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Government writing off loans

Writing off loans affects other depositors. Banks with a large number of toxic loans tend to have a high lending rate to recover their losses, this leads to a lower deposit rate and hence lower capital formation. A low capital formation rate hinders the growth of an economy. Are we really facing it?

It came with a bang and went with the whimper- The Big Bank clean up or protecting the“blue eyed boys”

It is known that the Indian financial sector faces a crisis. The Reserve Bank of India publishes financial stability reports which show bad loans as a percentage of total loans at the end of a financial year. But under certain circumstances, when the actual ratio exceeds the reported ratio banks need to find tools to manage the crisis. In the light of this, there has been a continuous debate after Reserve Bank of India (RBI)  on 24th April 2020, revealed that banks have written off loans of top fifty defaulters as a response to Right to Information query by an activist, Mr. Saket Gokhale. In response to the Right to Information query, RBI revealed that it has written off Rs 68,607 crore outstanding loans of the top fifty defaulters till September 30th, 2019. The list of the top 50 defaulters included Mehul Choksi’s Gitanjali Gems, Gili India, and Nakshatra Brands with loans of   Rs 5,492 crore, Rs 1,447 crore and Rs1,109 crore respectively written off. Vijay Mallya’s Kingfisher Airlines with an outstanding loan of Rs 1,943 crore written off. REI Agro with Rs 4,314, Winsome Diamonds with Rs 4,076, Rotomac Global Private limited with Rs 2,850 crore, Kudos Chemie Ltd with Rs 2,326 crore, Ruchi Soya Industries Limited, which is now owned by Patanjali Ayurveda, with Rs 2,212 crore and Zoom Developers Private Limited with Rs 2012 crore loans written off. The list includes other big shot “wilful defaulters” too.

The supreme court had earlier ordered RBI and commercial banks to reveal the names of the defaulters to those seeking inquiry for the sole purpose of transparency.  This is because when banks use write-off as a tool, the government has to recapitalize the banks and thus the burden falls on the taxpayer, and efficient taxation means, the taxpayer should be completely aware of the use of tax revenue.  However, the list did not include oversees borrowers because according to section 8(1)(A) of RTI act 2005 and para 77 of Supreme Court judgment of Dec. 16, 2015, in Jayantilal N Mistry case information about oversees borrowers are not for public disclosure.

The Political hue and cry – “Modi government is following dupe and depart policy” Congress spokesperson.

A constant tug of war between the ruling party and the opposition has not left any stone unturned.  The opposition bashed the ruling party and its agenda of cleaning up of banks. They claimed that the policy of writing off loans worth Rs 68,607 crore of top 50 defaulters which includes giant absconders, amidst the global pandemic, clearly reflects the misconceived priorities of the Modi government. They went on to say that the government is favoring the defaulters and this is an example of crony capitalization. As the country struggles through the Covid19 crisis, the Congress party stung the ruling party by raising pertinent questions like,  When, thousands of people have donated money to PM cares fund, National relief funds, and State care funds then why did the government have no money to help the laborers who were stranded at their workplace for almost a month or so?,  How will the government recapitalize the banks after cleaning its balance sheets if it has no money to pay Dearness Allowances to Indian army, navy, air-force and around hundred and thirty lakh government employees?. Congress spokesperson criticizes the government for cutting almost Rs37000 crore Dearness pay and not extending any financial help to the Micro Small and medium enterprises sector amidst the Covid19 crisis.  The attack went on to mentioning helpless farmers facing the fury of nature but not receiving adequate help. The opposition party further called upon Prime minister Modi to answer the queries and explain the situation.

Finance minister Nirmala Sitharaman came up with the reply for the refutes caused by the opposition and claimed that Congress has been trying to misguide and mislead the citizens of India and is creating chaos at a time when peace and solidarity are highly required. The Finance minister went on to her Twitter account to accuse the opposition party leader of having half-knowledge and information about write-offs and bank clean-ups and asked him to read more about the policy in detail. The finance minister called write-offs an act of prudence and not forgiveness.

In a recent interview of opposition leader Rahul Gandhi with Nobel prize winner Abhijit Banerjee on economic impact post Covid19 crisis and remedies to boost the economy, Abhijit Banerjee suggest a large stimulus package is required to revive demand and increase spending. He further suggesting that writing off loans “post” Covid19 crisis may be beneficial as it will give people the power to sustain. In the light of this, numerous questions have risen which requires to be answered at the earliest.

What is a wilful default and writing off loans?

 A “wilful default” occurs when a borrower defaults in the repayment of his loan amount to the lender even when they have the capacity to honor the obligations imposed on them.  Under such circumstances, banks write off loans. Banks writing off loans does not mean the loan is waived off. Loan write off is a tool used by banks to clean up their balance of payments and to increase tax efficiency. Banks sometimes write off toxic loans that are, loans that cannot be collected or are immensely difficult to collect because such loans reflect poorly on the balance of payments of the banks and may also divert resources from crucial and productive activities. Writing off loans decreases banks’ tax liability.

How do banks manage these “Bad Apples” through write offs?

