Why Do Banks Write Off Loans of Top Wilful Defaulters? And What About Others?
Recently, there has been a lot of controversy surrounding the resale of loans by the Reserve Bank of India (RBI). In this article, we will aim to clarify the complexities behind loan write-offs and address the concerns of why only top wilful defaulters’ loans are written off, but not the cases of others, particularly those facing financial hardship.
Understanding the Concept of Write-Off
Many people view the write-off of loans as a form of fraud, but let us take a step back to make this concept clear. Imagine you have saved Rs 10,000 for your child's college fees for the next year. A friend borrows this money, promising to repay it when you need it. However, the date for payment of the fees arrives, and your friend refuses to pay back. You decide to pay the fees from your savings considering it a necessity. Technically, this debt has been written off, and for the year, you may claim a tax break, stating that your income is down to the extent of the loan that was written off.
The following year, you learn that your friend has moved to another city and has spent all the borrowed money. You confront him and, while you collect whatever you can from his home and sell it, you still owe him the money. This leftover can be treated as profit, but because the debt is outstanding, you can file a police complaint for cheating. The state government is responsible for prosecuting the defendant in criminal matters.
Why Do RBI Ask Banks to Write-Off Loans?
When a loan is not getting repaid, it is written off to ensure that borrowers feel secure that they won't be held responsible if the loan is not repaid timely. By writing off a loan, banks can show that they have their own resources to repay the debt. If the loan is not written off, the bank continues to show the interest as income on its books, thereby distorting its financial health and requiring the bank to pay taxes on this 'income' during the year when there is no money coming in.
Is Loan Write-Off the Same as a Loan Waiver?
No, they are not the same. A bank may write off a loan on its books but can still pursue recovery through various legal avenues. In cases where the borrower has suffered a sudden change in market conditions or government regulations, the bank may attach the borrower's and guarantor's assets, labeling them defaulters and moving on. If the borrower has cheated, they are classified as 'wilful defaulters' and criminal complaints are filed against them.
It’s important to understand that loan write-offs do not mean that the loan is forgiven entirely. Rather, the bank acknowledges the unlikelihood of repayment and reallocates the funds to better uses, potentially reducing its risk exposure.
Do Corporates Benefit from Loan Write-Off?
No, corporates do not gain from loan write-offs. In fact, they might face significant repercussions. Banks can initiate insolvency proceedings and sell large companies, such as Essar Steel, to the highest bidder. From the bank's perspective, writing off a loan is simply good accounting practice. It helps them clear the books and allocate resources to better opportunities.
However, for the borrower, losing a business is a severe outcome, particularly for those who have built a company over many years. The process of selling a company may lead to the loss of valuable assets and the potential closure of operations.
Are Indian Banks Flourishing with Such Practices?
Unfortunately, the situation is not as rosy as it might seem. Historically, many lenders have acted like venture capitalists or private equity investors. They take the risks on projects without the upside of profit if the business succeeds. Furthermore, the recovery process in India has been notoriously slow. Initiating insolvency proceedings and selling assets through this process can be a marathon, with each delay amplifying the debt.
A real-life example of this issue is a under-construction five-star hotel that raised a Rs 700 crore loan at an interest rate of 12%, expecting to complete the project in three years. Every year of delay increases the liability by Rs 84 crore. By the time the bank seizes the property, the dues often double, reaching a staggering Rs 1400 crore. This extended process also prolongs the resolution time in the courts, which in India, can be significantly lengthy.
In conclusion, the write-off of loans is a complex process aimed at safeguarding the financial health of banks and ensuring that assets are allocated effectively. While it may appear harsh to some, particularly those facing genuine financial hardships, it is a necessary measure to maintain the stability of the financial system. Understanding the nuances of these practices can help mitigate misconceptions and foster a clearer understanding of the Indian banking landscape.