intention drives it.
 
(PV Vijay Kumar is a writer and critic. Views expressed in this article are his personal.) 
 
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    COMMENTS

    Jayatirtha Rao

    4 years ago

    Though writer and critic Mr.P V Vijay Kumar has made full efforts to describe what Write Off means, I feel it would have been better to make it clear in simple language. Banks follow income recognition norms i.e. when any asset (Loans and advances) fails to generate income by way recovery of loan including interest on it, the same becomes Non Performing Asset (NPA) and on every such NPA depending upon its tenure in the books of accounts of Banks, it needs to make certain % of provisioning by debiting its profit and loss account which reduces its earned profit. When such provisioning crosses 100% of ledger outstanding banks do write off of these NPAs to the extent of provisioning or to the extent of unsecured portion of the loan. Now question is what is secured and unsecured loan ? Whenever any loan is sanctioned and disbursed by the bank some security is taken by way of Primary Security which is created out of Bank's finance and Collateral Security to fall back upon in the event of default made by the borrower. When there is no security to recover any loan outstanding in the books of accounts of banks, they do write off such portion/entire loan. In this process banks Profit gets reduced. In reality and in practice bankers hardly make any efforts to recover the written off amount. Only in the case where there is an ample security to cover the loan outstanding efforts are made to pressurize the borrower when he comes with an compromise proposal. In the recent steps taken by SBI the timing is more important as it was in financial crisis and its balance sheet was in bad shape and hence to give confidence in their customers and investors entire exercise of write off and demonitization has been carried out by Govt. by being a party to it. Why SBI is being favoured so much is another big question? Reason may be it is one of biggest banks in Country or is one of the bank where big influential business tycoon's (like Ambanis/Adanis etc.)financial needs can be taken care of with political intervention? Our Finance Minister in his address has stated that how demonitization would help the bankers as well that banks would be infused with capital who in turn would be able to finance to more needy persons/sectors , Bank's balance sheets would be clean once such write off process is being carried out. I fail to understand how FM is going to assure the bankers that by making huge funds available to bankers that there would not be any additions in furhter NPAs.
    (J S RAO - Views expressed in this article are personal based on experience)

    Milind Sharma

    4 years ago

    in the other countries you are being provided with unemployment allowances ... dow we do in india ?? Then how come you can compare othher countries? Do other countries allow for adulterated food... Then why in india ?? Do not compare or if you compare then compare everything

    B. Yerram Raju

    4 years ago

    The author says that the black money is created when loan is originated. It can happen only when such loan origination takes place without a corresponding asset creation at the loanee's end. The second stage is when the banks tend to ignore the erosion in the value of the asset created by the loanee due to wanton neglect or failure in monitoring and supervision. It is absolutely right that when loan not recoverable any longer but getting continuously provided for in the annual Profit and Loss account does not get into the 'unaccounted' portfolio or blackmoney bag.
    Annual loan write off is a regular ritual of the banks. But having waited for over nine years, in the case of King Fisher, the SBI chose to write off in Nov 2017 and surprisingly announced at a time when the whole economy is getting exercised over demonetisation. Such large scale write-off announcements do not come into public generally. The timing of the announcement could be due to the merger exercise in the SBI or due to diverting the investors' attention from more serious issues in the merger!!!

    gopalkrishnann1

    4 years ago

    Can not understand your logic. If value erosion has happened, for window dressing you can show loss as asset ( Intangible; really nothing worthwhile ). With out proper backing ( ie tangible solid consideration had not been taken while giving your valuable asset ), justification of talk will not help. If you are saying is right, how the share values of PSU Banks have come to this condition.
    Thanks.

    REPLY

    Nanda Patel

    In Reply to gopalkrishnann1 4 years ago

    Stay away from banks. which have poor management.

    NPA problem is not going to solve any faster... That's all I understand from this.

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