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What Is A Bad Loan?

Context:

Recently, Finance Minister told Parliament that banks had written off bad loans worth ₹10,09,511 crore during the last five financial years.

  • National Asset Reconstruction Company Ltd. (NARCL) was announced in the Union Budget for 2021-2022 to resolve stressed loans amounting to about ₹2 lakh crore in phases.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

  1. What is a loan write-off?
  2. What is a bad loan?
  3. NPA recognition

What is a loan write-off?

  • Writing off a loan essentially means it will no longer be counted as an asset.
  • By writing off loans, a bank can reduce the level of non-performing assets (NPAs) on its books.
  • An additional benefit is that the amount so written off reduces the bank’s tax liability.
Why do banks resort to write-offs?
  • The bank writes off a loan after the borrower has defaulted on the loan repayment and there is a very low chance of recovery.
  • The lender then moves the defaulted loan, or NPA, out of the assets side and reports the amount as a loss.
  • After the write-off, banks are supposed to continue their efforts to recover the loan using various options.
  • They have to make provisioning as well. The tax liability will also come down as the written-off amount is reduced from the profit.
  • However, the chances of recovery from written-off loans are very low  which raises questions about the assets or collateral against which the banks lent funds to these defaulters.

What is a bad loan?

  • A bad loan is that which has not been ‘serviced’ for a certain period.
    • Servicing a loan is paying back the interest and a small part of the principal — depending on the agreement between bank and borrower — to begin with so that over time, you pay back the principal as well as the interest accrued in the duration.
  • In 2009, the RBI brought out norms that set out categories of NPAs and what banks must do as these bad loans aged.
  • Bad loans are a problem, for, with time, there is less and less certainty that the loan would be paid back in full.

NPA recognition

  • The RBI’s master circular in 2009 started off the journey on NPA recognition.
  • It states that if an asset has been ‘doubtful’ for a certain period, the value of that asset must be provided for in parts, as the asset ages.
  • There was a revision in October 2021 which made recognition far more stringent.
  • Interestingly, even if the asset is standard and there is no problem with it, banks are expected to make provisions depending on the risk element for that sector.
    • Like home loans with teaser rates are at greater risk than those that aren’t. Hence provisions have to be made for such loans.

Why is there a need to recognise NPAs?

  • In the banking system, the government and regulatory authorities need to have a good view of how healthy the financial system is.
  •  A weak financial system can eventually ruin lives and livelihoods
  • India became more aggressive in recognising loans as ‘bad’ in the 2014 to 2015 period.
  • The periodic asset quality review was introduced.
  • Further, the regulator stepped in to prevent evergreening of loans (i.e., lending more to an already stressed asset in the hope that it could be brought back to its feet).

Has recognising NPAs helped?

  • With the transparent recognition of NPAs, this percentage for gross loans rose from 4.1% in March, 2014, to 11.46% in March 2018.
  • The government’s “strategy of recognition, resolution, recapitalisation and reforms,” NPAs had since declined to 5.9% by March 2022.

-Source: The Hindu


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