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.)