During the last five years — from 2017-18 to 2021-22 — scheduled commercial banks (137) wrote off non-performing assets (NPAs) worth ₹9,91,640 lakh crore out of which 12 public sector banks accounted for ₹7,27,330 crore.

Minister of State for Finance Bhagwat Karad, said this in a written reply to a Rajya Sabha unstarred question raised by Mallikarjun Kharge, in August.

According to RBI data, banks have written off ₹10,09,510 crore over the last five years. Public Sector Banks (PSBs) accounted for ₹7,34,738 crore of these write-offs.

Banks were able to recover only 13 per cent of this amount subsequently.

Analysts have questioned why banks are able to recover only a fraction of the written-off amount when banks normally lend funds against assets or collaterals.

Though there are rumours of bank officials siphoning off a potion of the written-off amount in cahoots with failed businessmen, there is no truth in this.

The causes

Losses in any business can occur for a variety of reasons. Losses in banking / financial sector (BFSI) broadly reflect the downturn in real economy and businesses that these institutions lend to. An economic downturn could hit the profitability of businesses and the banks that lend to them.

Some businesses are impacted by technological disruption, change in government policies, regulatory hurdles or even increased competition. Fraud or malfeasance is only one among the many reasons.

It is also possible that a lender/banker may commit an error of judgement in advancing funds to a particular borrower or industry. Factors that are beyond the control of both the banks and the borrowers could also lead to defaults. Under such circumstances, one cannot attribute malafide intentions on banks.

It may also be important to realise that all loan write-offs are not lost money. Significantly, many write-off cases continue to be on “birth register’ of banks/financial institutions.

Losses in BFSI sector can either be charged to profit and loss account or can be piled up threatening the solvency of entities. In the past, losses in PSBs were periodically made good by the government through infusion of recapitalisation funds irrespective of the fact that it did not add any fresh capital to the banking system.

Loan write-offs are generally undertaken when a particular business, not necessarily the underlying assets, is failing. In fact, it may be worse than a ‘fire-sale’ or a ‘retrieval-sale’.

Prudential norms on Income Recognition, Asset Classification and Provisioning (IRACP) pertaining to advances have been in force for more than two decades. Despite this, Indian banks hid losses for decades. The ‘write-offs’ we are investigating today would not have been possible but for a policy change by the RBI in 2015 that mandated all banks to come clean on the extent of bad loans they had been hiding in their financial reports.

Write-off is an internal accounting procedure to clean up the balance sheet of a bank. It is resorted to even in cases where the bank has not exhausted all avenues for recovery of dues. Such write-offs do not affect the right of the bank to proceed against the borrowers to collect the dues. Any recovery made against the borrower is considered as a profit for the bank in that financial year.

In a reply submitted to the Estimates Committee of Parliament in 2018, Raghuram Rajan, former Governor of RBI, had stated “Loan classification is merely good accounting – it reflects what the true value of the loan might be. It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. If the losses do not materialize, the bank can write back provisioning to profits. If the losses do materialize, the bank does not have to suddenly declare a big loss, it can set the losses against the prudential provisions it has made. Thus the bank balance sheet then represents a true and fair picture of the bank’s health, as a bank balance sheet is meant to.”

Why haircuts

Coming back to the issue of realising less than the book value of loan assets and agreeing for huge haircuts under the insolvency and bankruptcy code (IBC), M Rajeswar Rao, Deputy Governor of RBI recently explained that: “There have been some concerns about the high levels of haircuts that creditors have had to take in resolutions that happened under IBC. In these discussions, we miss the fact that in a public-auction based resolution model, the extent of haircut represents the discount the market demands in continuing to invest in an insolvent borrower. Since significant value deterioration may have happened to the assets of the insolvent borrower, comparison with the outstanding amount may not be a reasonable indicator to evaluate the effectiveness of resolution.”

Thus, the gap between the period an asset shows stress and the date on which it is transferred to an asset reconstruction company or disposed of by a resolution professional appointed by the IBBI, the erosion in value of fixed assets as also the death of a business idea gets reflected in the price offered by an acquirer. This gap is the amount that the bank ends up recovering less from the outstanding amount.

Banks raise capital abroad through issuance of bonds. That necessitates adopting generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS). Some of them are also part of MSCI index, which creates a demand for their stocks by foreign portfolio investors (FPI) and overseas funds.

Holding a high percentage of NPAs relative to the total assets of a bank can deter investors from investing in its stocks. The more NPA a bank holds on its books, the less attractive it is for potential investors.

To conclude, loan write-offs are a combination of financial health-farming, tax-planning, turf-greening, image-enhancing and backyard-cleaning. Nothing more, nothing less.

The writer is a former central banker. Views expressed are personal