What is the difference between a loan forgiveness and a write-off?

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What is that?

Earlier this month, the Center told parliament that non-performing assets (NPAs) worth 2.41 lakh crore were written off from the books of public sector banks between April 2014 and September 2017. Given that banks were only able to recover 11% of distressed loans worth 2.7 lakh crore within the allotted time, the rest had to be written off according to regulations. However, the government has clarified that defaulters will have to repay the loans, even though they have been written off. Thus, a write-off is technically different from a loan waiver in which the borrower is exempt from repayment. This, of course, does not mean that banks will be successful in collecting contributions from defaulting borrowers.

How did it happen?

For a long time, India lacked an appropriate legal framework to help creditors get their money back from borrowers. According to the World Bank, the country ranks 103rd in the world in bankruptcy resolution, with the average time taken to resolve a bankruptcy case spanning more than four years. In fact, Indian banks are only able to recover an average of 25% of their money from delinquent debtors, compared to 80% in the United States. groups. Instead of classifying bad loans as distressed assets and taking steps to recover them, banks have often chosen to hide these assets using unethical accounting techniques. Since 2014, however, the Reserve Bank of India has stepped up efforts to force private and public sector banks to honestly recognize the size of bad loans on their books. This has resulted in a dramatic increase in the reported size of stressed assets in recent years.

Why is this important?

The news of the huge loan cancellation comes amid efforts by the Union government over the past few years to speed up the bankruptcy process and improve collections. The most notable of these was the Insolvency and Bankruptcy Code (IBC), which entered into force last year. Many large corporations, as well as small businesses, were allowed to be liquidated under the IBC so that the proceeds could be used to pay off banks. The bad loan collection reported by the government poorly reflects the ability of the new bankruptcy law to help banks collect their loans and increases pressure on bank balance sheets. It should be noted that the Center recently pledged to inject 2.11 lakh crore into public sector banks to protect their balance sheets from the impact of bad debts. Poor recovery may increase the size of the funds that the Center will have to allocate for this purpose.

What awaits us?

It seems unlikely that banks will be able to drastically improve their collection rates because the new bankruptcy code is far from perfect. Critics say the IBC focuses more on resolving cases over time than maximizing the amount of money banks can recover from distressed loans. In particular, given that strict deadlines are imposed on the resolution process, there is an imminent danger that it could lead to the discounting of valuable assets at low prices. This can affect the incentives for investment. But, for now, the speedy resolution of bad debts will free up the resources of struggling businesses and put them back to the more efficient.

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