In the banks point of view, a loan is an ‘asset’ and the interest earned from it is the ‘income’. The balance sheet of the bank will show the loan amount in the asset side as long as the borrower’s account is normal. When the borrower stops paying his monthly instalments, banks generate lesser revenue due to decrease in interest income, but the bank does not immediately remove the loan amount from the assets sides as the bank still hopes to get back the loan amount. As per RBI guidelines, after a certain point if the bank continues to generate negative revenue, that is if the borrower continues to default, then the banks have to cover up the loss of the loan amount and then eliminate it from its balance sheet. This technical process is termed as write-off or sometime even called charge-off. The trick here is that, that the borrowers of written off loans are not completely exempted from repayment rather remain liable for the repayment. This means banks do not give up the right to recover loans and also does not write off the entire loan because some loans are taken against collateral securities which can be recovered. As the banks recover the money, it adds up to the banks profit and provisions are reduce by equal extent. Recovery of toxic loans are done in accordance to RBI guidelines and through financial legal mechanisms which involves Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act,2002 which allows banks and financial institutions to recover their non-performing assets without the court’s intervention and Debts Recovery Tribunal (procedures) 1993.

 What are the advantages of write offs?

The two major advantages, of using write-off of toxic loans as a tool is that it gives a fair and transparent picture of the “asset” that is nothing but the toxic loan amount and the banks get a tax exemption on the losses incurred due to toxic loans. As the banks face losses, the recapitalisation of the banks is majorly done by the government through tax revenues, which means the government too losses its revenue base. Most public sector banks expand their loan base by showing the defaulting accounts as normal and not lending money to the ones who need it the most.  If the government recapitalise the banks before they write off the bad loans, banks may use the amount to hide losses. Therefore, to increase bank lending and boost the economy, banks are encouraged to write off the toxic loans and start on a fresh note.

 Does “bad apples” stink? – What are the social and economic impacts of write off?

Banks are the apex institutions of Indian economy. Its major borrowing and lending activities banks cater to the huge population of India. After the commencement of Banking Sector reforms 1947 in India, bank branches expanded to all part of India and promoted a huge amount of capital movement through facilitating loans. With lower Cash reserve ratio and Statutory  liquidity ration banks encouraged loans for different sectors. The sole purpose of this activity was to increase the derivative deposits with the bank, that it to encourage capital formation. Capital formation is vital for the growth of an economy and checks the financial health. However, as India stepped towards major industrial projects and as the importance of service sector increased, with huge loans came huge non- performing assets, that is toxic loans. The government has used write off earlier. Between 2014-2017, the banks hand written off 2.4 lakh crore bad loans but the question which triggers most of us is whether it effects the social and economic structure of the country. Yes, it does to some extent.

Writing off loans affects other depositors. Banks with a large number of toxic loans tend to have a high lending rate to recover their losses, this leads to a lower deposit rate and hence lower capital formation. A low capital formation rate hinders the growth of an economy. Generally, the smaller defaulters are not given the same leeway as to the bigger defaulters. This is because smaller defaulters eventually pay back their dues due to pressure tactics used by the banks. On the other hand, bigger defaulters find it difficult to raise a second loan until their earlier loan amount is recovered. Writing off loans puts a significant tax pressure on the taxpayers. It is nothing but shifting of liability.  The process of recapitalization “stings” the amount kept for public expenditure. It may give rise to social unrest and dissatisfaction among the citizens and might encourage them to evade taxes.  It also increases the cost of administrating the bad loans. One major potential problem with writing off loans is that “It may become a norm”. If the government keeps writing off loans through banks other borrows may find it easy to declare themselves as bankrupt or insolvent and make their loans written off. A public sector bank controls almost seventy percent of the country’s banking assets and the bad loan ratio of the public sector banks are higher than that of private sector banks. Therefore, the cost of writing off loans is higher in public sector banks which in turn is the cost to the general public.

Alternatives to write off loans?

Economist suggests various other tools to manage bad loans such as Lok Adalats 2001, Asset Recovery Construction Industry Limited (ARCIL), Corporate Debt Restructuring (CDR 2005), Credit Information Bureau (2000), Joint Lenders Forum (2014). However, bad loans remain a major issue of Indian banks. The government along with RBI are working rigorously to come up with various one-time settlement schemes for top defaulters before taking strict actions against them. Still, India has a long way to go when it comes to debt recovery and strengthening the banking sector.  Although the government claims that write off are technical and prudential in nature, that means the government has made 100 percent provisions for it The way to the good financial health of the country is the quick recovery of toxic loans from all corporate giants and whether writing off loans is a step towards it or not will only be known as we walk further into this financial year.

Nayonika Chakraborty
My name is Nayonika Chakraborty. I am a BSc Economics(Hons) graduate. My outlook on the world is a combination of diversity and knowledge and I practice it in my life as well. I aspire to become an economist and face the growing economic challenges of the country while keeping myself attached to the roots of my culture through my immense passion for classical dance and music.

1 COMMENT

  1. Excellent write up. Student of your age and background can be so immaculate in sending a deep message to the society is just amazing

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